The Uranium Shakedown: How Mongolia and Russia Conspired Against Western Investors (Part 3)

n the final part of our probe into the curious case of Khan Resources, and the reallocation of its uranium mine to Russian control, we review events leading to the seizure of the company’s Mongolian assets and its chairman’s unusual death in an Ulaanbaatar hotel.
In April 2015, a 59-year-old Canadian named James Doak travelled to Ulaanbaatar to negotiate with Mongolia’s government.
His company, Khan Resources, had been granted $100 million in compensation for the government’s decision to expropriate the Dornod uranium project. But Mongolia was refusing to pay.
Doak, Khan’s chairman, and Grant Edey, its CEO, met with officials on April 22. Then, during lunch at his hotel, Doak fell ill. He went to his room to rest before their flight home.
When Doak didn’t answer his phone later that day, hotel staff opened the door. He was dead.  An autopsy determined that the cause of death was complications related to the onset of late-stage Type 1 diabetes.
A mere three days later, in what could charitably be described as blithely insensitive toward the Doak tragedy, Mongolia’s Justice Minister announced that the government would rescind the payment awarded to Khan and attempt to annul the international arbitration claim.

How to Dismantle a Uranium Mine

Doak’s death has not been treated as suspicious – though whispered rumors abound in Mongolian business and government circles. But the events that stripped his company of its Mongolian assets should be.
It is clear that the government used the reactionary Nuclear Energy Law in 2009 as a construct to re-acquire the Dornod deposit licenses and sell them to Russia. The detail of the law was left opaque on the matter of how to avoid violation. Much clearer was the compulsion that all license holders must re-register, or re-apply – an essential element to coerce foreign mining companies to sign new and disadvantageous investment agreements with MonAtom Mongolia’s Nuclear Energy Agency and MRAM (Mineral Resources Authority of Mongolia).
Russia – through ARMZ, the mining unit of the state-owned nuclear energy company Rosatom – sealed the deal with a hostile bid for Khan’s equity stake, valued at 65 Canadian cents per share. The Russian government also extended some juicy offers to its southern neighbor: debt forgiveness, agricultural loans, and the promise of infrastructure financing and possible nuclear energy plant construction.
China duly provided the decoy with its offer from the China National Nuclear Corporation, or CNNC, of 96 Canadian cents per share for Khan’s stake. And Khan accepted the Chinese offer – less than two days after it had signed a new memorandum of understanding with the Mongolians which paved the way for its licenses to be reinstated.
Khan insists that it had every right to make such a decision on commercial grounds, and of course it did. However, the opaque new laws and anti-Chinese sentiment allowed the government to block the Chinese-Canadian collusion on grounds of national security.
Khan was held in technical breach of the terms of its license by proposing to accept the offer from CNNC. Rather than entering into dialogue or suspending its license, Mongolia confiscated it, revoked it and handed it to the Russians. Khan made a fatal error by misreading the Mongolian political climate in an election year when it agreed to do business with the Chinese.
We also noted a very interesting statement from CNNC, reported earlier this month. In its 2015 year-end financials, published by the Hong Kong Stock Exchange last week, the Chinese company announced:
During the Year, [CNNC] had negotiations with the representatives of the Mongolian Government in relation to the formation of a joint venture company for the operation of the uranium mine in Mongolia. The Group is still waiting for feedback from the Mongolian Government.”
While the exact nature of this ‘joint venture company’ is not yet known, it will be interesting to see whether CNNC soon announces any involvement in the formerly Khan-controlled Dornod project.

A Change of Heart?

