The capital City of Mongolia making its move to modernity
Mongolia is on the move. During rush hours in the capital city of Ulaanbaatar, Japanese and Korean second-hand cars jam the dusty lanes criss-crossing the city.
The 30km an hour traffic speed quickly slows to a crawl with bottlenecks at street junctions. Traffic signals are few and far in between; driving skill is what determines whether you arrive at your destination on time – and in good condition.
Mongolia is on the move. During rush hours in the capital city of Ulaanbaatar, Japanese and Korean second-hand cars jam the dusty lanes criss-crossing the city.
The 30km an hour traffic speed quickly slows to a crawl with bottlenecks at street junctions. Traffic signals are few and far in between; driving skill is what determines whether you arrive at your destination on time – and in good condition.
Until recently, it was not so, says a long-time foreign resident of the city. Government ministers, for example, used to be able to leave their offices a few minutes early and still arrive in time for an official meeting elsewhere in the city. As a matter of habit, they still do cut it close these days, only now they have to battle the traffic to arrive on time.
At an international conference on capital raising and investing in Mongolia in June 2011, several of the invited ministers were indeed noticeably late. It did not seem to matter, though. Local and foreign delegates – bankers, hedge fund managers and investors – many first-time visitors to Ulaanbaatar, patiently waited at the main lecture hall of the conference venue, the Mongolian Children’s Palace, with a sense of giddiness intent to become a player in globalization’s latest economic sandbox.
Five-hundred kilometres south of the capital, however, what’s at stake is no child’s play. The sands of the Gobi, with its extreme temperatures of -40ºC during winter to +50ºC in the summer, have attracted an ever increasing number of the world’s largest names in mining and resources: Ivanhoe Mines, Rio Tinto, Peabody Energy, BHP Billiton, Vale, China Shenhua Energy, ArcelorMittal, Xstrata, Gazprom, Mitsui, among others.
The world’s most powerful bankers, financiers and investors have become regular visitors too – J.P. Morgan, Morgan Stanley, Deutsche Bank, Goldman Sachs, CICC, BoC International, Credit Suisse, Citi, BNP Paribas; sovereign wealth funds such as China Investment Corporation (CIC), Government of Singapore Investment Corporation, Temasek Holdings; and companies controlled by Asian billionaires such as Robert Kuok Hock Nien (郭鶴年) of Malaysia and Cheng Yu-tung (鄭裕彤) of Hong Kong. And the list is growing.
On June 2 2011, MIAT, the Mongolian airline, began a regular direct Boeing 737-800 flight between Ulaanbaatar and Hong Kong cutting down the travel time by half, to four hours – a great relief for the suits who previously had to transit either in Beijing or Seoul travelling a day to get into Ulaanbaatar. One banker calls the twice-weekly service “money runs”. MIAT has placed orders for three more Boeing jets at a cost of US$245 million intent to offer additional “money runs” from Ulaanbaatar to other financial capitals, including London and New York.
Hong Kong has already become one of Mongolia’s most important funding centres. In January 2010, South Gobi Energy Resources, a Canadian company operating a coal mine in Ovoot Tolgoi, 45-kilometres north of the border with China, raised US$436 million in a secondary IPO that kickstarted Mongolian-related entities to list on Hong Kong’s bourse. South Gobi, which is listed on the Toronto Stock Exchange as well and is controlled by Robert Friedland’s Ivanhoe Mines, counts both CIC and Temasek as significant investors.
Winsway Coking Coal Holdings, a trading and logistics company sourcing coking coal, was next and it raised US$472 million in September 2010. The company is backed by Hopu Investment of former Goldman Sachs rainmaker, Fang Fenglei (方風雷), a unit of China’s Minmetal and Japan’s Itochu Corp.
In October last year, Mongolian Mining Corporation (MMC), in which Robert Kuok’s Kerry Group is a shareholder, raised US$650 million; it was the first indigenous Mongolian company to list on the main board of an international stock exchange.
If all goes as planned, the mother lode of IPOs from Mongolia will come Hong Kong’s way in the form of the offering of shares in Erdenes-Tavan Tolgoi LLC, the holding company of the Tavan Tolgoi coal field, at the end of this year or the first half of 2012. It will be the first direct offshore listing of a Mongolian state-owned company, which could raise from US$3 billion to US$5 billion.
At estimated reserves of some six billion tonnes, the mine is believed to be one of the largest high-grade untapped coal beds and is the second largest coal field in the world.
The series of Mongolia-related IPOs – together with listed Chinese coal mining companies such as China Shenhua Energy, China Coal, Yangzhou Coal, Fushan International Energy and Hidili Industry – have transformed Hong Kong’s stockmarket today into the world’s largest in terms of the daily equity trading of coal companies, surpassing even the New York Stock Exchange.
1 - A new era
Mongolia’s largely untapped but world-class mineral and energy resources reignited the interest of foreign investors only belatedly.
