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UNCLAS SECTION 01 OF 05 KABUL 001172 SIPDIS SENSITIVE SIPDIS DEPT FOR SCA/FO (Deutsch), SCA/RA, AND SCA/A CENTCOM FOR CG CFC-A DEPT PASS AID/ANE, OPIC, AND TDA PLEASE PASS USGS (MEDLIN, MIRZAID) NSC FOR AHARRIMAN TREASURY PASS TO LMCDONALD, ABAUKOL, AND JCIORCIARI OSD FOR BRZEZINSKI COMMERCE FOR DEES E.O. 12958 N/A TAGS: EMIN, ECON, ENRG, EFIN, ETRD, ELTN, PGOV, AF SUBJECT: SUBJECT: Afghanistan: Aynak Copper Deposit: A Test Case for AfghanistanThis message contains SENSITIVE BUT UNCLASSIFIED information. Please protect accordingly. SUMMARY ------- 1. (SBU) The large Aynak copper deposit has the potential to generate the first significant, long-term international investment in Afghanistan. Nine companies, including the American firm Phelps Dodge, are in the fray in a competitive bidding process. The bids are due on May 15 and will be followed by an evaluation process, selection and negotiations with the winner for a long term concession. In addition to a possible $300-400 million annual revenue stream for the GOA and significant direct and indirect employment and infrastructure and services benefits, a successful Aynak deal could boost investor confidence. It is important for Afghanistan's economic development that the GOA gets this process right. If the process stalls, there is hint of non-transparent dealings, or either side is seen to have received an unfair bargain, the experience could have a chilling impact on an already difficult investment climate. 2. (SBU) The Aynak privatization process has proceeded well to date but faces a number of potential pitfalls which we will need to watch closely. The most pressing concern is whether the Ministry of Mines can successfully manage the next steps. To structure a credible deal, MOM will need the services of a recognized international legal firm to assist in upcoming negotiations with the selected winner (see septel action request). A complicated, multi-year international project such as Aynak will inevitably generate varying expectations, differing interpretations, disagreements and disputes among the parties. Close Embassy and donor monitoring will be required to promote transparency and fairness. END SUMMARY. Aynak: Crucial Investment For Afghanistan ----------------------------------------- 3. (U) The copper deposit at Aynak, 35 kilometers south east of Kabul, has the potential to generate the first large-scale, long-term international mining investment in Afghanistan. The competitive bid process, which has been moving forward steadily, is now at a critical juncture. Success or failure of the process is likely to have a wide-ranging impact on the nascent relationship between Afghanistan and the international investment community. If the concession award process is seen to be transparent, both the GOA and the successful bidder are seen to get a fair deal, and it leads to a successful extraction venture, this project could assist in "re-branding" Afghanistan as a place where international corporations can do business. World Class Deposit ------------------- 4. (U) The Aynak deposit has been described by most experts as a "world-class" copper resource. The copper occurrence is a sedimentary hosted deposit similar to copper deposits in Zambia. Located in northern Loghar province, the deposit is estimated to contain 185 million metric tons of ore at a grade of 2.37 percent copper. At unusually high current world copper prices ($2.50 per pound), the gross value of this resource is estimated at $25 billion. Using a more realistic projection of copper prices of $1.50 per pound, the gross value would be closer to $15 billion. The initial capital expenditure required for mine development (excluding cost for a potential smelting operation) is estimated at $600-900 million. If focused exploration were to begin in 2008, the project could be expected to commence operation in 2012-2014. This 5-7 year development period would include feasibility analysis, environmental assessment, design and construction. Mining is expected to include both open-pit and underground extraction. The mine life is estimated at 30 years. Economic Impact --------------- 5. (U) In addition to a possible $300-400 million annual revenue stream for the GOA and a boost in investor confidence, a successful Aynak will generate significant direct and indirect benefits. It should create hundreds of jobs during construction as well as hundreds of permanent jobs during operations. It should also create significant indirect employment in the backward and forward services linkages and ancillary businesses that emerge to support the operation. Second, the mine should help develop local infrastructure, including both physical infrastructure (e.g. energy) and services infrastructure (e.g. transport and other related businesses). It may also help in forcing improvements in the customs and transit operations. If the winning proposal includes a smelting operation, the benefits could be much greater. Status of Bidding Process ------------------------- 6. (U) The competitive bidding for mineral rights at Aynak is currently underway. After collecting and disseminating preliminary data with help from the British Geological Survey, the Ministry of Mines (MOM) in November 2006 solicited and received 13 expressions of interest from major international mining companies. These were narrowed down to a "short list" of nine (see para 14), including U.S. firm Phelps Dodge, to which the GOA sent bid information packages. The bids are due by May 14, 2007, which