Rio Tinto (NYSE:RIO) seems to be facing fresh trouble at its $13 billion Oyu Tolgoi copper-gold project in Mongolia. An influential group of Mongolian lawmakers have urged Prime Minister Norov Altanhuyag to seek talks with Rio to trim the mining giant’s stake. In a petition to the prime minister last week, a group of 24 members of parliament called for the enforcement of a parliamentary resolution (Resolution 57) which says that the Mongolian government should own 51% of the project once foreign partners recoup their start-up investment. At present, Rio holds a 66% stake in the project through Turquoise Hill Resources (in which Rio holds a 51% stake) while the Mongolian government holds the remaining 34%. ((REFILE-Mongolia lawmakers urge talks to rework Oyu Tolgoi deal, Reuters))
The Importance Of Oyu Tolgoi
Oyu Tolgoi is expected to become one of the world’s three largest copper and gold mines when it reaches full production in 2018. The mine is expected to begin commercial production in the first half of 2013. The deposit contains an estimated 41 billion pounds of copper and 21 million ounces of gold. It is anticipated that revenue from the mine could boost Mongolia’s GDP by one third. By the end of the first quarter of 2012, total capital invested in Oyu Tolgoi stood at approximately $4.6 billion, out of the $13 billion planned. ((Mongolia mines minister seeks bigger Oyu Tolgoi stake – report, MineWeb))
The original investment agreement signed in 2009 gave 66% stake in the project to Canada’s Ivanhoe Mines, now known as Turquoise Hill Resources and 51% owned by Rio Tinto. The terms of this deal allow Mongolia to increase its stake in the project to 50%, but only 30 years after it has gone into operation. These terms have been unacceptable to some nationalist lawmakers who have lobbied to reduce foreign ownership of the country’s mines.
In October 2011, nationalist lawmakers made their first attempt to change the Oyu Tolgoi agreement, but Ivanhoe Mines rejected the government’s request to reopen negotiations. Elections in June 2012 brought to power a coalition government whose composition has increased the risk for mining firms that Mongolia will seek greater control of its resources. More than 25% of Mongolia’s 76 seats in Parliament are now held by politicians who made foreign mine ownership a major election campaign issue. It doesn’t help that the coalition government has named a resource nationalist, Davaajav Gankhuyag, as Mongolia’s new minister for mining. He has been known to previously demand that the state have a larger ownership stake in Mongolia’s largest mining operations. ((Mongolia’s new mining minister is long-time resource nationalism advocate, MineWeb))
In response to the growing clamor to reduce foreign ownership of the country’s natural resources, the Mongolian government in May adopted a new investment law that limits foreign companies from owning more than a 49% stake in companies involved in mining, finance, media and telecommunications. So essentially, applying the law to Oyu Tolgoi would be tantamount to enforcing it with retrospective effect.
What Happens Now
Mining companies are not new to the rhetoric that accompanies resource nationalism, but there is precious little they can do beyond hoping that governments stick to their commitments. Attempts to leverage the possibility that they could withdraw from the project, leading to loss of jobs and revenues for the host country, don’t always work. This is because projects with immense potential attract attention from competitors and no company would want to gift its precious resource base to rivals on a platter. The biggest mining giants don’t enjoy political backing from their home countries for various reasons, and in any case such influence wouldn’t cut ice in every region of the world they operate in. In this case, we believe that Rio Tinto is entirely on its own and at the mercy and whims of the Mongolian government. In fact, despite 94% of the project having been completed, it is yet to reach an agreement with the Chinese government to source power for Oyu Tolgoi.
Meanwhile, another mining-related issue facing the new Mongolian government is fears of camel and goat herders that the mega-mines are gobbling up water, particularly in the South Gobi Province, where drought can wipe out herds. Herders have also claimed that mining trucks kill their animals and kick up dust that ruins pastureland. Oyu Tolgoi has offered compensation to the herders, which includes helping a family put a child through college. To summarize, the project isn’t exactly popular among people in the local community.
The situation at Oyu Tolgoi is still evolving. The Prime Minister of Mongolia, Norov Altanhuyag, is yet to spell out his stand. The lawmakers behind the petition would need to garner more support from coalition partners to make their position stronger. On the other hand, any attempt to renegotiate will only delay the project, leading to huge opportunity costs in terms of lost revenues. Rio,on its part, can ill-afford to give concessions because that would have repercussions on similar agreements it has with other countries. At the same time, Oyu Tolgoi is perhaps the most important project in Rio’s pipeline right now so we believe that it would like to tread with caution. 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%. ((Rio Tinto Is Confident About China Power Supply Agreement For Mega Mine, Trefis))
We believe that if the Mongolian government does adopt a nationalist stance, Rio would be forced to the negotiating table. It is, however, not expected to give up its majority stake holder status in the project because that would be tantamount to ceding operational control. This is turn would enable the government to dictate terms on production and pricing which would upset Rio’s plans. Since Mongolia enjoys a love-hate relationship with China, which is expected to be the largest customer for Oyu Tolgoi’s output, it might seek to use resource supplies as a measure of leverage in any future conflict or disagreement. Rio would want to avoid becoming a casualty in such a scenario, which can be best ensured by retaining operational control of the project. In the worst case, if things get really unpleasant, we believe that Rio might settle for a 51% stake after being duly compensated for the loss.
We will keep an eye on how the situation evolves further and factor it into our estimates going forward.
We recently revised the Trefis price estimate for Rio to $45 which is nearly 5% below its market price.