Most pinpoint that start to October 2009 when a landmark US$4 billion deal was signed by the government with Ivanhoe Mines and Rio Tinto to develop Oyu Tolgoi. “That’s when 803 years of Mongolia’s history came to an end and a new era began” was how one banker described it.
Delayed for at least three years partly because of the global financial crisis, the government needed also to come together and to come to terms with how to tap its natural wealth and how to spread the wealth to its people. It had a false start in 2006 when parliament passed a mineral law imposing a windfall profits tax of up to 68% on all copper, gold and iron ore exports. Investors’ interest in investing in mining dried up quickly and all activity came to an abrupt halt. Now, the October 2009 agreement has set the template for future deals, especially the legal package and removed the windfall tax, elevating the importance of the mining licence.
Oyu Tolgoi is located 550 kilometres south of the capital in the South Gobi region. Its promoters describe it as the “world’s largest undeveloped copper-gold project”. Estimates by Ivanhoe Mines indicate that Oyu Tolgoi contains about 81 billion pounds of copper and 46 million ounces of gold. At today’s price, Frontier Securities, a broker in Ulaanbaatar, estimates that the net present value of the deposits is US$15 billion. Commercial production is anticipated to commence in two years.
Until then, it is not the glitter of gold that is dazzling investors today; rather it is coal, or more specifically coking coal – the low-ash, low-sulphur variety that is prized for power generation. Mongolia may be landlocked, sandwiched between its two giant neighbours Russia and China, but it has been thrust to the limelight with the rise of China, which is now the world’s largest buyer of coking coal and other commodities such as iron ore and copper.
In 2010, China imported around 47.2 million tonnes of coking coal, an increase of 37% compared to the 33 million tonnes in 2009. Mongolia supplied 32% of the total, which was nearly a three-fold jump over the previous year. Australia, the other main supplier of coking coal saw its share decline to 37% during the same period, from about 66% in 2009. Coal exports has become the fastest growing sector and production has doubled in the last five years.
Given the rising demand and the increasing price of coal, which last year surged by 47% to US$70.8 per tonne and as of June 2011 hit a record US$90 per tonne, the race is under way in the Gobi on scooping the coal, loading them to trucks and transporting them south – in the fastest and most cost-efficient way – to supply China’s energy-hungry steel mills located in the Inner Mongolia autonomous region and in Gansu, Hebei and Shandong provinces.
2 - Trucks, trucks
There is one word now in Mongolia, says Randolf Koppa, president of Trade & Development Bank, the largest corporate lender in the country, “trucks”.
And with the trucks, comes the equipment to get the coal loaded onto them – excavators, shovels, bulldozers, scoopers, etc. There are the 240-tonne trucks that pick up the coal, go one-kilometre up the hill and transfer the coal to the transport trucks. Each excavator, some as large as 660 tonnes, is matched with four to five of the 240-tonne trucks.
To do the job, Alexander Molyneux, president and CEO of South Gobi Energy Resources, says his company buys the world’s largest hydraulic excavators. “In open-pit coal mining, the capacity of a mine is based on these excavators,” he explains. South Gobi buys its large excavators from Liebherr, a German company with its factory in Colmar, France.
These excavators are the size of a four-storey house. In each scoop, it is able to hold 80 tonnes. If you fill the scoop with water, park a car under the scoop, and release the water, Liebherr has shown in a video how the car is washed, but also crushed. The excavator bucket is 34 cubic metres, able to fit 40 people standing with enough elbow room.
Loaded with 70 tonnes and up to 120 tonnes of coal, the transport trucks begin their journey to the border with China, which is depending on the location of the mine, 50 kilometres (in the case of South Gobi) away or 250 kilometres away (MMC). In a single day, 400 trucks, and sometimes 500 trucks, repeat this journey travelling at 25 kilometres per hour, 300 metres to 500 metres apart, and running for 12 hours daily. On average, 41,141 tonnes of coal is transported each day.
Frontier Securities’ Dale Choi, chief investment strategist, calculates that Mongolian mines up to June 2011 exported US$3.84 million worth of coal each day or US$115 million a month. The total value of coal exports to date totalled US$634.64 million, 178% more than last year. Total volume year-to-date reached 6.8 million tonnes, 43% more than the 4.7 million tonnes a year ago.
South Gobi’s coal output has grown from 1.3 million tonnes in 2009 to 2.5 million tonnes last year. Molyneux reckons that the company’s total coal output should reach 4 million to 4.5 million tonnes this year. By 2014, the company will be producing 10.5 million tonnes of coal a year.
Battsengel Gotov, CEO of MMC has a similar story. The company increased coal production by 114% between 2009 and 2010 to 3.9 million tonnes. Indeed, in the last eight months of the year, it was able to step up production to 400,000 tonnes a month.
This year, it has set an ambitious target of seven million tonnes, solidifying its position as Mongolia’s largest producer and exporter of coal.
