Rio Tinto (NYSE:RIO) has expressed confidence that it would reach an agreement with China over power supply to the Oyu Tolgoi project well in time so that production begins on schedule. Oyu Tolgoi is one of the world’s largest undeveloped copper and gold assets, with a resource base estimated at 41 billion pounds of copper and 21 million ounces of gold. Rio Tinto is spending close to $6.2 billion on the mine’s development in the first phase. Around 94% of the work is complete. Initial output of copper and gold concentrate is set to begin before the end of this year, and commercial production is expected to start in the first half of 2013. ((Rio ‘Confident’ Of Securing China Power Supply For Oyu Tolgoi, Bloomberg))
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The Final Hurdle
Oyu Tolgoi is located close to the Chinese border, and there is a paucity of power options near Oyu Tolgoi, which is located in the South Gobi desert. Hence, Rio needs to rely on importing power from China, at least for the initial years of its operations.
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The power transmission lines in both Mongolia and China are already in place. They have been tested with full power loads and are ready for commissioning. However, a power supply agreement with China remains mired in negotiations even though one whole year has passed since the talks began. Mongolia and China have had a tense relationship over many centuries, so striking a deal between the governments can be tricky. The Mongolian government holds a 34% stake in the Oyu Tolgoi project and hence is a party to negotiations. If negotiations aren’t successful, Rio Tinto will have to build a dedicated power plant, which would cause a delay in the production schedule. ((Rio Tinto’s Oyu Tolgoi Project 94% Complete, Fox Business))
Impact On Rio
Oyu Tolgoi arguably ranks as Rio Tinto’s most important growth project. The mine is expected to have an average annual output of 425,000 tons of copper and 460,000 ounces of gold. To put things in perspective, Rio produced 520,000 tons of copper last year. Increased copper production from Oyu Tolgoi will help Rio Tinto diversify its income stream. Iron ore contributed to 78% of Rio’s profit last year, followed by copper at 12%.
We believe that the power supply agreement with China will be finalized sooner or later, and Rio won’t have to set up a plant of its own. This is because China is going to be the primary consumer of what is produced at Oyu Tolgoi, so it is in its own interest to have the project online at the earliest. Due to geographical proximity of Mongolia to China, copper from Oyu Tolgoi will come at a much lower price to China.