Mongolia’s cold deserts hide enough treasure in metals and minerals to make the world’s biggest players want in. Michael Turner reports on the newest frontier.
Landlocked Mongolia and Australia have a lot in common. Both consist mainly of desert, the populace of both countries live in outcrops around the greener edges and, most importantly, both are capable of exporting game changing amounts of metals and minerals.
Analysts estimate that around 70% of elements from the periodic table are economically minable in Mongolia. The most important and abundant of these are coking coal and copper.
In coking coal alone, Mongolia will be rivalling Australia and Canada once all facilities reach full production. The six coal fields of Mongolia’s Tavan Tolgoi in the South Gobi desert are tipped to produce around 15 million tonnes of coking coal a year for the next 60 years. Tests are currently underway to gauge the possibility to double output.
According to the Tavan Tolgoi Incorporate Company that is running the mines, there are 6.5 billion tonnes of coal in the mines and 66.9% of it is coking coal.
“In other words, it is more qualified coking coal than Canada and Australia,” the company says. It’s not only coking coal that is set to thrust Mongolia onto the world centre stage.
In a Q3 2011 Mongolia mining report by analysts at Research and Markets, copper production is forecast to grow by 46.2% a year until 2015. This means that the country will be producing 720 thousand tonnes a year of the orange metal. Alongside this comes gold, which is regularly found as a by-product of mining copper, and the research report puts the annual average growth rate of gold at 31.4% to reach 791 thousand ounces a year.
The bulk of the country’s copper and gold production will come from the Oyu Tolgoi mine, a joint venture between Rio Tinto and Ivanhoe and situated just 80kms north of the China border. If this forecast is realised, Mongolia will only be around 180 thousand tonnes a year off of Australia’s 2009 copper output, with the key difference being that Mongolia has got there with very little infrastructure and within 15 years of becoming a free market.
The lack of infrastructure in Mongolia is a sticking point in how the country will proceed to grow its economy from here with its two biggest trading partners of China and Russia.
Mongolia is currently served by a single 2,000km north south railway that runs like a jugular vein from Russia to China. The Gobi desert region, where the largest mines are including Oyu Tolgoi and Tavan Tolgoi, is not currently connected to this rail line.
“The real challenge with the rail links and connections to the border from the South Gobi coal mining belts is accommodating the geopolitical issues which Mongolia needs to constantly address due to its landlocked nature,” says Chris Bradley, a consultant to Standard Bank who has been visiting Mongolia monthly to originate business for the bank since
“I think it fair to say in respect of these rail links, financial or geographical challenges are secondary to geopolitical challenges. “Where the first tracks are required, the topography is undulating and not as daunting as rivers, ravines and Alps could be. I would say the policy banks, as well as the usual emerging market international fi nanciers, would have strong interest in this funding requirement – in a heartbeat.”
The geopolitical challenge has strong roots in the way that Mongolia has built up relationships with Russia and China. During the Soviet era, Mongolia was well behind the iron curtain and home to five Soviet military divisions through the 1980s.
After the fall of the Soviet Union, Mongolia adopted a democratic constitution but many hangovers from the Soviet era remain. The main leftover for commodity exports relates to Mongolian railway lines.
Mongolian rail runs on Russian gauge track and the rail monopoly Russian Railways has stated that it is prepared to invest up to US$1.5bn in extending Mongolia’s rail system to the Tavan Tolgoi mines.
Russian Railways is also trying to win a contract to convert Mongolian rail to the same gauge as the trans-Siberian railway. If Russia is successful in this tender then Mongolian exports will be able to reach eastern Russia and Japan without having to go through Chinese territory.
The possibility of substantial Russian investment may also go some way in explaining why a rail link has yet to be built between the Chinese border and the South Gobi mines, including Tavan Tolgoi and Oyu Tolgoi, even though the gap is less than 100km.
