Mongolia have two English weekly newspapers, UB Post and Mongol Messenger. On July 24, 2009, UB Post published an article written by Mr.Jargalsaikhan, former chairman of Mongolian Foreign Investment Agency and board member of Anod Bank and one of the founders of Civic Coalition, a civic group. The story is about Oyu Tolgoi Investment Agreement. Jargalsaikhan is one of progressive minded civic leaders of Mongolia.
Will Sharing be to Mongolia’s Benefit?
The Mongolian Parliament agreed to approve the Oyu Tolgoi agreement after the Naadam festival, two weekends ago.
If that deadline wasn’t met, a different partner would replace Ivanhoe, as the minister responsible for those negotiations warned. It looks like Rio Tinto – Ivanhoe’s partner that owns a 10 percent equity stake – may back out from the option of buying 30 percent shares of Ivanhoe Mines, which was agreed a few years ago. In any case a “dog barking is getting close” as we Mongolians say. The nation is coming to a crossroads after a long ride with irresponsible mining in the past, and it’s a time to choose how much the government should share with the company that found and estimated the huge reserve of gold and copper in the southern mine of Oyu Tolgoi.
The question is, is it worth sharing? It is the duty of society to contribute their opinion when choices are being made in a democratic country, but the final decision is in the government’s hands.
Profit sharing
The Oyu Tolgoi agreement has been focusing mainly on profit sharing for the last few years. Our political leaders have been dividing the “skin of a bear, which is not yet dead”. Meanwhile, the general public has been confused on whether the government will own shares of the company, or own shares of the reserve.
Under the constitution, Mongolia owns 100 percent of the undersurface minerals in Mongolia, which includes the Oyu Tolgoi deposits. Foreign and domestic companies are given rights to explore, and if they find anything, they are given the rights of developing and producing the minerals on behalf of the government. A portion of the proceeds from the sale of the minerals or products will be granted to that company for taking the risk, making the discovery, and developing the mine. The remaining profit is taken by the owner – the state. This is the common business practice all over the world.
The more the estimated amount of gold and copper in the Oyu Tolgoi deposit increased, the hungrier Mongolians were to own a larger share of the mine. There has been an attempt at majority share, and now it has been settled to be a large chunk of the total profits. If the government didn’t receive this larger share, political powers threatened not to give permission for further operations of the mine. Furthermore, they made a law saying not only Oyu Tolgoi’s, but also all ‘strategic deposits” must be owned at a minimum 34 percent by Mongolia.
The reply from the investor was simple: The government has to buy shares of the company and take responsibility as equity owner. The government’s share of the investment will be about US$1.7 billion. If the government can’t invest now, they are given the option to borrow from Ivanhoe and pay later, with an interest rate of 10 percent per year.
This means that if the government does not pay anything in 10 years time (which is likely since it’s running a deficit), the country will be subject to interest payment equal to the principle sum, which in 20 years is two times the amount – in 30 years, three times. In such case, the total required investment for the project (US$5.1 billion) will be paid in time and in total by the Mongolian side. If this is the case, it would be a domestic investment, rather than the expected foreign investment. Even after the money is invested by the country, Mongolians still only receive 34 percent of the profit.
There is also a technical problem of owning 34 percent of Ivanhoe Mines because it is part of a bigger picture. Ivanhoe is listed on the New York Stock Exchange and the Toronto Stock Exchange, and owns a number of mineral mines and deposits in several countries. It has a coal mine in Australia, a coal deposit in South Mongolia (South Gobi Energy resources) and a gold mine in Kazakhstan (Bakhychkir), along with the Oyu Tolgoi project Mongolia. It is technically hard to separate one already listed company.
The only responsible solution to financing the project is a fund, which should be raised at the capital market by Ivanhoe Mines, with the company’s Mongolian shares being owned by another entity like the Government of Mongolia. This would convert the investment into debt, which can be paid back to a mother company.
Production sharing
The first country to use a production sharing agreement as payment for extracting mineral wealth was Bolivia in the early fifties. Since then, this type of agreement has proven to be the best way of meeting the interests of a foreign investor, as well as a host country.
Mongolia used the same production sharing concept in petroleum law and regulations that were adopted in the early nineties. The contributor of this article had first-hand experience working with a team from Mongolian Petroleum Company, which had translated and studied some 60 countries’ petroleum laws and regulations in order to draft the law.
A mineral production sharing agreement is used successfully in a number of countries nowadays, including the Congo, Ghana, Kenya and Libya. The best example is in the Philippines, which uses the agreement as model form with foreign and domestic investors.
The concept of production sharing is first to stabilize the terms and conditions of the agreement and the taxation environment. Secondly the investor is to take full risk of exploration under the laws and regulations of the host country. Third, if they find a substantial reserve of minerals, the investor will have the first right to develop and produce. Upon production, the company will deduct its costs and expenses, and the balance is shared with the host country.
Both sides would agree to whether the whole production goes to full recovery, or a part thereof. In the case of Mongolian petroleum production law, they proceed to 40 percent of total production of a site. The balance is shared by a ratio that is agreed on between the company and the government. The government may receive its share in the form of product, or in internationally convertible currency from the sale proceeds of that mineral. From the day that cost recovery is attained, the sharing ratio is reversed in the favour of the government. In general the sharing percentage is in favor of investors up to the recovery, and reversed thereafter.
The sharing ratio is also dependent on whether royalty payments are made to the host country before or after cost recovery. According to Mongolian mining laws, that royalty payment is five percent from the first day of production.
The government could start with that five percent, then switch to 40 percent when the OT mine achieves cost recovery, with the balance shared 40:60. After recovery, the ratio could be changed to 70:30 in favor of the government. In any case, the important factor is to run the daily journal of total production very accurately in the manner mutually agreed, as well as to hold periodical, independent audits.
The sharing ratio can be changed in the process of negotiations, which is a principle of the typical production sharing contract. Another important term that should be agreed is how many times the agreement can be extended, and for which period in each extension. In this way, both parties would concretely know the exit strategies beforehand.
What is next?
We must complete the agreement as soon as possible. The coming two weeks will be a good time for taking the initiative in the final negotiations. The preferred choice should be production sharing, not profit sharing, as it suits our current conditions. The Mongolian negotiation team is running simulation models with the all terms on the table at the moment, much of which is unknown to the public. This team needs to act fast. The current delay is not because of Mongolian side. Our name on the international capital market shall not be hurt once again.
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