Monday, April 7, 2014

Mongolia counts cost of mine delay as RioTinto deadline passes

A dispute between the Mongolian government and its biggest foreign investor over the expansion of one of the world’s largest copper mines has added to concerns over the country’s faltering economy.

A financing deadline to expand the vast Oyu Tolgoi copper project passed last week without an agreement between developer Rio Tinto and the government in Ulan Bator. The delay is the latest twist in a long-running saga that has become a test for the investment climate in the country.

The expansion is seen as crucial to Rio’s plans, but the Anglo-Australian mining company missed a deadline to secure $4.2bn in project financing from banks for the project as discussions continued with the Mongolian government over how to divide the revenues.

Mongolia needs the revenues to fund spending commitments made in the first flush of optimism of a mining-based windfall for the landlocked nation’s nearly 3m people. But expansion of the mine, which began producing copper in 2013 and which could eventually generate one-third of the country’s gross domestic product, is now not likely until 2015.

“The worry will be how this is affecting the Mongolian economy,” said Munkhdul Badral, chief executive of Cover Mongolia, a market intelligence group. “The central bank is intervening all the time to keep the currency [the tugrik] stable but that cannot go on forever.”

Few believe the mine expansion will not happen, although it could be developed on a reduced scale. Existing project financing commitments also still hold, despite the missed deadline. But the haggling comes against the backdrop of an already deteriorating economy, and further delays only add to the pressure on the Mongolian government.

Despite Bank of Mongolia’s efforts, the tugrik is trading near historic lows at about MNT1,780 to the dollar. Data show the reasons for the weakness. Foreign direct investment fell 54 per cent last year, export revenues dropped by $800m and foreign exchange reserves dropped from $4.1bn to $2.4bn.

Weak copper and coal prices, fluctuating foreign investment and a simmering commercial bank dispute have all cooled what was one of the world’s hottest frontier markets. Distressed debt buyers have begun appearing at watering holes once favoured by foreign miners, such as the Grand Khaan Irish pub in central Ulan Bator.

The revision of a damaging gold tax helped shore up gold reserves in the first two months of this year. Paradoxically, it may also have contributed to the steep slide in the tugrik, as miners selling gold to the central bank exchange the local currency for dollars.

The Asian Development Bank has cut expectations for Mongolian growth to a still healthy looking 9.5 per cent this year, from 14 per cent previously.

Other frontier market currencies, from Kazakhstan to Nigeria, have also slumped after a long period in which those countries performed better than traditionally less risky emerging markets. But the case of Mongolia, with GDP of $11bn, illustrates the vulnerability of a small economy to huge capital ebbs and flows.

The stand-off with Rio hinges in part on whether the Mongolian government – a 34 per cent equity holder in Oyu Tolgoi – can get a guaranteed return, industry figures said. Mongolia, meanwhile, wants to ensure that cost overruns do not eat into its share of the revenues.

Amid lengthy negotiations, Rio wrote down the value of the unit developing the mine by $4.7bn and warned of another $800m in writedowns if underground mining does not begin in the next 12 months.

Oyu Tolgoi is naturally seen as a big test of Mongolia by foreign investors. They are cautiously optimistic about a revised foreign investment law, which it is hoped will stabilise regulations after years of sudden and destabilising reversals. Mongolia, for its part, is worried foreign investors could turn around and sell its most valuable assets to Chinese firms, increasing the country’s dependence on its much larger neighbour.

An agreement on the mine “would be a wonderful signal, but there has got to be a lot more than that,” said Jim Dwyer, head of the Business Council of Mongolia, which promotes trade and investment in the country.

In 2013, parliament passed a law to treat foreign and domestic investors the same. But foreigners remain concerned by Mongolia’s history of sudden regulatory changes and corruption probes that have sometimes ensnared foreign projects or citizens.

Brian Gordon, a partner at international law firm Holman Fenwick Willan, said of the fresh Oyu Tolgoi delay: “This will do little to bolster foreign firms’ confidence about committing themselves to projects in the region”.

Much will depend on the spring parliamentary session, which begins on Monday, when the government’s approach to Oyu Tolgoi will be debated.

“There has been a change in attitude. They are taking clear steps to attract international capital back,” said Alex Kim, co-founder of Skypath Partners, which advises foreign investors interested in Mongolian assets.

The weak currency and drop in Mongolian stock prices has had some benefits.

Two Japanese banks have set up shop in Ulan Bator while work has begun on the first power plant in the capital to be built since the 1980s. “In 2010-2011, lots of people said values were too high,” said Howard Lambert, chief representative of ING Bank in Mongolia. “Now we are starting to see those people come back.”

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