allows a period for "due diligence" visits by the prospective bidders. The World Bank selected international natural resources appraisal firm Gustavson Associates to act as the transaction advisor for the tendering process. Gustavson has prepared to international standards the tender documents which include instructions for bidders, rules for negotiation, and a model contract. The Minister of Mines has been closely involved in the process, and although he has occasionally had differing views, he has generally accepted the guidance of Gustavson and MOM's international advisors. In general, the process to date has been transparent and successful. Perhaps the key factor in this success is that key decisions are made by an inter-ministerial committee of GOA officials, including the Finance Minster and the Minister of Economy and closely counseled by international advisors. Next Steps Planned in the Bidding Process ----------------------------------------- 7. (U) After receiving bids on May 14, the GOA plans to evaluate them thoroughly to select the preferred bidder about mid-June. The GOA would open negotiations with the winner on or around June 26, 2007. Upon the conclusion of negotiations (expected to take around 60 days) and signing of the contract, the chosen bidder would be required to begin work on the project. This initial work will consist of confirmation drilling and the development of an environmental impact assessment. This process is designed to bring the project to the pre-feasibility stage. Should the negotiations with the winning bidder fail, the GOA can open negotiations with the runner-up. Terms of the model contract, drafted by Gustavson Associates, conform to international best practice with regard to royalties, social and environmental impact, and other critical factors. The model contract also reflects international best practice (including the IMF "Equator Principles") in requiring that the venture generate a positive economic and social impact on the region. Two licenses will be awarded to the successful bidder: an exploitation license to develop the known copper occurrence at Aynak as well as an exploration concession for at least three other known copper occurrences nearby. Embassy has been told that these copper deposits are very promising and that the keen interest in bidding for Aynak is driven in part by the eagerness of companies to win the rights to these other deposits. Potential Pitfalls ------------------ 8. (SBU) The Aynak privatization process faces a number of potential pitfalls, which will have to be closely monitored by the Embassy and the donor community. The most pressing concern is whether MOM can successfully manage the next steps. Minister of Mines Ibrahim Adel has been inclined to micromanage the process despite limited familiarity with a commercial extraction project of this type and magnitude. Although the World Bank has provided technical assistance and has funded the American firm Gustavson to assist MOM and prepare the tender documents, we understand that the World Bank assistance does not include resources to hire the services of a recognized legal firm to assist the MOM in upcoming negotiations. The selected bidder will undoubtedly bring a team of heavy-hitting international attorneys to the negotiating table. MOM will need the services of similarly competent international legal expertise to assist in upcoming negotiations and to provide practical training to one or more Afghan attorneys. This is critical for ensuring that the GOA gets a fair bargain and is able to navigate the complex commercial, technical, and financial issues that bear on success. (Septel will provide action request for Washington on this issue.) 9. (SBU) The Minister of Mines appears to have quite firm ideas on what the deal should bring to the GOA. This may lead him to centralize decision-making authority away from the current broad committee of stakeholders. It may also lead to the MOM simply stating its preferred terms and refusing to negotiate in good faith. We will need, therefore, to work with others in the donor community and with the international advisors to manage GOA expectations. The Embassy's Afghanistan Reconstruction Group is taking the lead role in monitoring this process. 10. (SBU) There is a suspicion among MOM's international advisors that some bidders (i.e., the Russian and Chinese firms) would offer an accelerated development schedule with commencement of operation within 3-5 years instead of the more realistic 5-7 years. The GOA may find such an offer very tempting and give less weight to other elements of the bid criteria. Given the high likelihood that these firms would slip on such a tight schedule, the GOA could end up with a sub-par bid as well as a longer commencement schedule. 11. (U) Aynak's substantial energy requirements pose an onerous challenge for the bidders. While simple extraction will require 40-50 MW of power, the addition of a smelting operation would raise the requirement to 80-100 MW. Although the selected company will be responsible for putting in place its own power needs, the GOA can help support this process by integrating Aynak's power needs into its nation-wide energy sector strategy. If smelting becomes a serious part of the planning, further exploration of water resources may also be necessary. 