By S.Bold-Erdene
Photo by Enkh-Amgalan
As the Oyu Tolgoi mine gets ready to begin production next year, heralding a new era in the Mongolian economy -- especially in mining and export -- debates over the OT investment agreement are getting fiercer, with the spotlight turned on those who worked on it.The project will proceed whether the agreement is a good one or not but my personal view is that those against the agreement, in their preoccupation with certain figures, are missing the more substantial issues. Making 34 per cent 51 or implementing the Government’s decree No.57 is important but not as significant as some others.
If the goal really is to modify the agreement to make it more beneficial for Mongolia, the protesters need to look at it from a different perspective. Prime Minister N.Altankhuyag spoke of this at his meeting with foreign ambassadors. He wanted more clarity on the impact of the increase in the initial investment. My suggestion to the MPs who keep calling for a change in the agreement is that they take up this issue, as it is obvious that Rio Tinto will keep giving the same answer no matter how long we continue to demand increasing Mongolia’s 34 per cent ownership to 51 per cent.
Cameron McRae has summarily dismissed any chance of re-negotiation of Mongolia’s income from the project. Indeed, all talk about getting more money from the project looks like a political show, with no serious review of how our interests, as mentioned in the agreement, are being consistently violated. The authorities of Rio Tinto have to explain how these legal and financial trampling of Mongolia’s interests is being allowed to go on.
Let us see what is actually happening.Both the Prime Minister and the Minister of Mining have said that the initial investment at OT has gone up from the anticipated $4.1 billion to $7.1 billion. OT puts the amount at $6 billion. It is crucial that we find out the reason why the amount has overshot the estimate at all, why the quantum of increase is shown differently, and what all this means to the Government of Mongolia, a principal shareholder in the project.
Exactly how much money has been spent on the OT project so far? Clause 9.5 of the OT agreement refers to the shareholders’ current loan amount and additional investment. The first is the amount of investment the shareholders had made before the agreement was signed on March 31, 2010. This was initially put at approximately $1 billion but was subsequently changed to $670 million after keeping out‘unnecessary expenses’. In other words, investors in the OT project had spent $670 million prior to the agreement coming into force.
If we subtract this $670 million from the $7.1 billion mentioned by the Prime Minister, we are left with $6.4 billion as the amount of investment made by Ivanhoe Mines, Rio Tinto and the Government of Mongolia between the signing of the agreement and the end of 2012. It is important to understand why and how much this $6.4 billion actually matters to Mongolia, if the investment has increased according to what the agreement says, and how much Mongolia’s actual debt to the other investors is.
Two sources for funds and their relative importance The agreement identifies two sources for Oyu Tolgoi LLC’s funds: loans and shareholders’ contribution. It also says 75 per cent of the total financial requirement is to be raised from the first and the remaining 25 per cent from the second. The loan is in the name of Oyu Tolgoi LLC and has no immediate bearing on Mongolia. $4.8 billion or 75 per cent of the total investment amount of $6.4 billion will be repaid by the company as it begins to make money from production.
On the other hand, the shareholders’ contribution matters directly to us. As we have seen, this now stands at $1.6 billion. This is to be proportionately shared by the shareholders according to their holding.Since Ivanhoe Mines (Turquoise Hill Resources) owns 66 per cent of Oyu Tolgoi LLC and Erdenes Oyutolgoi LLC (or the Government of Mongolia) owns 34 per cent, their respective share of investment under this head will be 66 per cent and 34 per cent respectively. This way, the Government’s share of the $1.6 billion is $530 million. According to the agreement, the Government ‘borrowed’ this money from Ivanhoe Mines at a high rate of interest. For the record, the Government would not have had to take the ‘loan’ if it had cash of its own to contribute.
It has to be emphasised that it is incorrect to say that the Government borrowed money to own 34 per cent share in the project. Oyu Tolgoi LLC had a start-up capital of MNT150 billion and the Government received its share of the equity for free. However, once its 34 per cent ownership was established, the Government was bound to pay 34 per cent of all expenses for the construction of the project. This is common business practice and is allowed under the Company Law of Mongolia. When we say Mongolia took a loan, we are talking about this 34 per cent share of expenses and the loan will be repaid from the dividends as and when they are due.
Deputy Speaker of Parliament S.Bayartsogt once said that taking the average copper price to be $4,408, Mongolia’s total income from taxes and fees from Oyu Tolgoi would be $29.1 billion while the investors’ income would be $25.7 billion. He therefore asserted that Mongolia’s share of the OT project income is 59 per cent as against the investors’ 41 per cent. This was said on the basis of the initial investment being $4.6 billion as suggested in the feasibility study. Now, that has gone up to $7.1 billion and may even reach $13 billion, if planned investments are actually made.
Simply speaking, as the initial investment amount increases, Mongolia’s revenue would fall. This is because Mongolia will have to reimburse OT its share of the investment -- whether it is $4.6 billion, or $7.1 billion or $13 billion – and the higher the investment on construction and development of the mine, the more Mongolia has to repay. As long as these repayments are outstanding, the net income of Oyu Tolgoi will be calculated as less and dividends will also be less, again affecting Mongolia’s income.
