June has been a good month for Azerbaijani gold miner Anglo Asian Mining (AAM). Thanks to a rally in gold prices in anticipation of - and following -  Brexit, the value of its shares increased by 56% on the month to 15.63 UK pence per share as of June 27, double what they were at the end of April, on a daily turnover that has more than doubled compared to previous years.

High gold prices and lower costs could mean that 2016 will be AAM's first year in the black, provided it overcomes the exploration challenges at its mines.

While its market capitalisation on London's Alternative Investment Market (AIM) remains a modest £18.7mn, making AAM a mid-tier gold miner, the company is a big deal for Azerbaijan. Not only does it represent the first and only successful gold miner in the country's post-independence history, but it is also the only Azerbaijani company listed on a major stock exchange.

It took almost two decades for well-connected Iranian businessman Reza Vaziri, whose Delaware-based company RV Investment Group received the rights to explore six mines in western Azerbaijan back in 1997, to build AAM into a publicly listed mining company. After signing the contract with Baku, AAM became RV Investment's mother company, and listed publicly on the London Stock Exchange in July 2005.

The prospects for AAM are good; gold prices are expected to rise to $1,400 per ounce by 2018, according to investment consultancy SP Angel; AAM produced a record amount of gold in 2015, confirmed by its audited  results published at the end of May; the company has made progress in reducing its high production costs by some 25% in 2015, and commissioned a new flotation plant in November that will enhance its recovery rates for gold and particularly for copper. 

But whether AAM will ever return to the levels of 2010-2011, when its stocks traded for £70, depends as much on gold prices as it does on its ability to meet production targets, which will be a feat given recent developments at its mines.

A bad deal

To date, AAM has developed two mines - the open-pit silver, gold and copper Gedabek mine, which has been in production since 2009, and, starting in 2014, the much smaller underground Gosha mine. Both are located in north-western Azerbaijan, close to the border with Armenia. A third mine is located in the autonomous exclave of Nakhchivan and it has three other sites in the territories under Armenian occupation, which AAM says it will explore when the political situation permits.

RV Investment Group' advent in the mid-1990s was oil-rich Azerbaijan's first-ever dabble with mineral exploration. Being an early bird has had its benefits, granting Vaziri unprecedented access to the ruling elites in the country. According to a document leak from Monaco-based oil company Unaoil, Vaziri is close enough to the country's ruling elites so as to be able to get Energy Minister Natiq Aliyev to "say exactly what we want".

But it has come with drawbacks as well. When RV Investment Group signed the exploration agreement with the Azerbaijani government in 1997, the only known model for such contracts at the time was the tested production sharing agreement (PSA) model used in oil and gas exploration.

Signing a PSA for mining was a bad deal, and has severely affected AAM's ability to deliver high profits. The contract allows the company to claim up to 75% of revenues as operating costs; everything on top of that, it splits with Azerbaijan's environmental and natural resource ministry on a 49%-51% basis. It also has to pay 32% profit tax on its share of profits. In contrast, mining companies in Russia pay 6% to 7% of their revenues in royalties, Sergey Raevisiy, mining analyst at SP Angel, explains to bne IntelliNews in an interview.

Its low profitability aside, the company has been grappling with problems related to high operating costs and low recovery rates that have affected its bottom line and its performance on AIM, Raevskiy explains.

For starters, it chose separation methods - agitation leaching, heap leaching, and sulphidisation, acidification, recycling and thickening (SART) - that did not render high-enough recovery rates, forcing the company to invest in a flotation plant to enhance them. Besides, its use of contractors for the actual ore mining, the need for high volumes of cyanide to separate the large amounts of copper in the ore and the fact that the gold is refined and processed in Switzerland, all increase operational costs.

"AAM is a high-cost producer", Raevskiy explains. "And high-cost producers are more susceptible to variations in the price of gold because their margins increase much more when prices go up than in the case of low-cost producers," he added. Indeed, AAM reports that it managed to reduce its average cash operating cost - that is, costs excluding taxes, head office costs, debt repayments, interest, or royalties - by 25% y/y to $724 per ounce of gold in 2015. And while that is an impressive cost cut, the company will have to continue to work at lowering costs, Raevskiy believes.

AAM's plan to reduce operating costs, according to a statement by Khosrow Zamani, AAM non-executive chairman, consists of cutting the cost of contractors and continuing to source cheaper cyanide from neighbouring Georgia, a practice that it started in 2015.

Relying on high output to cover costs has not been an option thus far, for production at the Gedabek mine, the company's largest concession, has a chequered history. The site has recoverable gold reserves of some 447,000 ounces, as well as silver (1.3mn ounces) and copper (65mn tonnes), but extracting gold has proven a challenge as complications such as rock hardness and high concentration of copper have affected gold output.

After a record year in 2015, when gold production peaked at 72,000, it declined again by 17.5% to 14,000 ounces on the year in the first quarter due to "weather conditions and [...] the harder rock that has been encountered, together with lower grade [ore]," Vaziri explained in an April production update. The company set the ambitious target of 73,000 to 77,000 ounces of gold for 2016, and is counting on the installation of a second grinding mill in the third quarter to help make up for the poor first-quarter results, Vaziri said.

Meanwhile, the newly commissioned Gosha mine has lower reserves than AAM had initially expected, the company discovered in 2014. During early production, "it became evident that the initial estimated vein thickness was not as expected. This not only affected the resource estimate, but also resulted in changes in mining method to decrease dilution during mining," AAM explains. The 44,000 ounces now believed to be in the underground mine will be extracted by end-2017, raising question marks about AAM's ability to maintain its gold production at current levels come 2018.

In the short term, however, AAM is a good investment, Raevskiy believes. "I see the benefits of investing in mining in Azerbaijan - and the wider region - at the moment because the depreciation of national currencies has given a boost to miners whose costs are in local currencies," he says.