UNDERLYING MINING DEVELOPMENT IN MONGOLIA PICKS UP DESPITE UNCERTAINTY REGARDING THE OYU TOLGOI INVESTMENT AGREEMENT
Rio Tinto and Turquoise Hills Resources last week publicly and firmly rejected a request by the Government of Mongolia to renegotiate the Oyu Tolgoi Investment Agreement (‘OT IA’), which is widely viewed as a benchmark for Mongolia’s commitment towards foreign investment and the country’s flagship mining development project. Specific details and the timing of the government's request have not been disclosed but it is believed to be related to the topic of sliding scale royalties mentioned below.
As we highlighted in our September 25th comment on the new Government’s Action Plan, overall we view the proposed policy platform as favorable to foreign investment, putting forward vigorous reform and guideline to current policy.
However, we note mixed messages and a lack of coordinated and clear public approach from the Mongolian authorities on the OT issue. Just after renegotiation pressures were diffused by not naming OT IA specifically for amendment in the Action Plan, or so we thought, a new draft budget for 2013 proposes to increase budget revenues by 445.8 billion MNT (approximately $318 million USD) by introducing sliding scale royalties as well reducing certain tax discounts and waivers to OT. This move has been publicly supported by the Prime Minister and the Democratic Party (‘DP’) Parliament Caucus Leader.
The proposed 2013 draft budget has been submitted to Parliament for approval and we believe it will be accepted since it has the backing of the DP Caucus. As a whole we view the proposed budget as progressive as the first budget in compliance with the landmark Fiscal Stability law that binds government structural deficit to 2 per cent of GDP. The composition and timing of the budget comes at a critical point for Mongolia as the headline Chinese economic growth has slowed, impacting associated equities and commodities.
National statistics show revenue from coal, the country's biggest current export, has been significantly reduced over the summer because of a drop in both price and volume. This situation has not meaningfully improved since and Foreign Direct Investment has remained subdued waiting much needed and proposed clarification or revision to the current law.
Last week the European Bank for Reconstruction and Development (‘EBRD’) announced that it would provide a direct $250 million USD loan and syndicate a further $100 million USD on the international markets to fund the ongoing development of the Tsagaan Suvarga copper mine located in the central part of the South Gobi porphyry copper belt in southeast Mongolia about 140 kilometers along trend from OT. The Tsagaan Suvarga project is privately owned by Mongolyn Alt Corporation (‘MAK’), one of Mongolia’s largest national mining companies. EBRD is owned by 63 countries, two intergovernmental organizations and has committed $846 million USD across 47 projects in various sectors in Mongolia since 2006 and mobilizing an additional $1.8 billion USD for those projects from other investors.
Origo Partners View
§ We believe that the latest news flow relating to OT IA partly relates to a lack of dominant political leadership and unity from June’s elections, resulting in a fragmented and fractured ruling Coalition of political parties and agendas. Similar to previous election cycles we expect consensus opinion on core issues to emerge with policy to support progressive economic development rather than the current situation that is being largely politically motivated. We believe that Mongolia and OT investors have substantially aligned interests for the financial success of the project, a point very much highlighted by the recent impact of coal prices/volumes, subdued Foreign Direct Investment and the uncertain global and China macro situation.
§ Alongside all the current speculation, controversy and fanfare, we emphasize this ‘noise’ illustrates that Mongolia’s democracy is indeed fully functioning. In our view, a key political issue will remain achieving this fine and acceptable balance for both parties. There is acknowledgement in Mongolia that significant foreign investment is needed but it must be in a controlled manner and on mutually beneficial terms, particularly for strategic sectors and projects.
§ As such we are not surprised to see continued controversy over OT but highlight that we don’t expect this underlying issue to ever be far from public comment. It is obvious OT will always be in the news and speculation regarding the potential revision to OT IA will not go away in a hurry! Despite considerable nervousness in the market and possible complications such as approval of the budget we reiterate our view of Mongolia primarily in the context of being vibrant and robust frontier democracy which at times will have unsettle periods of political change and economic growth.
§ Our recommendation to investors is not to overreact to the ongoing variety of posturing, gestures, and noise emphasized in most press articles but instead focus on the real core outcomes of the Mongolian policymakers and underlying transactions and business developments. We expect that further clarity regarding OT IA and Foreign Investment Law will in time be forth coming as the new Government further outlines and implements its Action Plan and agenda for its next 3.5 year term. Against this background there continues to be considerable operational progress and investment in Mongolia’s emerging South Gobi copper belt.
OT essentially complete with almost $6 billion invested in only three years
§ Rio Tinto and Turquoise Hills Resources’ first public comment regarding the OT IA comes as phase one of the Oyu Tolgoi project is essentially complete and initial production is anticipated in the near term. We believe they would not have looked to make such a publicly and firm comment unless they had confidence in the core longer term legislative environment under that the OT project will be subject to after discussions with the new government. From this point of view, we consider OT power delay is more important immediate issue for the OT project.
