Tuesday, July 15, 2014

Mongolia looks to end mining purgatory

Colossal mineral deposits have led to Mongolia recording record levels of economic growth, but the government must stop passing populist laws if the country is to realise its potential

Just two years ago, economic observers around the world were enthusiastically trumpeting one Asian economy as the next great investment opportunity. While much has been said about China and India over the last decade, it was the more sparsely populated Mongolia that had got global investors so excited.

Here was a country that had been experiencing staggering GDP growth since 2008, as high as 17 percent in 2011 – as predicted by the IMF – and during a period of global economic strife to boot (see Fig. 1). Fuelled by the discoveries of vast quantities of coal, copper, gold and other minerals, and a subsequent mining boom, Mongolia’s economy was set to take off. According to the IMF, mining accounts for a colossal 71 percent of the country’s income, emphasising just how important it is to the economy, especially for a country of just three million people.

However, by the beginning of 2013, enthusiasm had taken a serious hit. A parliamentary election that was more about short-term populism and less about long-term strategy saw a series of rules brought in that seriously hampered investment opportunities and deterred many potential overseas investors. Slight amendments subsequently have suggested an acceptance of the need to get the country back on track, but Mongolia’s government still has much to do if it is to persuade the world that it really is the great investment opportunity it had promised to be.

Untapped frontier
For many mining explorers, Mongolia represents the largest and last untapped frontier in the world. Kincora, a Canadian-listed copper exploration firm, has been developing a number of projects in the country. CEO Sam Spring told World Finance that there is clearly vast potential in the country, but turning that potential into a commercially viable proposition is challenging. “It is one of those last untapped frontiers. When you have a look at its geology, it’s extremely prospective. When you look at places like Chile or Peru, with similar geological belts as down in the south Gobi, there are probably commercial operations found every 30 or 40 kilometres. That potential is very much unknown still in Mongolia, because you haven’t had the stability or the exploration to make those discoveries in the copper space. In the coal space the potential is well known – a bit like iron ore in Western Australia, you can kick your toe on it. It doesn’t need much exploration to find it. With that underground copper there are more of those advanced techniques that need to take place.”

Largely dominated by coal and copper deposits, Mongolia has a plethora of other valuable minerals deep within the ground. The largest deposits of coal and copper can be found in the Ömnögovi Province to the south of the country, with the Tavan Tolgoi coal mine and the Oyu Tolhgi (OT) copper mine being the most important sources.

While many investors talk passionately of gold, uranium and other valuable deposits, coal and copper are in such huge quantity that they are the cornerstones of the country’s economy, according to IHS’ Asia-Pacific analyst Neil Ashdown. Speaking to World Finance he said: “When we talk about copper and coal, it’s important to stress just how much there is. There are huge deposits and they’re right on the doorstep to China. I think sometimes people forget just how important these deposits are strategically in terms of Southeast Asia. In terms of other minerals, there’s uranium in the east of Mongolia, and that was mined by the Soviets.”

The leading firms exploring these deposits include partnerships between the government and other countries, such as the Chinese-Mongolian company Mongolia Energy Corporation and the Russian-Mongolian Erdent Mining Corporation. Private firms like Rio Tinto are also active, as well as a number of smaller explorers.

Stunted potential
Mongolia’s staggering potential and need for foreign investment is recognised by the government, says Ashdown: “There’s no doubt that the opportunity is there, in terms of minerals in the ground. I think also, if you look at things very broadly, in terms of the government’s attitude [it] is very aware of the need for foreign participation, particularly in the mining sector and especially some of the more technically advanced projects that it’s thinking of working on.”

Yet, investor sentiment was badly hit by the uncertainty that resulted from the election campaigns of 2012 and 2013. According to Ashdown: “There are a couple of countervailing points. Firstly, we had the election cycle in 2012 and 2013. That really was very disruptive for Mongolia’s mining industry and… foreign investment, and the perception that it was a good place for foreign investment. The parliamentary election in 2012 was particularly bad, because… the outgoing parliament rushed through the Strategic Entity Foreign Investment Law (SEFIL), which did a lot of damage to the country’s investment environment and [the] perception [of it] as a good place to invest.”

Shortly before the 2012 parliamentary election, the outgoing government hastily passed a bill that was designed to assuage local fears over the rampant exploitation of Mongolia’s natural resources. SEFIL was rushed through before the election in May and proved deeply unpopular among foreign investors. The law made it much harder for foreign firms to obtain approval for mining, in particular the Aluminium Corporation of China’s (CHALCO) bid to seize control of a large coal deposit. As a result, analysts believe that the law culminated in a massive slump of 43 percent in overseas investment over the course of the following year.

Coupled with a halt to new exploration licences, 2012 proved to be a difficult period for the mining industry in Mongolia. “It’s been quite a difficult recent history,” says Spring. “The Chalco dispute over the south Gobi, [which] came just ahead of the 2012 election, led to a new foreign investment law that shut things down. Before that, there was a moratorium on exploration licences. If you look at the exploration sector, per se, you’ve gone from about 50 percent of Mongolia’s territory that was covered by exploration licences, to a number that I think is less than eight percent.”