3 - Environmental challenges
As these trucks travel in a procession on the unpaved dirt road, the plume of dust cloud, which can be seen from afar, spreads several kilometres and contaminates edible herbs and surrounding vegetation
Last year, there were 23 road fatalities, attributable in part to a combination of the often poor visibility from the dust cloud and an inadequate driving skill.
On April 20 this year, Mongolia’s transport authorities had to close the 245 kilometres dirt road from Tavan Tolgoi to the Gashuun Sukhait border-crossing being used by MMC and others for three weeks due to the road degradation, which also caused 12 accidents and three fatalities since the start of the year.
MMC is rushing to complete a paved road by August this year connecting its mine in Ukhaakhudag and the Gashuun Sukhait border point, which should be able to handle 18 million tonnes a year. Last year, MMC spent about US$15.50 per tonne of coal sold for transportation either using its own fleet or contracted trucks.
The reality is that for bulk commodities such as coal and iron ore, rail is far more economical, efficient and reliable. Both MMC and South Gobi are prepared to build rail networks going south directly connecting into China. MMC estimates the total cost today of its 250-kilometre rail link to be about US$698.8 million and should take two years to complete. South Gobi, which is closer to the border with China, had earlier earmarked US$150 million for its 50-kilometre rail link to the border but has since postponed the plan.
Although the solution is apparent, how they get implemented isn’t that simple. By quirk of history and geopolitics, Mongolian rail track is 152 cm wide, following the Russian gauge. China uses a standard gauge of 143.5 cm, in use by 60% of the world’s railways.
The government is also on a different track, so to speak. Its railway development masterplan, which was approved by parliament a year ago, has placed the highest priority on first building a rail line going from west to east – in total 1,830 kilometres at a cost estimated to be in the billions of US dollars. This proposed line, which will likely be undertaken by UB Railway, the Mongolian-Russian 50/50 joint venture railway company, will connect to the existing Trans-Mongolian line and eventually link into Russia’s east coast and port facilities at Vladivostok.
The problem is financing. No one, not even the government, is clear on how it could raise the funds to undertake this ambitious project, which runs through remote, desolate parts of the country, with no commercial possibilities.
If anything, the government’s rail development approach reflects its nervousness of being overly reliant on China both as a market – even though China today buys 90% of Mongolia’s coal and copper – and as a future transit point for its exports. If implemented according to the government masterplan, Mongolia will be able to, if it so chooses, completely bypass the need for exports to be sent through Chinese territory.
4 - Competing priorities
With its considerable mineral wealth, Mongolia in theory could undertake the first phase of the rail plan and other critical infrastructure.
But today, much of that wealth is locked underground and is in the form of future revenue. At the earliest, that wall of money is coming Mongolia’s way in 2014 with the commercial start of the Oyu Tolgoi mine.
As the government unlocks the country’s considerable natural wealth and brings the economy into the 21st century, it is not just infrastructure that the government needs to redress. Competing demands and priorities mean Mongolia needs to focus too on building more power plants and to double its current capacity in five years.
It will need to deal with the looming water shortages, including in Ulaanbaatar. Although aquifers have been discovered in South Gobi recently, these are not renewable. Rainfall has not been plentiful enough and so the question is: how much is there and how long will it last?
Rapid urbanization, which saw the population in the capital increase by 30% since 2007, has led to housing shortages. In Ulaanbaatar, 65% of the 1.2 million people live in tents or so-called ger (or yurt, in Russian) within ‘ger districts’ surrounding the city with inadequate sanitation and power. For heating during the frigid cold winters, coal is used contributing to the city’s already problematic pollution.
The government wants to build 100,000 apartments to switch residents to live in two-bedroom modern apartments, at an estimated cost of over US$6 billion.
Until the recent boom in mining, agriculture and herding used to be an integral part of the Mongolia economy, exporting meat to Russia and cashmere to China, but now severe winters and the overgrazing of grasslands are posing challenges. And then there are the social issues such as education – need for a new university – health care, pension, and redressing wealth distribution, where 36% of the population is below the poverty line and 11% is out of work.
Mongolia, by one estimate, will need close to US$50 billion between 2010 and 2020. That is a lot of money for a country with 2.75 million people and 34.8 million head of livestock, consisting mostly of goats, sheep, horses, cattle, and camels. That is also more than seven times the country’s GDP of US$6.7 billion at the end of 2010. Tapping the international capital market is being considered to raise up to US$500 million, Mongolia’s début sovereign bond. Launching it today, however, could prove to be a challenge, in view of the sovereign debt crisis in Europe.
The country’s financing requirements probably could be addressed easily by reaching out to China, which has the resources and the willingness to strengthen bilateral economic ties.
Already, the government has at the end of June 2011 reached out to China for a priority shipment of 22,000 tonnes of gasoline with octane grading of 92 to address a looming fuel shortage. It has further requested to be able to import 10,000 tonnes per month in future.
But as one observer at the conference notes, “Mongolia’s economic problems are geopolitical”. While it knows it could easily seek help from China given the cordial ties with its biggest customer – and supplier, Mongolia is determined to keep an independent stance balancing China’s influence by still keeping close ties with Russia and the US.