12. (SBU) Another area that the GOA and the donor community should pay attention to is the handling and ultimate use of GOA revenues that are expected to accrue from extraction at Aynak. International experience has demonstrated that large revenues resulting from natural resource extraction, when managed poorly, can lead to a variety of economic ills, including corruption, overdependence on one resource, susceptibility to price fluctuations, and stifling of other industries. Comment ------- 13. (SBU) The size and visibility of the Aynak project raises the possibility that its success would attract increasing positive foreign investor attention to Afghanistan as well as foster improvements to the investment climate. If, on the other hand, the project reaches an impasse, there is any hint of non-transparent dealings, or either side is seen to have received an unfair bargain, the experience is likely to have a long-term chilling impact on an already difficult investment climate. In particular, if there is a perception among the Afghan people that a multinational company has swindled them out of their national asset -- stolen the crown jewels -- it will damage significantly the prospects for future foreign investment projects. The harm would be difficult to reverse. Thus, close donor monitoring will be required throughout the bidding and negotiating processes to promote transparency and fairness. The World Bank consultant's efforts to steer the GOA towards a transparent and market driven process based on international best practices are key to this effort. Identifying donor assistance to fund legal advice for the GOA in the upcoming negotiations with the winning bidder will also be critical. 14. (SBU) We should be prepared for long term engagement on Aynak. A successful concession award will be followed by a relationship between the GOA and the winning bidder which will no doubt encounter many challenges. A complicated, multi-year international project such as Aynak will inevitably generate varying expectations, differing interpretations, disagreements and disputes among the parties; the international community may be called upon at some point by one side or both to intercede. End Comment. Short-Listed Companies ---------------------- 15. (U) Short list of prospective bidders, with profiles compiled by MOM's advisors: -- Hunter Dickinson Inc. (HDI), Canada (www.hdgold.com): Based in Vancouver, HDI is a diversified mining company with interests around the globe. HDI currently manages eight companies in North America, Africa and Asia and has interests in gold, PGE and base metals. To date the company has raised over $500M to invest in its projects. -- MCC China Metallurgical Group (MCC), China www.cec-ceda.org.cn/english_version/): MCC is a state-owned conglomerate of 70 companies with a reported combined asset value of 32 billion yuan. The group has diverse interests including construction, iron and steel making as well as geotechnical surveying and scientific research, and is ranked in the top 50 companies in China. -- Tyazhpromexport, Russia (http://enc.ex.ru/cgi-bin/): Tyazhpromexport is a state-owned enterprise specializing in the export and import of complete plant and equipment for facilities producing ferrous and non-ferrous metals. It was responsible for the feasibility study of the Aynak deposit and, therefore, should have a good knowledge of the techniques used and resources. -- Zijin Mining Group Co. Ltd, China (http://english. zjky.cn/): Zijin is a leading Chinese gold and base metal producer listed on the Hong Kong Stock Exchange. The group is principally engaged in the exploration of gold, copper and other non-ferrous metals. -- Hindalco Industries Ltd, India (www.hindalco.com): Hindalco is ranked in the top ten companies in India and has core businesses in aluminium and copper. It imports copper concentrate from Indonesia and South America and operates two copper mines in Australia. Hindalco also owns the largest copper refining and smelting operation in India, and it is registered on the London Metal Exchange as a grade "A" producer. -- Kazakhmys Consortium LLC, Kazahkstan (www.kazakhmys.com): Kazakhmys is a copper mining company headquartered in Dzhezkazgan. Its principal business is the mining, processing, smelting, refining and sale of copper and copper products, including cathodes and rods. In October 2005, it listed on the London Stock Exchange with an opening market capitalization of #5 billion. -- Phelps Dodge Corporation, USA (www.phelpsdodge.com): Phelps Dodge Corp. is one of the world's leading producers of copper with operations in North and South America, Europe, Africa and China. The company is a world leader in the production of molybdenum, and the largest producer of molybdenum-based chemicals and continuous-cast copper rod. The company's two divisions, Phelps Dodge Mining Co. and Phelps Dodge Industries, employ 15,000 people worldwide. -- Bahar Consortium, Australia (www.sallymalay.co and www.intec.com.au): This is a consortium between three Australian companies, Sally Malay Mining Ltd., Intec Ltd. and Pearl Mining and Metals. Sally Malay owns and operates the Sally Malay nickel-copper mine and the Lafranchi nickel mine in Western Australia. Intec is the world's leader in chloride hydrometallurgy and is currently developing the Hellyer Metals Project in north western Tasmania. Pearl Mining is an Australian group of that arranges funding for mining projects in developing countries. -- Strikeforce Ltd, Russia (Souzmetallresourc), Russia: Souzmetallresourc (SMR) manages the mining and exploration assets of Basic Element Group, one of the largest investment groups in Russia. The core assets of the Group are in energy, machinery, resources, financial services, and construction and development. Norland