But now, to the bigger question: has anything changed?
In these final months before the June elections, everything feels hauntingly similar to events in the run-up to 2012.
Yes, 2015 saw the restoration and re-tendering of the all-important yardstick – the licenses revoked in 2013. And, yes, the Rio Tinto debacle was finally resolved in a ‘work-out’ agreement – seven years in the making. Even Khan – after its five-year battle – has been promised a much-tapered $70 million payment.
But these events, coming in such close succession, seem to be the hallmarks of a jittery government that desperately hopes the investor confidence issue will just go away.
Its actions are being sold to the electorate as being in the public interest. The reality is that Mongolia remains captive to the same old system of tribal protectionism under the guise of national politics. Backdoor deals have done nothing to counter the country’s economic stagnation.
The economic malaise is matched by political stagnation. This election will see a greater influence from fringe parties, and therein a government with many voices. In a country where intra-party factionalism is already a significant barrier to political cohesiveness, Mongolia’s worst fate in 2016 may become a reality: an even weaker government coalition.
Fractured leadership could become Mongolia’s worst nightmare as it attempts to improve its well-deserved reputation within the global mining industry as a wholly unreliable and unpredictable investment partner, where political risk eclipses business opportunity.
To the educated observer, the Rio Tinto workout and Khan settlement look like last-minute attempts to demonstrate commitment to economic reform and improved investor relations. Yet the drumbeat from the main parties is populist. Their reforms have failed to incentivise the return of big business beyond the state sector.

What Lies Ahead?

This year marks the third election cycle in which Mongolia’s government is entering a bind of its own making. The investor confidence issue won’t just go away. Will Mongolia now begin to court international investor confidence by repealing more of the restrictive laws? Or will it choose to continue with the nationalist politics and xenophobic legislative activity that have had such a disastrous effect on its economy?
A transition to more investor-friendly policies would be a tall order for even a united and strong government. Mongolia was unable to accomplish this after the 2012 elections, and it would be little short of miraculous if Mongolia finds such a transition possible after June of this year. The proliferation of fringe parties and rhetoric from the government’s leadership has collectively bred political impotence, with an inability to dampen down resource nationalism or channel it into a more useful force.
The reality in Mongolia is that politicians, not businessmen, are in control of the private sector – and these are the same men who are responsible for re-starting the economy. Too many are fixated on protecting themselves, their personal interests, their factions, and their tribes. The country’s economic health and long-term prosperity is of secondary importance – or, more likely, not even a consideration.
The idea that Mongolia’s government might renege on its promised payment to Khan Resources almost defies logic. The country’s finances are in a dire state, and it has effectively been locked out of the global bond market for the past two years. Both Standard & Poor’s and Fitch downgraded their sovereign ratings to ‘B’ – effectively beneath where most private fund managers will consider offering support.
Earlier this month the Mongolian Finance Ministry announced that they would retain investment bank Credit Suisse to lead a $200m syndicated loan to help shore up the country’s desperate finances. This was after several failed attempts to raise capital from private investors in Hong Kong, Singapore and the USA. While final terms will not be known until April 1 of this year, it is believed that they will be far more attractive treatment than the country could expect to receive from the bond market. And it’s also safe to assume that any astute would-be investor will be watching to see whether Mongolia honors its commitment to Khan Resources.
It is worth mentioning that, after five years of legal wrangling and false horizons, the agreed bill of $70 million is a significant compromise from Khan’s original position. Still, unlike Rio Tinto, Khan has been waved an unequivocal dasvidaniya. Its commitment to Mongolia has been deemed unimportant, and unlike Rio Tinto, it is dismissed as replaceable.
The same short-sighted politicians who sealed Khan’s fate in 2009 are still at the forefront of government and party decisions now. Failure to make a final payment to Khan would certainly put Mongolia at risk of an indefinite lock-out from the global capital markets. Yet Mongolia’s politicians have shown a disturbing tendency to act against their country’s national interest during election years.
To that point, it should be noted that the final $70 million payment to Khan Resources will need to be incorporated in the national budget, which will require approval by parliamentary vote before the May deadline – and only a few short weeks before parliamentary elections in June.
In summary, May 16 will make for a very interesting Monday morning. If Khan understands now what it failed to appreciate when its troubles began, it will have little faith in the payment deadline being met.

Phill Hynes and Mark Burke are analysts at ISS Risk, a frontier and emerging markets political risk management company covering North, South and Southeast Asia from its headquarters in Hong Kong


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