Despite these transition issues, the potential of the country is not diminished. The International Monetary Fund predicts Mongolia’s GDP will reach US$10 billion by 2015 with the GDP growth averaging 20% per annum from 2013 to 2016. Total GDP will double again by 2020 largely driven by investments in the mining sector. Per capita GDP is predicted to increase from US$1,916 in 2010 to reach US$10,000 in ten years.
A few years ago, the kind of investor that would turn up and do anything in Mongolia was looking for 40% return on investments. Now, Mongolia is being looked at like China – like an investment-grade jurisdiction. The listed companies with operations in Mongolia have attracted the world’s most discriminating investors, the likes of Fidelity, pension funds from Germany and Canada including the Ontario Teachers Pension Plan, and so on. However, Mongolia will still likely go through more of what some describe as “clarification of policies”. “There are [still] a lot of hiccups with certain things,” says one banker.
Foreign visitors to Mongolia like to describe it as a happening place, on the cusp of one of the most amazing economic transformation in modern times; like its nomadic populace that are descended from the 12th century Chinggis Khan, one of history’s most famous nomads and the country’s founding father, Mongolia is once more on the move but ever conscious and determined to keep its national identity. Koppa at TDB describes it well: since October 2009, Mongolia was given this huge A-380 jumbo jet; it is there in the desert; they are revving the engine and they are learning how to run it. Meanwhile, they are building the runway; the plane is starting to taxi; it is building speed for take-off; will the runway be built before the lift-off or will they just crunch into the sand?
5 - Managing powerful geo-political issues
The latest investment agreement sets the stage for the entry of powerful players
When Mongolia unveiled the much awaited results of the international bidding for the production rights of the West Tsankhi block of Tavan Tolgoi in early July 2011, it illustrated the deliberate and careful balancing act that the government has learned to perform as it pursues partnerships with competing and powerful interests.
The draft Tavan Tolgoi investment agreement, which was revealed on July 4, awarded China’s Shenhua Group a 40% stake in the production rights; with Peabody Energy from the US – the world’s largest private coal miner – taking a 24% stake; and a Russian consortium taking the remaining 36% stake. Unclear as to their participation are other bidders including Brazil’s Vale, Swiss-headquatered Xstrata, London-listed ArcelorMittal, South Korea’s Korea Resources and Japanese conglomerates – Mitsui, Itochu, Sumitomo and Marubeni.
Highlights of the draft agreement also included construction of a railroad to the south and eastern border; construction of a 2 x 300 MW power plant and other facilities such as CTL (coal-to-liquids) and coking plants; and the payment of a total of US$1 billion – US$500 million non-refundable payment and a prepayment of US$500 million. In addition to the taxes and fees for the production rights, Erdenes Tavan Tolgoi (ETT) is to receive 5% from all sales minus transportation costs.
The draft agreement is to be submitted to the National Security Council and parliament in mid-July for final approval.
Even with the draft agreement, several challenges remain for the West Tsankhi block according to the World Bank. The project needs to complete a bankable feasibility study for the contractor to secure financing. Long-term availability of water remains also a concern for the washing of coal in order to be able to fetch a higher value.
The West Tsankhi block forms part of the vast Tavan Tolgoi coal deposit in the Gobi desert, which has been mooted as the world’s second largest coal field with estimated reserves of 6.5 billion tonnes. About a quarter of the deposit is coking coal while the rest is thermal coal. ETT LLC, the holding company for the reserves, was set up by Mongolia in December 2010.
ETT will have full ownership of the Eastern Tsankhi block and is in the process of hiring a mining contracting firm. Australia’s Macmahon Holdings, German mining consortium BBM and India’s Nesco are shortlisted for this project.
According to the World Bank, one of the financing options for the Eastern Tsankhi block is for ETT to float a bond of up to US$500 million. Of this total, US$250 million will be used to finance the start-up infrastructure investment and the remainder as a tax prepayment to the government.
An IPO is planned for the first half of next year for ETT; it will be the first offshore listing of any state-owned company by Mongolia. The plan is for the government to retain a 51% stake of ETT with 29% of the shares to be offered to global institutional investors. The government has set aside a further 10% for local investors at a discounted price and another 10% to be given to Mongolian citizens under the Human Development Fund as part of the government’s income distribution programme. The programme will be funded through the tax prepayment portion of the planned bond issue of ETT.
Eventually, for the coal field to achieve full potential, the World Bank says that rail transit will become critical. “Currently, the route straight south to China through Gashuun Sukhait is the most cost-effective,” the bank notes. “However, the railway strategy adopted by parliament called for Mongolia to have more than one option to export the minerals from the Talvan Tolgoi area. This would imply establishing a Talvan Tolgoi-Sainshand railway link going east.”
It adds that the rail straight south to China is not expected to be completed until the north-eastern bound railway is under way.
“Any delay in railway access to China has the potential of reducing or limiting the value and profitability of the Talvan Tolgoi developments until such market infrastructure is in place,” it concludes.
