Chinese president Xi Jinping’s visit to Mongolia last week was a timely reminder of why foreign investors have poured money into the country over the past five years.
While the two neighbours share a difficult history, relations appear to be warming, and the geography is hard to ignore.
Resource-rich Mongolia, which is sitting on top of huge reserves of copper, gold and coal is right next door to the world’s biggest market for minerals. That combination prompted Rio Tinto to sink billions of dollars into the Oyu Tolgoi gold and copper mine and attracted dozens more resources companies, including a handful of ASX-listed explorers, to try their luck in the mining frontier.
But Mongolia has had a tough few years.
Many of the investors, who flocked to the country in the euphoria which followed the 2009 signing of Rio’s investment agreement with the government, have lost faith.
Foreign investment in Mongolia slumped 70 per cent in the first half of this year and economic growth slowed to just 5.3 per cent, from as high as 17.5 per cent for the full year in 2011.
Confusing legislation, over-the-top regulation and the scarcity of exploration licences have frustrated the ambitions of many a foreign miner who set up shop in the capital, Ulan Bator.
Mongolia-Rio Tinto ties strained
Relations between the Mongolian government and Rio have been strained, putting the $6 billion second-stage underground project at Oyu Tolgoi under a cloud.
And some companies are reluctant to base staff in the country, fearing they will become targets for regulators, which appear hostile to foreign operators.
All of this is contributing to Mongolia’s deteriorating economic outlook with investment plunging, the currency sliding and inflation running at just under 15 per cent. That has pushed up living and production costs and made it hard for businesses to operate.
“The business environment has been pretty stagnant,” says Minter Ellison partner Elisabeth Ellis, who is based in Ulan Bator.
“While we’ve actually had a busy six months, it’s been advising on redundancies, potential enforcement, insolvency and, unfortunately, helping a few companies leave the country.”
However, Ellis says there is “absolutely no doubt” about Mongolia’s potential and there has been an increase in investor enquiries over the past month. Part of that is related to the improving relationship with China.
Xi’s visit to Mongolia – the first by a Chinese president in 11 years – is significant. Mongolia, sandwiched between Russia and China, has been wary of its neighbours and in the past, adopted a foreign policy aimed at bolstering relations with third party countries. But in recent months the government has reached out to both Beijing and Moscow as it looks to boost its flagging economy.
China and Mongolia signed more than 20 infrastructure and investment deals while Xi was in town and set a target to boost annual trade between the two countries to US$10 billion by 2020 from just over US$6 billion currently. China has also agreed to give Mongolia better access to its ports and railways and upgrade diplomatic ties.
A nation well-resourced
“The country has huge reserves of resources and is improving ties with China,” Ellis says.
“Mining majors, investment funds and commodities traders still see the inevitable growth potential and want to invest in Mongolia – they’re just looking for the right time. “What’s needed is more clarity around the legislation and regulations,” Ellis says.
Some progress is already being made. The government has repealed its unpopular foreign investment law and last month, it revoked a four-year suspension on the granting of new exploration licences in a bid to boost investment. But it still needs to set the rules for how the application process will work.
Investors will be watching closely to see whether the government reaches an agreement with Rio on the Oyu Tolgoi project’s second stage before its financing deadline at the end of next month. The government owns 34 per cent of Oyu Tolgoi but can lift its stake after 30 years. The rest is owned by Rio-controlled and Canadian-listed Turquoise Hill, formerly Ivanhoe Mines. Funding commitments from a raft of global banks for the project’s second stage expire on September 30, a deadline that had already been extended by six months.
If it goes ahead, that project would create one of the biggest, deepest mining facilities anywhere in the world.While the returns from the existing open pit mine are significant, it is believed that 80 per cent of the project’s value lies underground.
In a positive sign, Rio secured an agreement with the government earlier this month for the construction of a power generation plant to feed the project. But one of the remaining sticking points is an outstanding $127 million tax bill, which the company believes it shouldn’t have to pay.
Positive stories emerging
Travis Hamilton, chairman of Khan Investment Management, is optimistic. He believes an agreement will be reached before the deadline and that, combined with the improving Beijing-Ulan Bator relationship, will serve as a “positive catalyst” for a resurgence in foreign investment.
While many of the ASX-listed exploration companies focused on Mongolia have struggled in line with the country’s deteriorating economic outlook and complex regulatory issues, there are some positive stories emerging.
Shares in Xanadu Mines, which switched its focus from coal to copper and gold, have quadrupled to 16¢ over the past two months on the back of positive drilling results at its flagship Kharmagtai project.
Chief executive George Lloyd says the company has “a high level of conviction about the value of our copper-gold projects and the development potential of the south gobi region.”
He believes some of the difficulties facing companies in Mongolia have been caused by unrealistic investment expectations three to five years ago. These days, a lot of the “hot” money has gone, and remaining companies are taking a more sustainable approach.
“The issues at Oyu Tolgoi say more about the technical and commercial challenges of building a complex $10 billion project – anywhere in the world – than they do about the business environment in Mongolia,” he says.
Lisa Murray is The Australian Financial Review’s North Asia correspondent.
The Australian Financial Review, in commercial partnership with ANZ Banking Group, is looking beyond the economic numbers to the real business opportunities in the rise of Asia. Opportunity Asia will examine some of the key challenges for business, as both partners view the changing Asian economic outlook as central to the future of Australia.