Ben Aris in Berlin -

It's not clear just how much natural wealth Russia has until you start looking at the mineral deposits that have simply been ignored. The iron miner Anglo Russian Industrial Commodities (Aricom) has stumbled over several large iron ore deposits that remained untouched in Soviet times because there was so much of the stuff in the western parts of the country.

Over the last four years, the company has set about building a business that will ship iron over the border to Chinese steel mills, which have used up all their own ore. What is so remarkable about the plan is that in a business where transport costs are the key to success, no one thought of it before.

With so many deposits of oil, gold and other minerals lying about, it has taken a decade and half for entrepreneurs to move onto something as boring as iron ore. Since Aricom floated on London's Alternative Investment Market (AIM) in 2003, its market capitalisation has more than tripled to just over $1bn and the company should be worth at least four times that if it delivers on its promise.

Aricom is a spin-off from the successful Peter Hambro Mining (PHM) that mines gold in Russia's Far East. PHM inherited the Kuranakh iron ore deposit in the Amur region just over the Chinese border. The ore field formed the basis of Aricom in 2003, which is run by Peter Hambro's son Jay Hambro, a former investment banker with HSBC who specialised in the metals markets.

Making tracks to China

Iron ore is cheap on a per tonne basis, but it is heavy. So the economics of making an iron ore mine work turn on how far away the brown ore is from the customer base, as transport costs can make or break a mine.

The fall of the Soviet Union in 1991, and more recently the rise of China as an economic powerhouse, has changed the economics of iron mining. Prickly relations between communist China and Soviet Russia meant there was little cross-border trade. But in today's capitalist climate, the iron ore deposits in Russia's Far East suddenly have an insatiable customer that is literally little more than 100 kilometres away.

All of Aricom's assets are located just across the Chinese border in the Amur region and the Jewish Autonomous Republic (EAO). It is a magnetite ore, which simply means the ore is in a magnetic form that doesn't rust, rather than the more common ferro-form, which does. The advantage of a magnetite ore is that because it is already magnetised, it is very easy to process as you simply crush the ore and run it under a magnet to which it will stick.

Despite being in the middle of nowhere, the deposits are served by excellent transport infrastructure, thanks to former dictator Joseph Stalin. The Amur deposits sit on the Baikal-Amur Mainline Railway, better known as the BAM railway line, one of Stalin's pet projects. Likewise the EAO assets lie on the BAM's more famous sister track, the Trans-Siberian railway. Aricom's proximity to China and the two railway lines means its transport costs are a 10th of its peers. The cost of transporting Brazilian or Australian iron ore to their international customers is between $50-$70 per tonne, but Aricom can get ore to its Chinese customers for as little as $4.85 per tonne.

China has turned into a massive consumer of iron ore. One tonne of iron ore out of every three produced globally is shipped to the insatiable Chinese markets, or about 360m tonnes a year (t/y). Most of this ore is shipped to the mills in the industrialised south of the country, but China has its own steel industry in the Heilongjiang region in China's north.

"The deposits that Aricom are working are the same deposits that the Chinese industry in the north was built on. Except it has this international border running through the middle of it. The Chinese built up a processing industry on the basis of these deposits but they are now running out of ore, so it makes sense to buy the ore from Russia where the deposits have barely been touched," says Jay Hambro.

Heilongjiang has a small production of about 500,000 t/y of ore, but the big mills in the region could handle as much as 2m t/y and are only 160 km from Aricom's deposits, which has already signed off-take agreements with the Chinese National Gold Group Corporation (CNGGC), the Chinese state-owned gold and non-precious metals producer and trader.

Aricom's first deposit at Kuranakh will go into production sometime this year, followed by the Kimkanskoye and Sutarskoye (K&S), Gaarinskoye and finally Bolshoi Seym deposits, each of which will be phased in until all four are fully operational in about 2012. Between them, just the Garinskoye and K+S deposits have reserves of 979m tonnes of ore, or enough to supply the Chinese mills with ore for another 50 years.