Source : The Asset - Daniel Yu
The 30km an hour traffic speed quickly slows to a crawl with bottlenecks at street junctions. Traffic signals are few and far in between; driving skill is what determines whether you arrive at your destination on time – and in good condition.
Mongolia is on the move. During rush hours in the capital city of Ulaanbaatar, Japanese and Korean second-hand cars jam the dusty lanes criss-crossing the city.
The 30km an hour traffic speed quickly slows to a crawl with bottlenecks at street junctions. Traffic signals are few and far in between; driving skill is what determines whether you arrive at your destination on time – and in good condition.
Until recently, it was not so, says a long-time foreign resident of the city. Government ministers, for example, used to be able to leave their offices a few minutes early and still arrive in time for an official meeting elsewhere in the city. As a matter of habit, they still do cut it close these days, only now they have to battle the traffic to arrive on time.
At an international conference on capital raising and investing in Mongolia in June 2011, several of the invited ministers were indeed noticeably late. It did not seem to matter, though. Local and foreign delegates – bankers, hedge fund managers and investors – many first-time visitors to Ulaanbaatar, patiently waited at the main lecture hall of the conference venue, the Mongolian Children’s Palace, with a sense of giddiness intent to become a player in globalization’s latest economic sandbox.
Five-hundred kilometres south of the capital, however, what’s at stake is no child’s play. The sands of the Gobi, with its extreme temperatures of -40ºC during winter to +50ºC in the summer, have attracted an ever increasing number of the world’s largest names in mining and resources: Ivanhoe Mines, Rio Tinto, Peabody Energy, BHP Billiton, Vale, China Shenhua Energy, ArcelorMittal, Xstrata, Gazprom, Mitsui, among others.
The world’s most powerful bankers, financiers and investors have become regular visitors too – J.P. Morgan, Morgan Stanley, Deutsche Bank, Goldman Sachs, CICC, BoC International, Credit Suisse, Citi, BNP Paribas; sovereign wealth funds such as China Investment Corporation (CIC), Government of Singapore Investment Corporation, Temasek Holdings; and companies controlled by Asian billionaires such as Robert Kuok Hock Nien (郭鶴年) of Malaysia and Cheng Yu-tung (鄭裕彤) of Hong Kong. And the list is growing.
On June 2 2011, MIAT, the Mongolian airline, began a regular direct Boeing 737-800 flight between Ulaanbaatar and Hong Kong cutting down the travel time by half, to four hours – a great relief for the suits who previously had to transit either in Beijing or Seoul travelling a day to get into Ulaanbaatar. One banker calls the twice-weekly service “money runs”. MIAT has placed orders for three more Boeing jets at a cost of US$245 million intent to offer additional “money runs” from Ulaanbaatar to other financial capitals, including London and New York.
Hong Kong has already become one of Mongolia’s most important funding centres. In January 2010, South Gobi Energy Resources, a Canadian company operating a coal mine in Ovoot Tolgoi, 45-kilometres north of the border with China, raised US$436 million in a secondary IPO that kickstarted Mongolian-related entities to list on Hong Kong’s bourse. South Gobi, which is listed on the Toronto Stock Exchange as well and is controlled by Robert Friedland’s Ivanhoe Mines, counts both CIC and Temasek as significant investors.
Winsway Coking Coal Holdings, a trading and logistics company sourcing coking coal, was next and it raised US$472 million in September 2010. The company is backed by Hopu Investment of former Goldman Sachs rainmaker, Fang Fenglei (方風雷), a unit of China’s Minmetal and Japan’s Itochu Corp.
In October last year, Mongolian Mining Corporation (MMC), in which Robert Kuok’s Kerry Group is a shareholder, raised US$650 million; it was the first indigenous Mongolian company to list on the main board of an international stock exchange.
If all goes as planned, the mother lode of IPOs from Mongolia will come Hong Kong’s way in the form of the offering of shares in Erdenes-Tavan Tolgoi LLC, the holding company of the Tavan Tolgoi coal field, at the end of this year or the first half of 2012. It will be the first direct offshore listing of a Mongolian state-owned company, which could raise from US$3 billion to US$5 billion.
At estimated reserves of some six billion tonnes, the mine is believed to be one of the largest high-grade untapped coal beds and is the second largest coal field in the world.
The series of Mongolia-related IPOs – together with listed Chinese coal mining companies such as China Shenhua Energy, China Coal, Yangzhou Coal, Fushan International Energy and Hidili Industry – have transformed Hong Kong’s stockmarket today into the world’s largest in terms of the daily equity trading of coal companies, surpassing even the New York Stock Exchange.
1 - A new era
Mongolia’s largely untapped but world-class mineral and energy resources reignited the interest of foreign investors only belatedly.
Most pinpoint that start to October 2009 when a landmark US$4 billion deal was signed by the government with Ivanhoe Mines and Rio Tinto to develop Oyu Tolgoi. “That’s when 803 years of Mongolia’s history came to an end and a new era began” was how one banker described it.
