Mongolian Government Suspending Licenses Doesn’t Augur Well For Rio Tinto

by Trefis Team
+5.55%
Upside
50.93
Market
53.76
Trefis
RIO
Rio Tinto
Rate   |   votes   |   Share

The specter of resource nationalism in Mongolia has come to haunt Rio Tinto (NYSE:RIO) once again. The Mongolian government has announced its cancellation of the decision made in 2009, under which it converted the Shivee Tolgoi and Javhlant exploration licenses held by Oyu Tolgoi and Entree Gold, into mining licenses. The licenses now stand suspended, pending review of the decision.

Oyu Tolgoi owns 80% interest and Entree 20% interest in production from the mining licenses. Oyu Tolgoi is controlled by Rio Tinto through its Turquoise Hill Resources unit. The Mongolian government has a 34% stake in Oyu Tolgoi, which it is keen to increase to 50%. [1]

The government’s move is being seen as a tactic to exert pressure on Rio, ahead of key talks over funding for the mine which will run out in three days. The two sides are slated to meet on February 27 and 28, to hash out problems and find a compromise. The larger dispute is about ownership in the mine. The Mongolian government is desirous of increasing its stake to 50% immediately in violation of the agreement signed with Rio, which only provides for incremental government ownership over time.

See Full Analysis for Rio Tinto Here

Impact On Rio

Rio stands to lose from the cancellation of the mine licenses because it is Entree Gold’s biggest shareholder, with 23.6% of the shares. The area covered by the license contains 25% of the inferred mineral resources of the Oyu Tolgoi vein, according to Financial Times calculations based on technical reports.

What the Mongolian government ostensibly intends to do is to transfer Entree Gold’s licenses to Oyu Tolgoi, in order to boost its own revenues since it owns a part of Oyu Tolgoi. While Rio Tinto is obviously a stakeholder in Oyu Tolgoi as well, its overall revenue share will go down if licenses are cancelled. [2]

The Larger Issue

Financing for the $6.6 billion Oyu Tolgoi copper and gold mine, which will become the world’s five largest once it reaches full production, runs out in three days, and talks to extend its funding are being held on February 27 and 28. If an agreement is not reached, either the mine will have to suspend operations or Rio will be forced to extend it a credit line.

The outcome is crucial to both sides. At full capacity, production from Oyu Tolgoi will account for nearly a third of Mongolia’s economy, while Rio Tinto is dependent on the mine to drive growth outside its massive iron ore business. Having suffered massive writedowns in its aluminum business for two consecutive years, Rio is looking for avenues to allow significant yet profitable diversification from iron ore. Also, almost all of Rio’s iron ore production is tied up in the Pilbara region of Australia, where cyclones are quite common and lead to production outages.

While the main grouse of the Mongolian government is budget overruns, we wonder why Rio wouldn’t want to control costs. It has been a stated objective of the company to reduce costs, reaffirmed in its latest earnings release and presentation through quantified cost saving targets for the next three years. The step is essential to stabilize the company’s financials and shore up its balance sheet.

If the two sides fail to reach an agreement in talks and Rio decides not to extend a credit line to Oyu Tolgoi, we see international arbitration as its only option. But that would delay production beyond June 2013 – Rio’s stated target. This will have an impact on the company’s performance for 2013. Also, arbitration proceedings are not enforceable, so little may be gained in the end even if Rio wins.

We have a Trefis price estimate for Rio of $45, which will be revised now that the fourth quarter earnings results are out.

Understand How a Company’s Products Impact its Stock at Trefis

Notes:
  1. Mongolia puts pressure on Rio Tinto ahead of Oyu Tolgoi talks, Reuters []
  2. Mongolia suspends key Oyu Tolgoi licences, Financial Times []
Rate   |   votes   |   Share

Comments

Name (Required)
Email (Required, but never displayed)
Be the first to comment!