§ We highlight the landmark OT IA was originally signed in October 2009, and became fully effective in March 2010, and has been fundamental in the creation of thousands of jobs for Mongolians in the subsequent three year period. Under OTIA tax rates were frozen over the life of the mine, however, the proposed 2013 budget calls for a sliding royalty on revenue that would rise to 15 percent on the concentrate depending on the copper price (the 2009 OTIA set the royalty rate at 5 percent) and also increase the effective tax rate by eliminating income tax allowances. Estimates in the current draft budget are for increased tax receipts of $160 million USD from the royalty and $163 million USD from corporate income tax.
§ Rio Tinto spent $935 million USD in July to maintain its 51% stake in the project and despite nearly $6 billion USD having spent to date project financing is still required for the proposed second, $4 billion USD stage and support production increasing from 184kT Cu pa via open pit operations to 628kT Cu pa from underground – according to Oyu Tolgoi in 2020, 80% of wealth will come from underground operations. Rather than proposing the highly doubtful additional taxes on OT we believe that the Government would most benefit from resolving urgently power issue, starting phase one production as soon as possible and providing a legislative framework supportive of the significant investment still required for underground operations.
Foreign financing secured for a second large scale copper mine, South Gobi porphyry copper belt emerging
§ EBRD’s investment in the Tsagaan Suvarga copper mine is the latest sign of investors starting to come back to support Mongolia post the election. The Trade and Development Bank (‘TDB’) recently issued senior notes on the Singapore Stock Exchange worth $300 million USD and in view provides a real time precedent and positive sign for investment appetite for Mongolia in the capital markets.
§ Tsagaan Suvarga is a significant scale project investing considerable capital into the immediate region (power line, roads, water, small airstrip, rail loader at Sainshand which is 220km east) and is 140km from OT along trend. To help put its targeted 40,000t/ day operation into perspective, initial production at OT is only 20,000t/ day ramping up in stages to the 160,000t/ day target in 2018. Tsagaan Suvarga is expected to become the third largest copper mine in Mongolia with plans to employ 860 people during construction and 1,080 people on a rotational basis during operations.
§ There are now two large scale greenfield copper construction projects in the South Gobi copper belt which are expected to enter initial production within a 3 year construction period, a feat which is unlikely to be achievable in most established copper producing regions for similar scale greenfield projects. While there have been recent concerns regarding potential changes to mining and foreign investment legislation the ability of such large scale projects to be constructed in such a short time relative to other established mining regions highlights Mongolia as an attractive location for new mining and infrastructure development.
§ We would like to also highlight that these developments are extremely positive for a number of Mongolian junior mining and exploration companies along the South Gobi porphyry copper belt’s trend for the following reasons: reducing the regions infrastructure hurdles; providing a blue print for potential mine development; highlighting the prospectively of the immediate region; and, enhancing the potential for regional commercial agreements/M&A.
As we highlighted in our September 25th comment on the new Government’s Action Plan, overall we view the proposed policy platform as favorable to foreign investment, putting forward vigorous reform and guideline to current policy.
However, we note mixed messages and a lack of coordinated and clear public approach from the Mongolian authorities on the OT issue. Just after renegotiation pressures were diffused by not naming OT IA specifically for amendment in the Action Plan, or so we thought, a new draft budget for 2013 proposes to increase budget revenues by 445.8 billion MNT (approximately $318 million USD) by introducing sliding scale royalties as well reducing certain tax discounts and waivers to OT. This move has been publicly supported by the Prime Minister and the Democratic Party (‘DP’) Parliament Caucus Leader.
The proposed 2013 draft budget has been submitted to Parliament for approval and we believe it will be accepted since it has the backing of the DP Caucus. As a whole we view the proposed budget as progressive as the first budget in compliance with the landmark Fiscal Stability law that binds government structural deficit to 2 per cent of GDP. The composition and timing of the budget comes at a critical point for Mongolia as the headline Chinese economic growth has slowed, impacting associated equities and commodities.
National statistics show revenue from coal, the country's biggest current export, has been significantly reduced over the summer because of a drop in both price and volume. This situation has not meaningfully improved since and Foreign Direct Investment has remained subdued waiting much needed and proposed clarification or revision to the current law.
Last week the European Bank for Reconstruction and Development (‘EBRD’) announced that it would provide a direct $250 million USD loan and syndicate a further $100 million USD on the international markets to fund the ongoing development of the Tsagaan Suvarga copper mine located in the central part of the South Gobi porphyry copper belt in southeast Mongolia about 140 kilometers along trend from OT. The Tsagaan Suvarga project is privately owned by Mongolyn Alt Corporation (‘MAK’), one of Mongolia’s largest national mining companies. EBRD is owned by 63 countries, two intergovernmental organizations and has committed $846 million USD across 47 projects in various sectors in Mongolia since 2006 and mobilizing an additional $1.8 billion USD for those projects from other investors.
