Mongolia seeks to trade equity for royalties to boost mining

On Friday, Mongolia’s Prime Minister will propose to parliament an amendment of mining laws to decrease the state’s equity stake in strategic mines in exchange for higher royalties. The government hopes that the measure will revive stalled mining projects that have accounted for most of the country’s growth over the past few years and a large portion of its GDP.
Geologically and geographically, Mongolia is ideal for mining. It has some of the world’s largest and most valuable mineral deposits and it borders resource-hungry China, which is the destination for 90% of Mongolia’s exports. But the main obstacle for the mining industry is political, namely persistent resource nationalism. For example, on January 30, in Ulanbataar, three foreign businessmen were sentenced to over five years in jail on tax evasion charges, which has spooked the industry.
Mongolia is facing a major economic slowdown, with FDI dropping by 85% and its currency (the tugrik) falling by 30% against the dollar over the past two years. Exacerbating matters, the prices of its major exports, minerals and coal, have slumped in the past few months. Compared to its unprecedented GDP growth of 17% in 2011, its growth rate has steadily decreased to an estimated 7% in 2014 as contentious mining disputes remain unresolved.
Most prominently, Anglo-Australian miner Rio Tinto has stalled a $5.4 billion underground expansion project at Oyu Tolgoi, the gold and copper mine that is the country’s single largest investment, valued at $6.5 billion.  To explain itself, Rio Tinto cites arguments with Mongolia over cost overruns and $30 million in taxes that the government claims it owes. Mongolia is currently a 34% equity partner in the mine, and it must contribute 34% of the costs of the expansion, but this is proving to be problematic. The government is cash-strapped and the delays and overruns have significantly reduced its returns from Oyu Tolgoi compared to earlier expectations.
The government’s new proposal would solve two problems at once. By exchanging equity for royalties, Mongolia would accordingly reduce its need to finance expansions, and with additional foreign funding the projects would be able to advance more rapidly. Higher royalties would also speed up the government’s earnings from the mine compared to its equity holdings, which currently make Mongolia wait “until after investors recuperate their initial costs before receiving dividends for its shares,” according to Reuters.
Royalties are simpler and easier for governments to collect, and are preferred by the mining companies over equity stakes with unreliable bickering partners like Mongolia. If the amendment is passed, other mega-mines are more likely to go ahead, reviving Mongolia’s economic growth.
Resource nationalism is by no means dead, however, and one thing in particular looms in the background. Mongolia’s parliament passed a resolution in 2009 that the government can negotiate to increase its stake to 50% in Oyu Tolgoi once investors earn back their initial investment. Mongolia has a minimum 34% equity stake in the 16 “strategic deposits” in the country, but could ask for up to 50% if state funding was used for exploration. Following through on that once mines are profitable would be a sure way to kill off further investments.



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