Delayed for at least three years partly because of the global financial crisis, the government needed also to come together and to come to terms with how to tap its natural wealth and how to spread the wealth to its people. It had a false start in 2006 when parliament passed a mineral law imposing a windfall profits tax of up to 68% on all copper, gold and iron ore exports. Investors’ interest in investing in mining dried up quickly and all activity came to an abrupt halt. Now, the October 2009 agreement has set the template for future deals, especially the legal package and removed the windfall tax, elevating the importance of the mining licence.
Oyu Tolgoi is located 550 kilometres south of the capital in the South Gobi region. Its promoters describe it as the “world’s largest undeveloped copper-gold project”. Estimates by Ivanhoe Mines indicate that Oyu Tolgoi contains about 81 billion pounds of copper and 46 million ounces of gold. At today’s price, Frontier Securities, a broker in Ulaanbaatar, estimates that the net present value of the deposits is US$15 billion. Commercial production is anticipated to commence in two years.
Until then, it is not the glitter of gold that is dazzling investors today; rather it is coal, or more specifically coking coal – the low-ash, low-sulphur variety that is prized for power generation. Mongolia may be landlocked, sandwiched between its two giant neighbours Russia and China, but it has been thrust to the limelight with the rise of China, which is now the world’s largest buyer of coking coal and other commodities such as iron ore and copper.
In 2010, China imported around 47.2 million tonnes of coking coal, an increase of 37% compared to the 33 million tonnes in 2009. Mongolia supplied 32% of the total, which was nearly a three-fold jump over the previous year. Australia, the other main supplier of coking coal saw its share decline to 37% during the same period, from about 66% in 2009. Coal exports has become the fastest growing sector and production has doubled in the last five years.
Given the rising demand and the increasing price of coal, which last year surged by 47% to US$70.8 per tonne and as of June 2011 hit a record US$90 per tonne, the race is under way in the Gobi on scooping the coal, loading them to trucks and transporting them south – in the fastest and most cost-efficient way – to supply China’s energy-hungry steel mills located in the Inner Mongolia autonomous region and in Gansu, Hebei and Shandong provinces.
2 - Trucks, trucks
There is one word now in Mongolia, says Randolf Koppa, president of Trade & Development Bank, the largest corporate lender in the country, “trucks”.
And with the trucks, comes the equipment to get the coal loaded onto them – excavators, shovels, bulldozers, scoopers, etc. There are the 240-tonne trucks that pick up the coal, go one-kilometre up the hill and transfer the coal to the transport trucks. Each excavator, some as large as 660 tonnes, is matched with four to five of the 240-tonne trucks.
To do the job, Alexander Molyneux, president and CEO of South Gobi Energy Resources, says his company buys the world’s largest hydraulic excavators. “In open-pit coal mining, the capacity of a mine is based on these excavators,” he explains. South Gobi buys its large excavators from Liebherr, a German company with its factory in Colmar, France.
These excavators are the size of a four-storey house. In each scoop, it is able to hold 80 tonnes. If you fill the scoop with water, park a car under the scoop, and release the water, Liebherr has shown in a video how the car is washed, but also crushed. The excavator bucket is 34 cubic metres, able to fit 40 people standing with enough elbow room.
Loaded with 70 tonnes and up to 120 tonnes of coal, the transport trucks begin their journey to the border with China, which is depending on the location of the mine, 50 kilometres (in the case of South Gobi) away or 250 kilometres away (MMC). In a single day, 400 trucks, and sometimes 500 trucks, repeat this journey travelling at 25 kilometres per hour, 300 metres to 500 metres apart, and running for 12 hours daily. On average, 41,141 tonnes of coal is transported each day.
Frontier Securities’ Dale Choi, chief investment strategist, calculates that Mongolian mines up to June 2011 exported US$3.84 million worth of coal each day or US$115 million a month. The total value of coal exports to date totalled US$634.64 million, 178% more than last year. Total volume year-to-date reached 6.8 million tonnes, 43% more than the 4.7 million tonnes a year ago.
South Gobi’s coal output has grown from 1.3 million tonnes in 2009 to 2.5 million tonnes last year. Molyneux reckons that the company’s total coal output should reach 4 million to 4.5 million tonnes this year. By 2014, the company will be producing 10.5 million tonnes of coal a year.
Battsengel Gotov, CEO of MMC has a similar story. The company increased coal production by 114% between 2009 and 2010 to 3.9 million tonnes. Indeed, in the last eight months of the year, it was able to step up production to 400,000 tonnes a month.
This year, it has set an ambitious target of seven million tonnes, solidifying its position as Mongolia’s largest producer and exporter of coal.
3 - Environmental challenges
As these trucks travel in a procession on the unpaved dirt road, the plume of dust cloud, which can be seen from afar, spreads several kilometres and contaminates edible herbs and surrounding vegetation
Last year, there were 23 road fatalities, attributable in part to a combination of the often poor visibility from the dust cloud and an inadequate driving skill.
