A recent directive suspending the issue of new mining licences in Mongolia has confirmed concerns that the government is moving towards a more restrictive environment for overseas companies investing in its mining sector.
The directive also raises questions about the future of mining policy, particularly as the government also recently decided not to auction the giant Tavan Tolgoi coal mine.
The Mongolian government faces difficult challenges as it seeks to balance the need for foreign investment against domestic opposition to any perceived concessions to foreign firms when awarding licences. It will also need to attract substantial investment in related infrastructure, such as electricity generation/distribution and the rail network, at a time of global financial constraint.
President Tsakhiagiin Elbegdorj’s directive was issued just three months after the government scrapped an auction for a 49% stake in Tavan Tolgoi, one of the world’s largest undeveloped coal deposits.
The government swiftly stepped back from a ban on the transfer of existing licences between investors, but officials made it plain that new mining legislation, due for public discussion in June, would include tighter regulations and conditions. According to Mr Elbegdorj, almost 50% of licence holders failed to submit annual exploration reports, with many not actively investing in exploration.
Earlier optimism
The directive has dampened the optimism seen last October when the government reached an agree-ment with Ivanhoe Mines and Rio Tinto to develop the Oyu Tolgoi copper project. The long-awaited deal was something of a breakthrough.
Ivanhoe won the licence six years earlier, but a combination of weak governments unable to push the necessary laws through parliament, and genuine fears in the legislature that exploitation of Mongolia’s mineral wealth would benefit only local elites and foreign companies, resulted in negotiations dragging on for years.
Development of Oyu Tolgoi, one of the world’s largest copper deposits, is expected to bring substantial benefits. The US$7 billion investment in its development is more than Mongolia’s entire GDP, while the government forecasts that the mine’s construction and operation could raise employment by 10%. Although the need for imported machinery will weaken Mongolia’s current-account position in the medium term, export revenues should soar once Oyu Tolgoi comes on stream.
Yet, the agreement was not concluded without controversy, and the authorities have faced criticism for striking a deal that is viewed in some quarters as too favourable to foreign investors, besides pressure to avoid a repeat. Public protests in the capital, Ulaanbaatar, in April were driven partly by discontent at the government’s failure to live up to promises it made in 2008 to distribute the benefits of the deal.
To a certain extent, the government was pushed by external circumstances to conclude the deal when it did. With commodity prices under pressure in 2009, and access to foreign financing even more constrained than usual, the agreement was, arguably, a milestone for a country that has only just begun to exploit its substantial natural resources. It had to make some concessions, however, which included agreeing to repeal the 68% windfall tax on copper and gold from 2011 – a decision that will lead to a loss in revenue of as much as 5% of GDP.
Warning signs
Even as the Oyu Tolgoi deal was being finalised, two pieces of legislation, approved in 2009, hinted at a more intrusive mining policy.
In July, parliament approved a nuclear-energy law, giving the government the right to assume ownership without payment of a 51% stake in any uranium-mining project or joint venture with state-funded exploration, or a 34% stake in the case of privately-financed exploration. The expropriatory nature of this legislation directly contravenes the 2006 mining law, under which the government is obliged to compensate licence holders at fair market value.
A second piece of legislation, approved in July, grants local administrations extensive powers to prevent companies developing mines if they judge the deposit to be too close to a water source or forested land. The existing mining law also gives local authorities the right to prevent licence holders exercising their exploration or mining rights, even if the central government awarded the licence.
The president instructed the government to hold public discussions last month, and public opinion is likely to be firmly behind a more predatory stance.
The government has said its main priorities will be to increase revenue and facilitate the development of the sector. Yet the potential contradictions between these two goals has already become apparent in the decision to remove the exemption from 10% value-added tax (VAT) applied to goods imported to bring a mine into production (many countries zero-rate imports when a mine is in the development phase).
Furthermore, the positive decision to repeal the windfall tax (described by the IMF as distortionary) is likely to be partly offset by the imposition of a so-called ‘increased royalty’ tax on minerals, including copper, gold and molybdenum, in what appears to be an attempt by the government to make up for the loss of windfall tax revenue.
The government’s most important stipulations are likely to make unwelcome reading for many potential investors. These include the warning that when awarding contracts, preference will be given to those companies and consortiums that have the backing of their governments, and that selection will be conditional on their governments agreeing to some ‘advance payments’.
Prime Minister Sukhbaataryn Batbold noted that for Russian and Chinese companies to win new contracts, their governments would have to reduce the transit tariffs charged for Mongolian goods crossing their territories, while a US company’s bid might be conditional on the conclusion of a free-trade agreement.
The government has already shied away from giving companies equity stakes in major projects; instead proposing operating contracts. Such conditions may prove impossible for many firms to fulfil, particularly if their governments tend not to get involved in commercial contracts.
Needs must
Given Mongolia’s vast investment needs and limited access to financing, the government cannot afford to alienate potential investors. Investment is required not just in the mines themselves, but in the infrastructure serving the industry, ranging from electricity generation and distribution networks to transport links.
Failure to improve infrastructure could also carry social consequences if existing housing and other facilities prove inadequate to meet the day-to-day needs of the thousands of workers expected to migrate to the underpopulated mining areas.
The government made a start by approving the construction of more than 5,000km of railways earlier this year, which will expand the limited Soviet era (and 50% Russian-owned) network to serve the southern mining regions.
However, a US$1.2 billion sovereign eurobond scheduled for the final quarter of 2010 is a drop in the ocean, considering the World Bank’s estimate that US$5.2 billion is needed for infrastructure projects in the resource-rich South Gobi region alone.
Planned legislation on public-private partnerships should eventually open up opportunities outside the mining sector, although infrastructure development on its own is unlikely to prove commercially attractive – Mongolia is too sparsely populated for this to be a goal in itself.
Anna Walker is a senior analyst, and Corene Crossin is an associate director at Control Risks