Mongolia’s Mining Squabbles Squander Sovereignty And Gift China Power
Since August 2011, a swathe of Mongolia’s politicians have committed themselves to a series of public squabbles with international mining companies operating in Mongolia. These politically staged disputes are ultimately diminishing a century of work by Mongolia’s politicians to be independent of China. The politicians behind these schemes seem unable to comprehend the knock-on effects of their grandstanding that renders their country more beholden to China with each passing month of their maneuvers.
While many mining companies have been impacted with 106 mining licenses at one point suspended, this article will focus on a particular circle of companies. This group of companies matters because of their importance to Mongolia’s international image and the tangle of relationships between them that leads to knock-on effects to all companies in the circle when one is impacted. Those in Mongolia’s politics that have undermined these companies have failed to understand that their undermining of these companies has in turn made them susceptible to takeover by progressively larger international companies with whom the Mongolian government has exponentially less negotiating leverage. The companies are:
SouthGobi Resources, a coal mining company.
The Oyu Tolgoi copper-gold mine that according to a deal signed in 2009 that came into effect in 2010 is 34% owned by the government of Mongolia and 66% privately owned.
Turquoise Hill Resources which was formerly known as Ivanhoe Mines until 2012, the owner of the 66% share of Oyu Tolgoi.
Ivanhoe/Turquoise Hill importantly also owned a 58% majority stake in SouthGobi in 2012.
Rio Tinto, an international mining conglomerate that accumulated a majority ownership of Ivanhoe Mines in 2012, pushed out the former CEO and changed the company name to Turquoise Hill to denote new management.
Glencore, another international mining conglomerate that has been viewed as prospectively buying Rio Tinto.
Robert Friedland, the former CEO of Ivanhoe Mines/Turquoise Hill literally put Mongolia on the investment map by discovering the Oyu Tolgoi copper-gold deposit in 2001. The legendary Mr. Friedland who is widely acknowledged as one of the best marketers in the mining industry developed a corporate presentation that showed this mine would ultimately be one of the top five producing copper mines in the world. The classic slide in the presentation showed the size of the mine as overlayed over a map of Manhattan and showed its depth by comparing its depth to the Eiffel Tower.
In 2001 when the mine was discovered, Mongolia’s GDP was U.S. $1.268 billion. Many exponents of that number in investment would be required just to develop the early phases of the Oyu Tolgoi mining project. After years of negotiations, Mr. Friedland and the government of Mongolia signed the Oyu Tolgoi agreement in 2009 that came into effect in 2010 which created the partnership of a 34% government 66% Ivanhoe/Turquoise Hill owned mining interest.
Phase 2 of developing Oyu Tolgoi requires block caving. This phase, which should already be well underway, is currently on hold due to some government officials desire to renegotiate the 2009 agreement and Rio Tinto’s steadfast belief that the agreement is fair and will hold up under legal action in international arbitration. A senior stock brokerage executive notes that once Phase 2 is back underway, it will generate approximately U.S. $150 million of foreign investment spending per month by itself. For Mongolia’s economy, that had a GDP of roughly U.S. $12 billion last year, that $150 million per month is about 15% of last year’s GDP. That doesn’t include additional mining capacity that will generate additional tax revenue; nor does it include the fact that once problems with Oyu Tolgoi and other mining company issues clear, other mining executives will be more comfortable putting money to work in Mongolia.
For the sake of this article, let us assume all government disputes are legitimate. Be that as it may, the two problems with the government disputes with the Oyu Tolgoi agreement are (1) their own actions have created an increasingly unwinnable situation and (2) there is a fundamental misunderstanding of how much negotiating leverage the government has that exhibits either foolishness, blind arrogance or a combination of the two without an iota of sensible realpolitik.
When a December 11, 2011, arbitration hearing ruled against a poison pill policy Ivanhoe Mines had to avoid a hostile takeover, it cleared the way for Rio Tinto to complete accumulating a majority stake in the company. Local and foreign analysts, pundits and politicians in Mongolia broadly cheered the decision. One exemplary stock brokerage analyst enthusiastically noted:
Rio’s latest win against Ivanhoe marks an important step in consolidating Oyu Tolgoi’s ownership. As Rio gains the upper hand, the international giant looks to be edging in on Ivanhoe to eventually take control of Mongolia’s prize asset. For Mongolia, this may mean the opportunity to deal with one of the most experienced miners in the world – one that has trodden the political/social line well in the past and knows how to placate all parties involved. As [summer 2012] elections loom, resource nationalism bubbles in the local psyche, and mining becomes the main topic of political discourse, we believe a stronger international partner will help to smooth any further hitches in the plan such as the one we saw earlier this year. The aggressive young Ivanhoe may well give way to a more diplomatic Rio and for the better, in our opinion.