On April 20 this year, Mongolia’s transport authorities had to close the 245 kilometres dirt road from Tavan Tolgoi to the Gashuun Sukhait border-crossing being used by MMC and others for three weeks due to the road degradation, which also caused 12 accidents and three fatalities since the start of the year.
MMC is rushing to complete a paved road by August this year connecting its mine in Ukhaakhudag and the Gashuun Sukhait border point, which should be able to handle 18 million tonnes a year. Last year, MMC spent about US$15.50 per tonne of coal sold for transportation either using its own fleet or contracted trucks.
The reality is that for bulk commodities such as coal and iron ore, rail is far more economical, efficient and reliable. Both MMC and South Gobi are prepared to build rail networks going south directly connecting into China. MMC estimates the total cost today of its 250-kilometre rail link to be about US$698.8 million and should take two years to complete. South Gobi, which is closer to the border with China, had earlier earmarked US$150 million for its 50-kilometre rail link to the border but has since postponed the plan.
Although the solution is apparent, how they get implemented isn’t that simple. By quirk of history and geopolitics, Mongolian rail track is 152 cm wide, following the Russian gauge. China uses a standard gauge of 143.5 cm, in use by 60% of the world’s railways.
The government is also on a different track, so to speak. Its railway development masterplan, which was approved by parliament a year ago, has placed the highest priority on first building a rail line going from west to east – in total 1,830 kilometres at a cost estimated to be in the billions of US dollars. This proposed line, which will likely be undertaken by UB Railway, the Mongolian-Russian 50/50 joint venture railway company, will connect to the existing Trans-Mongolian line and eventually link into Russia’s east coast and port facilities at Vladivostok.
The problem is financing. No one, not even the government, is clear on how it could raise the funds to undertake this ambitious project, which runs through remote, desolate parts of the country, with no commercial possibilities.
If anything, the government’s rail development approach reflects its nervousness of being overly reliant on China both as a market – even though China today buys 90% of Mongolia’s coal and copper – and as a future transit point for its exports. If implemented according to the government masterplan, Mongolia will be able to, if it so chooses, completely bypass the need for exports to be sent through Chinese territory.
4 - Competing priorities
With its considerable mineral wealth, Mongolia in theory could undertake the first phase of the rail plan and other critical infrastructure.
But today, much of that wealth is locked underground and is in the form of future revenue. At the earliest, that wall of money is coming Mongolia’s way in 2014 with the commercial start of the Oyu Tolgoi mine.
As the government unlocks the country’s considerable natural wealth and brings the economy into the 21st century, it is not just infrastructure that the government needs to redress. Competing demands and priorities mean Mongolia needs to focus too on building more power plants and to double its current capacity in five years.
It will need to deal with the looming water shortages, including in Ulaanbaatar. Although aquifers have been discovered in South Gobi recently, these are not renewable. Rainfall has not been plentiful enough and so the question is: how much is there and how long will it last?
Rapid urbanization, which saw the population in the capital increase by 30% since 2007, has led to housing shortages. In Ulaanbaatar, 65% of the 1.2 million people live in tents or so-called ger (or yurt, in Russian) within ‘ger districts’ surrounding the city with inadequate sanitation and power. For heating during the frigid cold winters, coal is used contributing to the city’s already problematic pollution.
The government wants to build 100,000 apartments to switch residents to live in two-bedroom modern apartments, at an estimated cost of over US$6 billion.
Until the recent boom in mining, agriculture and herding used to be an integral part of the Mongolia economy, exporting meat to Russia and cashmere to China, but now severe winters and the overgrazing of grasslands are posing challenges. And then there are the social issues such as education – need for a new university – health care, pension, and redressing wealth distribution, where 36% of the population is below the poverty line and 11% is out of work.
Mongolia, by one estimate, will need close to US$50 billion between 2010 and 2020. That is a lot of money for a country with 2.75 million people and 34.8 million head of livestock, consisting mostly of goats, sheep, horses, cattle, and camels. That is also more than seven times the country’s GDP of US$6.7 billion at the end of 2010. Tapping the international capital market is being considered to raise up to US$500 million, Mongolia’s début sovereign bond. Launching it today, however, could prove to be a challenge, in view of the sovereign debt crisis in Europe.
The country’s financing requirements probably could be addressed easily by reaching out to China, which has the resources and the willingness to strengthen bilateral economic ties.
Already, the government has at the end of June 2011 reached out to China for a priority shipment of 22,000 tonnes of gasoline with octane grading of 92 to address a looming fuel shortage. It has further requested to be able to import 10,000 tonnes per month in future.
But as one observer at the conference notes, “Mongolia’s economic problems are geopolitical”. While it knows it could easily seek help from China given the cordial ties with its biggest customer – and supplier, Mongolia is determined to keep an independent stance balancing China’s influence by still keeping close ties with Russia and the US.