Cash rich and well connected

With a solid set of financial numbers and the added bonus of a commodity play in the Chinese market, Aricom's IPO went off very smoothly. The company's stock grew fast from its initial price of 15 pence and then soared to an all time high of 80p in April after a report by mining consultants Wardell Armstrong said the reserves at the K&S deposit were worth $1.67bn - much more than previously thought.

Since then, the company's share price has been knocked by the brouhaha on international markets cause by the US' sub-prime credit debacle and was trading at about 50p at the start of October, giving the company a market capitalisation of about $1bn.

However, by chance or by skill, Aricom had already finished its major fundraising before the instability hit. In May, Aricom tapped the stock market a second time and raised $554m - the largest ever secondary offering on AIM - leaving the company in a comfortable position.

The problem most start-up mines face is financing their operations until the cash starts to flow. While digging ore out of the ground doesn't seem hard, it is the volumes that make things complicated. When at full volume Aricom will be processing some 40m t/y of earth and ore, "which is a massive logistical exercise," says Hambro. Typically, young mines have several rounds of financing whereas Aricom already has enough cash in the bank to cover itself through all the initial stages - a rarity in this business - and no debt at all.

"We have de-risked the fund raising part of the equation," says Hambro, who adds that because of the interest it is earning on its huge cash pile, the company will show an operating profit this year despite not having put yet put a spade in the ground.

Although the company is in an enviable position and seems to have put all the pieces in place, it still has to come up with the goods if it is going to get to the $1bn of revenue by 2010 it is aiming for. Investors gave Aricom a vote of confidence by buying the secondary placement offer in May, but more recently Aricom garnered a new and even more powerful fan.

Friends in high places

Earlier this year, PHM had a run-in with Oleg Mitvol, Russia's environmental pitbull and the scourge of firms like Royal Dutch Shell, when the Federal Service for Natural Resources Oversight, or Rosprirodnadzor, threatened to review several of the company's gold mining licenses. However, the company was quickly cleared of wrongdoing (indeed, three of the five licenses in question did not even belong to PHM but to a company called Kongor-Chrome) and rather than expropriating PHM's assets, the Kremlin has turned to Aricom and the Hambro family to help them develop its own mining assets.

In September, Aricom announced it has been asked by Oboronimpex, part of the state-owned arms export agency Rosoboronexport and de facto holding company for the Siloviki, the Kremlin clique with ties to the security services, to act as an advisor on the group's mining operations. Jay Hambro says the two have not agreed to work on any specific projects yet, but that a few options were being considered and that the partnership will look at opportunities in Russia and elsewhere.

"In many ways we are the model of how foreign investment should be done in Russia," says Jay Hambro. "We are not buying state-owned assets and sweating them. Instead we come in and develop greenfield sites using Russian technology and Russian personnel to grow a Russian business that benefits the region and the country. As a model it has gone down very well with the government."

The basis of PHM's success has been to eschew expensive foreign technology and personnel, relying on Russian workers and locally produced technology - apart from the board of directors, Aricom has only one expat working on the operational side of things. The mix this produces means that the production is not the most efficient available, but the cost savings are dramatic and as time passes the Russian technology has been improving, further boosting profits.

And Rosoboronexport needs help. Almost all of Russia's non-precious metal production is done by large, vertically integrated companies. Another of Hambro's insights was to realize that the economics of just mining were more attractive than full-spectrum production and PHM has built up a reputation as being one of the best miners in the country.

Last year, Rosoboronexport took a 66% stake in VSMPO-Avisma, the world's largest producer of titanium. The arms trader also owns a 25.3% stake in RusSpetsStal, which supplies steel to the aerospace and military sectors. Rosoboronexport wants to tap Aricom's expertise in how to dig ore out of the ground efficiently and cheaply using just Russian resources.

"Rosoboronexport is very powerful in our sector. They said they wanted to benefit from our mining expertise in the future, as they don't have much mining experience. Holding Rosoboronexport's hand in this way will open a lot of doors for us," says Hambro.

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