What analysts missed then and Mongolia’s politicians seem to still not understand now is that this analysis was completely upside down. When Mongolia’s relationship was solely with Ivanhoe Mines as a stand-alone company, the Oyu Tolgoi project was the one and only prized asset of the company. For such a company, the project was the 1st, 2nd and 3rd priority to develop. For a worldwide mining company such as Rio Tinto, there are broader considerations of their total minerals mined worldwide and managing production versus fluctuations in natural resource prices (i.e. such companies work with global supply and demand and seek to reduce production when prices are down).
While a stand-alone company like Ivanhoe could perhaps be pressured to renegotiate because it needed to develop Oyu Tolgoi to survive, a larger company like Rio Tinto has other assets it can focus on. Rio Tinto can wait and use its legal team to enforce the 2009 agreement in international courts while Mongolia suffers the consequences of not developing Oyu Tolgoi in a timely manner. If Glencore and Rio Tinto do come together, this will mean Mongolia is negotiating at an even greater disadvantage to an even bigger company.
The thing government officials did well that questioned the Oyu Tolgoi agreement as early as August 2011 in the run up to 2012 elections was undermine Ivanhoe Mines share price. This made it cheaper and easier for Rio Tinto to accumulate shares and gain a majority stake. In the process, they lost the best international marketer of Mongolia and lost a corporate relationship in which they still had some leverage.
As a country only bordered by two powerful neighbors, China and Russia, Mongolia’s exports by and large must travel through one country or the other. In excess of 80% of exports go to China most years. Although the people of Mongolia have an historical enmity with the Chinese for about the past millennium, they need resource hungry China’s desire to purchase Mongolia’s natural resources to keep their economy afloat.
Following the path of consequence antithetical to desired results, Mongolia’s 2012 election year Strategic Entities Foreign Investment Law (SEFIL) designed to block the purchase of SouthGobi by the Aluminum Company of China has ultimately given China a position of greater strength over Mongolia. The poorly conceived SEFIL not only blocked the sale of SouthGobi to a Chinese company but was also seen as negative by foreign investors that led a decline in Foreign Direct Investment from 2012’s U.S. $4.45 billion to 2014’s U.S. $664 million.
2014’s Foreign Direct Investment being about 15% of what it was in 2012 has several reasons. The decline was also caused by the government’s ongoing dispute with Rio Tinto – acting as parent of Turquoise Hill – over the structure of a $4.2 billion financing agreement so that Oyu Tolgoi’s phase 2 can proceed. At the same time, Mongolia’s government has continued to spend as if things were as planned, as if Oyu Tolgoi was on schedule, as if Foreign Direct Investment was still trending upward, as if the prices of the natural resources coming out of its mines had not peaked and gone into decline around the same time Mongolia chose to pick fights with Rio Tinto, SouthGobi and foreigners in general.
And how does the government finance much of its battles with foreigners? With money lent to it by China.
As the Bank of Mongolia acknowledged in its own 2014 press release regarding expanding agreements in place with China:
Bank of Mongolia and People’s Bank of China relations have witnessed remarkable growth since 2011 when the first agreement was signed. With efforts from both sides, the new currency swap agreement and the expansion of its size marked a new step in development of bilateral relationship between two central banks.
The expansion of the currency swap agreement between the Bank of Mongolia and the People’s Bank of China are crucial in helping to provide liquidity, when necessary, to maintain the stability of the financial market. The new agreement will facilitate the further development of trade and investment between two countries.
China is Mongolia’s largest trading partner and investor for the past 10 years, with the bilateral trade volume reaching 5.4 billion U.S. dollars in 2013 and the renminbi is the second most used currency for cross border payments with China and Mongolia.
While there are other financiers backing Mongolia’s debt from Japan to the U.S., debt arrangements with China have now topped U.S. $2.5 billion (i.e. nearly one quarter of annual GDP). As Mongolia’s rule of law is in question internationally after sending three former SouthGobi employees to prison for more than 5 years each; and while Mongolia continues to try to finance extending negotiations with Rio Tinto; Mongolia will likely seek further financing from China. At the very same time, problems with SouthGobi and Rio Tinto drive the market prices of mines in Mongolia down across the board making them progressively cheaper for any remaining interested buyers. Buyers most likely to be interested in Mongolia’s natural resources, more than 80% of which export to China, are thus Chinese.
The heritage of Mongolia’s battles with companies once part of Robert Friedland’s Ivanhoe Mines group of companies is littered with unintended consequences that:
make Mongolia’s economy weaker;
make its government’s negotiating position in mining negotiations weaker;
make it beholden to progressively larger corporate interests with which it increasingly lacks leverage;
and have made the country progressively more indebted to and influenced by China.
At some point, Mongolia’s leadership must acknowledge its tactical failures. Policy notions going back to populist political campaigning for 2012’s elections that began in August 2011 need to be set aside. As it stands, there are significant groups of politicians who seek to double down on policies that have backfired. If the government is unable to acknowledge mistakes in judgment, it is doomed to stubbornly repeat them. This is not a question of whether foreigners are right or Mongolia is right. This is a question of determining the best action for the country after acknowledging the reality of Mongolia’s negotiating power, economic and geopolitical circumstances.