But while the relationship between Mongolia and its eastern neighbour is strong, there have been conflicting reports about Russia’s methods to secure what it deems to be a fair hearing when it comes to the tender for Tavan Tolgoi. Two businessmen based in Mongolia, who spoke on the condition of anonymity, told GTR that when it looked like Mongolia was looking for investors other than Russia to participate in the mine, the Federation blocked all petroleum imports into Mongolia, effectively threatening to grind the landlocked country to a halt.
The official Russian stance is that the petrol was needed for emergencies elsewhere, particularly due to the Japanese triple crisis of earthquake, tsunami and nuclear fallout, and that once this emergency was dealt with, petrol imports could (and did) resume. Regardless of the reasons behind the Russian import block, it shows how precariously Mongolia relies on its neighbours for essential trade to keep its fledgling economy growing.
“We are almost 100% dependent on Russian oil products because of the cheaper price than the Chinese oil and gas wholesale exporters,” says Ser-od Ichinkhorloo, vice-director of NGO the Business Council of Mongolia.
“I heard from the related authorities that we are taking the opportunity to find another link to import oil and gas products. We’re still under serious pressure,” he adds.
The southern frontier
Close proximity signals China as the most obvious option to diversify oil and gas providers, even if the prices are higher than Russian wholesale. Mongolia already participates in serious trade fl ows with its southern neighbour. In 2009, trade with China accounted for around US$2.4bn.
Commodity exports to China in 2009 alone were worth US$1.3bn and came to over a quarter of Mongolia’s 2009 GDP. This equalled roughly 70% of Mongolian exports at the time according to official government statistics. Trade between the two nations looks set to increase dramatically as China increases its appetite for raw materials during its industrialisation and Mongolia ramps up exploitation of its treasure trove of metals and minerals.
But trade will be hampered between the two if better links are not established – goods are currently trucked off-road across the desert. This is exacerbated by Mongolia’s policy makers, who are looking for diversification as they seem uncertain whether they want to rely on China any more than they already are.
This is particularly apparent with the tender for a contract for the Tavan Tolgoi mine in which Mongolia actively sought bids from the US, Korea and Japan as well as its Chinese and Russian neighbours.
At the time of going the press, a consortium involving Russia, China’s Shenhua and US coal company Peabody looks set to win the contract, which has been through preliminary approval and now awaits further parliamentary endorsement.
However, while a Chinese firm has a spot on the final consortium, there is growing evidence of concern among some businessmen in Mongolia that China might try and corner the Mongolian coal market, and one person with knowledge of the deal went so far as to say: “There are concerns that if the Chinese get a stranglehold on coal production and coal exports; they would seek to not pay a fair price on coal.” China has not given any indication to suggest that this would be the case.
With impoverished Mongolia’s 2009 GDP of just US$4.2bn, the country is anxious about relying too heavily on China for its sole source of export buyers. Whether this will prove to be detrimental to Mongolia’s economic development remains to be seen, particularly as China has shown itself to be willing and able toprovide fi nance to foreign mining projects as the country industrialises.
Mongolia’s drive for diversification opens opportunities for companies from other nations, particularly those willing to act in a consortium, to secure contracts in Mongolia. But in terms of finding financing, the road is still long for Mongolian projects.
“Although Mongolia certainly has the attention of the international fi nanciers, there are still years of exploration and drilling to do to truly tap the real and vast resource value of Mongolia, and concurrently, the infrastructure needs to develop in line with this vast resource,” Standard Bank consultant Bradley says.
“Notwithstanding the policy banks, Standard Bank is to date the only international bank to be able to claim a comprehensive cross-border lending book in Mongolia. When you look at the plane loads of bankers landing in Ulaanbaatar one would expect a greater international banking presence.
“The delay in obtaining project fi nance investment to date is perhaps due to the lack of projects which fit the set formula of cross-border banking. Nor is there presently a wide selection of resource projects at or close to production which is a key component for the general cross-border banking solution. A fi nancier needs to think outside the box in this country.”
The country’s projects are going to become reliant on international banks or corporate investment as Mongolia’s banking sector is not large enough to deal with the size of the investment needed. Estimates for the net worth of the local banks is between US$150mn and US$200mn and the most domestic banks can lend is around US$20mn. This is down to the country’s central bank setting a prudent maximum loan amount ratio of 10% of capital.
