Everywhere governments are trying to harness the wealth that their natural resources produce for the benefit of their citizens. Many countries have ventured in the iterative process that is finding the adequate combination of royalties, attractive corporate income tax rates, windfall taxes, tax credits and holidays to attract foreign direct investment while at the same time fulfilling their social commitments. Mongolia set in 2006 a windfall tax to benefit from the high prices of copper and gold to meet its development agenda. The 68% windfall tax severely deterred foreign investment to the extent that investment projects championed by foreign companies were simply abandoned.
With the price of most commodities bottoming earlier this year the country is finding itself on fiscally shaky grounds as it faces an expected deficit of US $80 million. With the mining industry accounting for 33 per cent of the country’s GDP in 2007, it is no wonder why only a few months after the presidential election the country has taken bold and swift steps to address the fiscal and legislative bottlenecks hindering investment in the mining industry. On August 25th, Mongolia officially became a hot property as the country repealed its damaging windfall tax and reviewed key legislative items.
Due to the immense untapped potential of Mongolia, analysts have been prompt to advertise the country as an imminent candidate for double-digit GDP growth and even alluded to the country taking Qatar’s position as the world’s fastest growing economy. While projects are unfolding at an incredible pace in comparison to previous years’ standstill, one wonders if mining projects have the potential to be drivers of economic development for Mongolia. Below is a review of projects currently being championed by the industry and government.
Flagship project: Oyu Tolgoi
Ivanhoe Mines LTD is probably the company that has the most to rejoice over as it has been working towards the exploitation of the Oyu Tolgoi copper and gold deposit since 2001. In the past weeks, Mongolia’s government has focused on fast-tracking this project.
Oyu Tolgoi is the world’s largest undeveloped deposit. It is estimated to contain 79 billion pounds of copper and 45 million ounces of gold. It is the new Escondida. The mining complex would support operations for 60 years however as resources keep being delineated Ivanhoe expressed confidence that the deposit would still be in operations in a hundred years (yep this came with the usual disclaimer about forward looking statements). The initial investment for this project is of US $4 billion. The mining complex is expected to be fully operational by 2013. As part of the agreement reached with between the Ivanhoe Mines LTD and the Mongolian government, the company has been granted with 30 years of stable tax rates and regulatory provisions which can be extended for a further 20 years. The government has taken a 34% interest through the state-owned company Erdenes MGL which will have three directors of the board.
Oyu Tolgoi could raise Mongolia’s GDP by more than a third. However this is unlikely to shore up the Government’s financial position in the short term and medium term. Due to the 10% investment tax credit granted by the government, the project is very likely to be a tax expenditure until the mine is fully operational in 2013. By then the company will start to have taxable income but in the meantime little revenue outside excise and sales tax will be available for social expenditures. While one can assume that economic spinoffs and spill over effect associated with this project will be considerable- work previously carried on the deposit has employed more than 4000 Mongolians and sourced goods and services from about 500 local businesses- one can also wonder if it has the potential to overheat the economy. More about the agreement can be found here.
This project is very promising. Rio Tinto who previously owned a 9.9% interest in Ivanhoe increased it stake in Ivanhoe to 19.7%. Under an established agreement between the two companies, Rio Tinto could increase its stake in Ivanhoe to up to 43.1% over the next two years. More on this here.
Second best: Tavan Tolgoi
With Oyu Tolgoi being close to a done deal the Government is reviewing the ownership agreement in relation to the development of Tavan Tolgoi, a coking coal deposit in the Gobi Desert whose development has been delayed for years. The deposit holds a coal reserve of 6.5 billion tonnes and its value is estimated at $2 billion. The Government has selected JPMorgan and Deutsche Bank to proceed to the sale of a 49 per cent stake in the mine. Mongolia is contemplating splitting Tavan Tolgoi coal deposit for to allow many companies rather a single bidder to take a stake in the mine. The need to satisfy multiple political allegiances is apparently the rationale behind this decision. This will have for effect of further complicating and slowing down the bidding process as two or three options are being studied to split the main deposit.
Potential bidders were expected to be China Shenhua Energy (a likely preferred bidder if one does not take in account Mongolia’s unease with the idea of being too dependant of China), Japan’s Itochu Corporation and Peabody. BHP Billiton, who previously held rights to the project in the 1990s, has withdrawn its offer. The successful sale of Tavan Tolgoi could hand Mongolia between $1 and $2 billion, plus ongoing revenues from its majority stake in the mine.
Dornod Uranium Project
Khan Resources, a Canadian company, has been seeking the renegotiation of its contract. Khan is in a joint venture with Russian State-owned Company JSC Priargunsky and the Mongolian government, for the exploration and development of the Dornod uranium project. With new laws taking effect, Khan is seeking to re-register mining and exploration license for the asset and also seek clarification of what level of ownership the government should have.
The Dornod project is expected to have a mine life of 15 years, and could produce an average of three-million pounds of the nuclear fuel, at $23.22/lb. The government of Mongolia could receive some $464-million in royalties and corporate income taxes, according to a feasibility study released in March.
Transformation vs Stagnation?
” Mongolia will generate the highest rate of growth of GDP of any country in the world over the next 10 years, surpassing that of Qatar, which had fulfilled that role over the past decade and a half,” said John Finigan, CEO of Mongolia’s Golomt Bank. “This is transformational.”
Will it really be transformational? All of aforementioned projects will lead to money pouring into Mongolia. To bring about change, it is estimated that several years of double digit billion USD investments will be needed. Mongolia’s potential at attracting such a heavy load of foreign investment could be impaired by the west perception of Mongolia as instable. The shadow of past and future relations with Russia and China, corruption within the country (Transparency International ranks Mongolia 102nd on its corruption perception index), the lack of funds to build the necessary infrastructure for resources to be exploited and the eviction of western investments in the recent past are all risks that need to be weighted. Last June, Centerra Gold’s licenses to the Boroo Mine have been revoked and operations halted after the government decided that it was not getting enough benefits from the development of the property. The licenses have since been reinstated.
Will the country be any better off once these projects get on stream? The general population is not likely to be feeling the benefits in the short term but could in the mid-term see some form of betterment, at least on paper. As for long term prospects it will all depend on the government playing its cards wisely to address the boom and bust commodity cycles. To that end, a budget stabilisation plan like those in place in Chile and Russia could be of use. However, with corruption widespread in Mongolia a vicious cycle of corruption, inequality and inefficiency could also be materializing. World Bank officials estimate Mongolia’s economy would grow 2-3 per cent this year, rising to 5-7 per cent or more next year.