Rio Tinto’s Mega Mine Faces Setbacks After Stirring Up Resource Nationalism In Mongolia

by Trefis Team
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Last week SouthGobi Resources Ltd., in which Rio Tinto (NYSE:RIO) is the majority stakeholder through Turquoise Hill Resources Ltd., fired its CEO Alexander Molyneux. SouthGobi, which is listed in Toronto and Hong Kong , did not give any reasons for the termination of Molyneux, who had been at the helm since October 2009.

This move came just more than a week after Aluminium Corporation of China Ltd. (Chalco) dropped a $926 million bid for the company. The company named as its new CEO Ross Tromans, who was previously working at Rio Tinto Coal Australia as General Manager of Marketing. SouthGobi Deputy Chairman Sean Hinton will lead the company until the appointment of Mr.Tromans is confirmed by the board. [1]

The attempt by a Chinese company to take over a Mongolian mining company had strained the latter’s relationship with the Mongolian government. We think that SouthGobi’s decision is understood to have been taken under instructions from Rio, which is keen to avoid antagonizing the Mongolian politicians at a time when it is facing increasing pressure over resource ownership issues. The fact that SouthGobi’s management is being gradually replaced by people from Rio Tinto only lends credence to this belief.

We think that Rio is examining all its decisions in Mongolia through the prism of the Oyu Tolgoi project, for this is the big prize Rio is actually after. This mine is critical to Rio’s long-term prospects. In addition to resource nationalism, it has also been facing power supply issues. At this juncture, we think that it makes sense for Rio to be pragmatic and lie low, lest it unintentionally provides another stick to politicians to beat it with. Politicians are expected to attempt to force Rio to the negotiating table to re-work the terms of the contract which guarantees Rio a stake of 66% in the Oyu Tolgoi project. Any confrontational move on Rio’s part would only strengthen the hands of nationalist politicians.

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The Background

Rio Tinto assumed control of Turquoise Hill Resources Ltd. in April in order to get its hands on the giant Oyu Tolgoi mine in Mongolia, which is a world-class copper-gold asset. Rio also ended up owning some non-core assets. One of them is the majority stake in SouthGobi. The latter controls the Ovoot Tolgoi coal mine in Mongolia.

Shortly before Rio assumed control of Turquoise Hill, Robert Friedland, the then Executive Chairman of Turquoise (then known as Ivanhoe Mines) cut a deal to sell its SouthGobi stake to Aluminum Corporation of China Ltd. This move caused an uproar among Mongolians, who are very particular about not letting next-door giant China assume control of the country’s resources. Mr. Friedland couldn’t have opted for a worse moment to cut this deal, for Mongolia was, at that time, going through an election cycle. This meant that political rhetoric and grandstanding were at at an all-time high. It didn’t help that many politicians’ campaign agenda included promising the electorate that they would force mining companies to cede majority ownership and control of Mongolia’s precious resources.

As the majority stakeholder in Oyu Tolgoi, Rio was the primary target of the resource nationalism campaign. The deal which Mr.Friedland had cut with Chalco only provided further ammunition to resource nationalists once Rio took over Turquoise. Gauging the overwhelming public sentiment in opposition to the deal, the Mongolian government quickly suspended SouthGobi’s licences. Also, the Parliament passed a foreign investment law, the main purpose of which appeared to be stopping this deal from going through. (See our previous article for more information on resource nationalism related problems being faced by Rio Tinto in Mongolia.)

Finally, a couple of weeks back, Chalco dropped its bid for a majority stake in SouthGobi after meeting stiff political opposition in Mongolia, citing difficulty in gaining regulatory approvals. But the whole affair caused an overall deterioration in the relationship between Rio and the Mongolian government. We think that although no one person was responsible for the fallout between the two parties, by changing the management team Rio is trying to send a signal that it values its relationship with the Mongolian government. [2]

Going Forward

We believe that Rio had been displeased with Mr. Molyneux’s public comments, seeing them as detrimental to its relations with the government. It may also have wanted to bring someone with mining experience into SouthGobi in order to manage a re-start of the mine. With his investment banking background, we think that Mr. Molyneux was not the right fit for the job. On the other hand, Mr. Tromans, his replacement, is a Rio Tinto veteran who has cut his teeth in this business for long. Hence, we think that he would be able to manage the business and relationships with all stakeholders in a much better way.

We recently revised the Trefis price estimate for Rio to $45 which is nearly 5% below its market price.

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Notes:
  1. UPDATE 2-SouthGobi fires CEO days after Chalco drops bid, Reuters []
  2. Rio Tinto Fires SouthGobi CEO Alex Molyneux; Move An Effort To Improve Relations With Mongolia, M.A.D Investment Solutions []
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