However, relying on international banks for their capital also allows local banks to build up their proficiency in trade finance; a knowledge that will pay dividends when local banks are ready to start leading deals in the future.
“Due to the small capital base of local banks compared with international banks, the international banks are providing financing to corporate clients,” says Nomulin Basbish, a senior officer in the correspondent banking, trade fi nance and funding management division at Mongolia’s Khan Bank.
“This is advantageous in bringing borrowing discipline and expertise into the local market. Local banks are also keen to cooperate with international banks to learn their practices and gain more expertise in the provision of banking services.”
Though the banking sector is not large in the country; it is sufficiently sophisticated that international banks should be looking to partner with local institutions. The higher pricing that Mongolian banks charge means that for now they are effectively ruled out of club deal involvement.
But having local knowledge can be a great asset when proposing a deal to credit committees and international banks that have had successes in the country have found ways of uniting their business with the local banks. Bradley at Standard Bank says: “If you go to your credit committee and you’ve got risk participation with a Mongolian bank it is a positive feature because a local player should have superior market understanding in comparison to a crossborder financier.” The size of the local banks and the tiny 2.8 million population means that in Mongolia, maybe more than anywhere else in the world, people know each other and relationships matter.
“It is very fair to say that if you don’t know what you’re doing, then you’regoing to get your fi ngers burnt. There are no questions about that,” says Jonathan Solomon, a partner at law firm SNR Denton who has been doing deals in the country for over a decade.“The thing that has impressed me with the Mongolian business people that I’ve met over the years is that, generally speaking, they want to make money but they also want all of Mongolia to benefit from the natural resources they have.
“They are naturally very wary of the possibility of people coming in and permanent investment in Mongolia and for the Mongolian people.”
Mongolia’s ‘embryonic’ law
Solomon explains to GTR the various ways in which unprepared investors standpoint. A key issue is that Mongolian law is looking to protect the country’s national security and social-economic developmental impact.
“However, there is no clear guidance as to what it means to have national security or whether there is social-economic developmental impact. What that means is that potentially, you could fi nd yourself at risk of a nationalisation or a seizure based on this premise, but have no idea whether you fall into this criteria or not.”
Furthermore, there aren’t currently any known cases of litigation over licenses held by offshore parties. There’s not a great deal of precedent or case law for legal documents to be based on and that can be a problem.
“The development of law in Mongolia is in an embryonic stage and a fundamental part of the advice we as lawyers will need to give on transactions must be to provide our clients with a proper assessment of the legal risks and to provide solutions.”
Solomon is spot on in his breakdown of Mongolian law; the country is very much in its infancy, though it has shown some positive signs of progression that will have potential investors’ feeling more comfortable. The country has signed up to the 1958 New York convention, which provides common standards for international arbitration.
The country’s civil code on security is based on the German equivalent, and Mongolia drafted in US legal experts to help create a registry for pledges on removables. There’s also a system that recognises a priority status over pledges, and this generally runs along the lines of whoever dates their pledge first gets priority.
A country apart
There is little doubt that Mongolia has the potential to stand apart from its fellow frontier markets. The country is sitting on a world-class amount of metals and minerals that are still massively underexploited.
The government has shown that it is willing to partner with foreign entities for trade so long as it can see where the benefit for the country will come from. This idealistic approach may be different from other, corruption-prone, frontier markets, though it is an approach which is, by definition, open to discussion and negotiation.
It is an approach that favours transparency and fair dealing.
The main challenges from here lie with the country’s relationships with its two big neighbours. The resistance it has shown to both Russia and China has been commendable and is indicative of how Mongolians may react if other entities, large international banks for example, were to enter the country and try to do business without paying close attention to local interests.
For now it seems that Mongolia is very aware that it is a poor country that has been presented with a silver spoon to get its tiny population out of poverty, and it is going to continue looking for the best way to use this for its people. GTR