In response to the negative sentiment from investors and subsequent downturn, Mongolia’s government swiftly axed SEFIL. “The 2013 presidential elections were less disruptive because people had realised what had happened and since then the Mongolian government has been working very conscientiously to portray itself as supportive of foreign investment. [It] passed in November 2013 [a] new investment law, which set out a level playing field for foreign and local investors, and addressed many of the concerns that were raised by SEFIL,” says Spring.

Despite these changes, Mongolia is still trapped in an election cycle that has done little to soothe the concerns of the mining industry, which requires around 10 years to get its projects up and running. “It’s going to come up again at the start of the next election cycle in 2016, which in terms of putting money into a major mining or infrastructure project is not very far away at all,” says Spring. “The concern is that if we see a repeat of the disruption that we saw in 2012 and 2013, then it will further exacerbate the damage that’s been done.”

Licensing disputes
Another issue that has deterred investors is the concern over the lack of new exploration licences being offered, as well as the disputes that are occurring over existing ones. Spring says that many of the existing licences are starting to get old and need to be renewed, and the uncertainty is harming investor sentiment. “Within the exploration space, despite all this huge potential, there hasn’t been a lot of work done. A lot of the licences out there are getting a bit old, and if you’re a major company and you know that it generally takes over 10 years to go from discovery to production, then you’re probably a bit hesitant coming in, as opposed to other jurisdictions.”

Disputes over licences are also causing uncertainty and concern that the government will try and renegotiate deals to assuage local anger. Ashdown says that disputes like the one involving the government and Rio Tinto over the second phase of the OT project have eroded the cautious optimism of last year. “The problem is that there have been a number of high profile issues, most notably the OT second phase expansion project, where there’s an ongoing dispute between the government and Rio Tinto,” says Spring. “The attention on that has taken the wind out of the sales [of] those positive regulatory developments.”

Kincora is currently involved in a licensing dispute, and Spring believes that such situations benefit nobody. “This licence dispute that we’re caught up with is not in anyone’s interest. It’s causing less investment and less employment. Any groups looking at Mongolia and doing their due diligence will get spooked by it, because security of tender and a transparent legal process are the cornerstones of foreign investment.”

He adds that lifting the restrictions on new licences also needs to happen if the industry is going to get investment back on track. “The exploration sector as a whole has come into somewhat of a natural death, unless they lift this moratorium. A lot of the licences are coming to the end of their term, and when that happens there is a security of tender issue. You look at all the other disputes that are taking place in Mongolia, and you can understand why people are getting a little bit nervous.”

China-Russia balancing act
Another issue that Mongolia’s government faces is its relationships with its neighbours. Previously controlled by both China and Russia, Mongolians are wary of being overly tied to either country. Its history as a Soviet satellite state is still an unwelcome memory for many Mongolians. And with China’s economic dominance, demand for natural resources and location just next to Mongolia, it is exerting increasing influence in the country.

The government is therefore engaged in a careful balancing act between the two nations. “In China, there is an appreciation that as Mongolia struggles economically then [it] will be more willing to accept the kind of Chinese investment that [it was] previously more hesitant about,” says Ashdown. “The Mongolian Government’s strategy has always been to lean towards Russia. They are very much aware that they’re engaged in a balancing act between these two countries. China is the country that perhaps has the most natural tendency to exert disproportionate influence over Mongolia, because it is the dominant trading partner by a long way, particularly in terms of exports.”

How Mongolia gets back on track will depend on what strategy the government takes in the future. It has two very enthusiastic customers right on its borders in the shape of China and Russia, but a relatively small workforce that is concerned about the impact of foreign investment and rampant resource exploration. One way to balance these demands is to use the profits from its mining industry to provide services to its people.

If it wants to provide a balanced economy in the future, the government must invest the profits from the mining industry towards building new infrastructure, while also training its workforce, says Ashdown. “The only way in which you’re going to make Mongolia’s economic growth sustainable is if you have an engine driving the economy – mining – and you funnel all that money into developing infrastructure or making a city like Ulaanbaatar a more liveable place. It’s not just about the mining industry, but you need it there if you’re going to make the economy sustainable in the long term.”

While the government obviously has a major role to play in educating the population, companies working within the mining industry are doing their bit, and education should remain the core focus for the country. “In a country like Mongolia that is a relatively young democracy, where the state took care of everything during the Soviet era, there still needs to be a very educational approach by the whole industry,” says Spring. “OT has done a great job in terms of educating and taking that lead, but it does need to come from junior firms like Kincora, all the way to bigger firms, in terms of lobbying for good policy to trying to employ local people, good training, and [having] best-in-class legislation that’s in the interest of all stakeholders.”

While the promise of 2012 has been replaced with a sense of disappointment, investors should still realise the vast potential that there is in Mongolia. Its GDP is still expected to rise at rates far greater than most other countries, and its many resources will always be in demand. “We’re talking about a country that’s had growth rates that have been world leading, and so when we talk of a downturn it’s about those figures not being quite so incredible,” says Ashdown.

What Mongolia must do is to assure foreign investors that it is a business-thinking country where their money is welcome and secure, and will be used for long-term growth, rather than short-term populism.

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