Despite these transition issues, the potential of the country is not diminished. The International Monetary Fund predicts Mongolia’s GDP will reach US$10 billion by 2015 with the GDP growth averaging 20% per annum from 2013 to 2016. Total GDP will double again by 2020 largely driven by investments in the mining sector. Per capita GDP is predicted to increase from US$1,916 in 2010 to reach US$10,000 in ten years.
A few years ago, the kind of investor that would turn up and do anything in Mongolia was looking for 40% return on investments. Now, Mongolia is being looked at like China – like an investment-grade jurisdiction. The listed companies with operations in Mongolia have attracted the world’s most discriminating investors, the likes of Fidelity, pension funds from Germany and Canada including the Ontario Teachers Pension Plan, and so on. However, Mongolia will still likely go through more of what some describe as “clarification of policies”. “There are [still] a lot of hiccups with certain things,” says one banker.
Foreign visitors to Mongolia like to describe it as a happening place, on the cusp of one of the most amazing economic transformation in modern times; like its nomadic populace that are descended from the 12th century Chinggis Khan, one of history’s most famous nomads and the country’s founding father, Mongolia is once more on the move but ever conscious and determined to keep its national identity. Koppa at TDB describes it well: since October 2009, Mongolia was given this huge A-380 jumbo jet; it is there in the desert; they are revving the engine and they are learning how to run it. Meanwhile, they are building the runway; the plane is starting to taxi; it is building speed for take-off; will the runway be built before the lift-off or will they just crunch into the sand?
5 - Managing powerful geo-political issues
The latest investment agreement sets the stage for the entry of powerful players
When Mongolia unveiled the much awaited results of the international bidding for the production rights of the West Tsankhi block of Tavan Tolgoi in early July 2011, it illustrated the deliberate and careful balancing act that the government has learned to perform as it pursues partnerships with competing and powerful interests.
The draft Tavan Tolgoi investment agreement, which was revealed on July 4, awarded China’s Shenhua Group a 40% stake in the production rights; with Peabody Energy from the US – the world’s largest private coal miner – taking a 24% stake; and a Russian consortium taking the remaining 36% stake. Unclear as to their participation are other bidders including Brazil’s Vale, Swiss-headquatered Xstrata, London-listed ArcelorMittal, South Korea’s Korea Resources and Japanese conglomerates – Mitsui, Itochu, Sumitomo and Marubeni.
Highlights of the draft agreement also included construction of a railroad to the south and eastern border; construction of a 2 x 300 MW power plant and other facilities such as CTL (coal-to-liquids) and coking plants; and the payment of a total of US$1 billion – US$500 million non-refundable payment and a prepayment of US$500 million. In addition to the taxes and fees for the production rights, Erdenes Tavan Tolgoi (ETT) is to receive 5% from all sales minus transportation costs.
The draft agreement is to be submitted to the National Security Council and parliament in mid-July for final approval.
Even with the draft agreement, several challenges remain for the West Tsankhi block according to the World Bank. The project needs to complete a bankable feasibility study for the contractor to secure financing. Long-term availability of water remains also a concern for the washing of coal in order to be able to fetch a higher value.
The West Tsankhi block forms part of the vast Tavan Tolgoi coal deposit in the Gobi desert, which has been mooted as the world’s second largest coal field with estimated reserves of 6.5 billion tonnes. About a quarter of the deposit is coking coal while the rest is thermal coal. ETT LLC, the holding company for the reserves, was set up by Mongolia in December 2010.
ETT will have full ownership of the Eastern Tsankhi block and is in the process of hiring a mining contracting firm. Australia’s Macmahon Holdings, German mining consortium BBM and India’s Nesco are shortlisted for this project.
According to the World Bank, one of the financing options for the Eastern Tsankhi block is for ETT to float a bond of up to US$500 million. Of this total, US$250 million will be used to finance the start-up infrastructure investment and the remainder as a tax prepayment to the government.
An IPO is planned for the first half of next year for ETT; it will be the first offshore listing of any state-owned company by Mongolia. The plan is for the government to retain a 51% stake of ETT with 29% of the shares to be offered to global institutional investors. The government has set aside a further 10% for local investors at a discounted price and another 10% to be given to Mongolian citizens under the Human Development Fund as part of the government’s income distribution programme. The programme will be funded through the tax prepayment portion of the planned bond issue of ETT.
Eventually, for the coal field to achieve full potential, the World Bank says that rail transit will become critical. “Currently, the route straight south to China through Gashuun Sukhait is the most cost-effective,” the bank notes. “However, the railway strategy adopted by parliament called for Mongolia to have more than one option to export the minerals from the Talvan Tolgoi area. This would imply establishing a Talvan Tolgoi-Sainshand railway link going east.”
It adds that the rail straight south to China is not expected to be completed until the north-eastern bound railway is under way.
“Any delay in railway access to China has the potential of reducing or limiting the value and profitability of the Talvan Tolgoi developments until such market infrastructure is in place,” it concludes.
Source : The Asset - Daniel Yu
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