Origo Partners View
§ We believe that the latest news flow relating to OT IA partly relates to a lack of dominant political leadership and unity from June’s elections, resulting in a fragmented and fractured ruling Coalition of political parties and agendas. Similar to previous election cycles we expect consensus opinion on core issues to emerge with policy to support progressive economic development rather than the current situation that is being largely politically motivated. We believe that Mongolia and OT investors have substantially aligned interests for the financial success of the project, a point very much highlighted by the recent impact of coal prices/volumes, subdued Foreign Direct Investment and the uncertain global and China macro situation.
§ Alongside all the current speculation, controversy and fanfare, we emphasize this ‘noise’ illustrates that Mongolia’s democracy is indeed fully functioning. In our view, a key political issue will remain achieving this fine and acceptable balance for both parties. There is acknowledgement in Mongolia that significant foreign investment is needed but it must be in a controlled manner and on mutually beneficial terms, particularly for strategic sectors and projects.
§ As such we are not surprised to see continued controversy over OT but highlight that we don’t expect this underlying issue to ever be far from public comment. It is obvious OT will always be in the news and speculation regarding the potential revision to OT IA will not go away in a hurry! Despite considerable nervousness in the market and possible complications such as approval of the budget we reiterate our view of Mongolia primarily in the context of being vibrant and robust frontier democracy which at times will have unsettle periods of political change and economic growth.
§ Our recommendation to investors is not to overreact to the ongoing variety of posturing, gestures, and noise emphasized in most press articles but instead focus on the real core outcomes of the Mongolian policymakers and underlying transactions and business developments. We expect that further clarity regarding OT IA and Foreign Investment Law will in time be forth coming as the new Government further outlines and implements its Action Plan and agenda for its next 3.5 year term. Against this background there continues to be considerable operational progress and investment in Mongolia’s emerging South Gobi copper belt.
OT essentially complete with almost $6 billion invested in only three years
§ Rio Tinto and Turquoise Hills Resources’ first public comment regarding the OT IA comes as phase one of the Oyu Tolgoi project is essentially complete and initial production is anticipated in the near term. We believe they would not have looked to make such a publicly and firm comment unless they had confidence in the core longer term legislative environment under that the OT project will be subject to after discussions with the new government. From this point of view, we consider OT power delay is more important immediate issue for the OT project.
§ We highlight the landmark OT IA was originally signed in October 2009, and became fully effective in March 2010, and has been fundamental in the creation of thousands of jobs for Mongolians in the subsequent three year period. Under OTIA tax rates were frozen over the life of the mine, however, the proposed 2013 budget calls for a sliding royalty on revenue that would rise to 15 percent on the concentrate depending on the copper price (the 2009 OTIA set the royalty rate at 5 percent) and also increase the effective tax rate by eliminating income tax allowances. Estimates in the current draft budget are for increased tax receipts of $160 million USD from the royalty and $163 million USD from corporate income tax.
§ Rio Tinto spent $935 million USD in July to maintain its 51% stake in the project and despite nearly $6 billion USD having spent to date project financing is still required for the proposed second, $4 billion USD stage and support production increasing from 184kT Cu pa via open pit operations to 628kT Cu pa from underground – according to Oyu Tolgoi in 2020, 80% of wealth will come from underground operations. Rather than proposing the highly doubtful additional taxes on OT we believe that the Government would most benefit from resolving urgently power issue, starting phase one production as soon as possible and providing a legislative framework supportive of the significant investment still required for underground operations.
Foreign financing secured for a second large scale copper mine, South Gobi porphyry copper belt emerging
§ EBRD’s investment in the Tsagaan Suvarga copper mine is the latest sign of investors starting to come back to support Mongolia post the election. The Trade and Development Bank (‘TDB’) recently issued senior notes on the Singapore Stock Exchange worth $300 million USD and in view provides a real time precedent and positive sign for investment appetite for Mongolia in the capital markets.
§ Tsagaan Suvarga is a significant scale project investing considerable capital into the immediate region (power line, roads, water, small airstrip, rail loader at Sainshand which is 220km east) and is 140km from OT along trend. To help put its targeted 40,000t/ day operation into perspective, initial production at OT is only 20,000t/ day ramping up in stages to the 160,000t/ day target in 2018. Tsagaan Suvarga is expected to become the third largest copper mine in Mongolia with plans to employ 860 people during construction and 1,080 people on a rotational basis during operations.
§ There are now two large scale greenfield copper construction projects in the South Gobi copper belt which are expected to enter initial production within a 3 year construction period, a feat which is unlikely to be achievable in most established copper producing regions for similar scale greenfield projects. While there have been recent concerns regarding potential changes to mining and foreign investment legislation the ability of such large scale projects to be constructed in such a short time relative to other established mining regions highlights Mongolia as an attractive location for new mining and infrastructure development.
§ We would like to also highlight that these developments are extremely positive for a number of Mongolian junior mining and exploration companies along the South Gobi porphyry copper belt’s trend for the following reasons: reducing the regions infrastructure hurdles; providing a blue print for potential mine development; highlighting the prospectively of the immediate region; and, enhancing the potential for regional commercial agreements/M&A.
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