Mongolia’s new government has decided to ignore calls for reviewing the Oyu Tolgoi mining deal made with Rio Tinto (NYSE:RIO) by the previous government. A group of 24 legislators had petitioned the government to assume a majority stake in the project. This should bring some relief to Rio because resource nationalism wasn’t its only problem. This project is also facing power supply issues and opposition from local communities over pollution concerns.
The Oyu Tolgoi project is important for Rio owing to its vast copper and gold deposits which are expected to drive Rio’s growth in future. The mine is owned by Oyu Tolgoi LLC, in which Rio Tinto’s Turquoise Hill Resources Ltd. owns 66%, and Mongolia the rest. The agreement between the two allows Mongolia to increase its shareholding to 50% over a period of 30 years from March 31, 2010. 
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The Power Supply Hurdle
Oyu Tolgoi is located close to the Chinese border where there is a paucity of power options. Hence, Rio needs to rely on importing power from China, at least for the initial years of its operations.
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. Ties between them were further strained this year when Chalco, a Chinese state-owned metals company, attempted to purchase a large coal mine in the Gobi desert and was met with fierce political opposition. It eventually dropped its bid. 
The Mongolian government is a party to negotiations as it holds a 34% stake in the project. If negotiations aren’t successful, Rio Tinto will have to build a dedicated power plant, which would cause a delay in the production schedule.
Opposition From Local Communities
Camel and goat herders fear 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. ((Mongolia’s new mining minister is long-time resource nationalism advocate, MineWeb)) The government will have to address their concerns to avoid any backlash in future.
On the brighter side, the decision not to renegotiate the deal should finally end any resource nationalism concerns. We have discussed this issue extensively in the past. You can read about it here.
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 estimated that revenue from the mine will 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 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 recently revised the Trefis price estimate for Rio to $45 which is in line with its market price.Notes:
- Mongolia Keeping Rio Tinto Deal Puts Focus on Tavan Tolgoi Coal, Bloomberg [↩]
- Rio Tinto faces Mongolian power struggle, Financial Times [↩]