If the initial investment amount had not changed, dividends would begin once Mongolia’s share of the $4.6 billion was adjusted. Now this can happen only after its 34% share of $7.1 billion and other additional loans are calculated as repaid. The feasibility study predicted the cash flow to be positive starting from 2017, when the $4.6 billion investment would be neutralised. Distribution of dividends would also start then. These dividends to the Mongolian Government were to be used to repay the ‘loan’ it took from Ivanhoe Mines. This would have been over by 2019 or 2020, and the Government would thereafter have enjoyed unencumbered access to its share of profits. It is the same for Rio Tinto also. The more the $4.6 billion increases, the longer the shareholders’ wait for dividends.
OT says Mongolia earning more in taxesOT has a different take on this issue. Mark Goodwin, head of the business analysis department there, says, “Naturally, shareholders will receive less as dividend as the initial investment amount rises. This is true for both Mongolia and Rio Tinto. However, the Mongolian Government is somewhat protected, as OT will be paying more taxes as it spends more on construction and the tax revenue will offset the lower dividend.”
In the course of a media conference, McRae said, “First of all, $6 billion or so which Rio Tinto and Ivanhoe Mines will have invested must be reimbursed to the international investors. We expect the initial investment amount to reach $6.2 billion and our estimate is that Mongolia would have already gotten between $7 billion and $8 billion by the time its share of this is fully paid off and the project starts to make a profit. Our present calculation is that all adjustments will be completed by 2021.”
We should not forget that apart from its share of the initial investment, Mongolia has to repay loans worth $530 million. Thus it may well be a decade from now that Mongolia can lay its hands on the dividend. Of course, this could be earlier if copper and gold prices remain high and also keep rising.
The OTIA provides for an amendment of its terms only if both parties agree in writing to do so. Neither party can effect a change unilaterally. The best course for Mongolia is to insist on a thorough review of the reasons behind the drastic increase in the initial investment on the OT project. The probe should be based on Clause 9.5 of the OTIA. This reads, “The Investor plans to make an additional investment in the OT Project, the estimated amount of which, as provided in the Feasibility Study referred to in Clause 3.6, will be approximately USD4 billion. The estimated initial capital will be invested over a period of 5 (five) years, and a schedule for this planned expenditure is contained in the Feasibility Study.”
Let me emphasise one thing here. The IA makes no mention of taking loans from any third party. It is specific that the shareholders will invest $4.6 billion, made up of $670 million invested by Ivanhoe Mines before the implementation of the agreement and the $4 billion to be invested later. There is no amuity about either the amount of investment or its period. Why, then, should the Mongolian Government accept the nearly 50% increase, from $4 billion to $6.4 billion? Moreover, how does the company intend to spend between $4 billion and $5 billion it is borrowing from the World Bank and the European Bank for Reconstruction and Development? We need clear answers to these questions. All expenses should basically tally with figures included in the Feasibility Study, as required in law.
As the 34% shareholder in the project, it is perfectly legitimate for Mongolia to demand to know from the investors why they have gone beyond estimates in the Feasibility Study. Do they disown the contents of the Study or do they suggest that the changes became imperative because of radically changed market conditions? The project cannot satisfy Mongolia’s interest if the formally approved Feasibility Study is ignored. Keeping the Study as the reference point for all arguments is the main card that the Government holds.
Oyu Tolgoi LLC considers that there is no need to change the Feasibility Study. Goodwin says the estimates have overshot by just 18 per cent. “Initially, we said we would need to spend $5.170 billion, and this has grown to $6.2 billion. An 18% rise is small and quite acceptable when seen against several other major projects in the world where initial investment estimates rose by 60% or more. The price of all material has gone up, inevitably leading to a cost overrun. There are many other contributory factors, too,” he has said.
Rio’s responsibility lies in being transparent
He has further explained that all investors try to keep the initial investment costs under control as any runaway increase is against their interest, adding that the 18% rise in expenses is no reason to amend the Feasibility Study for the law allows for a 20% to 30% rise. Supporting him, Kh.Amarjargal, chief lawyer of Oyu Tolgoi LLC, says the cost rise cannot be any reason to “touch” the OTIA. He adds that the agreement allows for amendments to the Feasibility Study every five years, after a review of changes in prices and other relevant factors.
Asked to explain why the Prime Minister’s figure of $7.1 billion does not tally with the $6.2 billion given out by Oyu Tolgoi LLC, Goodwin said he cannot say how the Prime Minister arrived at his figure. But the difference is of crucial importance. Some economists and analysts suggest we ask Rio Tinto to reveal details of its expenses in phases, without insisting on sticking to the Feasibility Study. A leading global company like Rio should be transparent and make public all its accounts details on Oyu Tolgoi. Surely, purchase details cannot be termed confidential information if the company wants to implement the project successfully for decades. We need to put pressure on the three gentlemen who represent Mongolia on the Board of Directors of OT LLC to speak up on this issue.
At the same time, the Government must strengthen its oversight mechanism, with the Mongolian Tax Administration inspecting all accounts relating to the investment. Only then shall we know the truth. For example, according to Goodwin, the VAT amount and $600 million paid as customs duty are included in the $6.2 billion. However, the decision not to exempt VAT on copper concentrate was passed in July, 2009, or just before the OTIA was signed, and so the $600 million of the initial investment was treated as money spent by the company. There are other similar knotty issues and only a thorough inspection can reveal whether or not VAT should be made part of the initial investment amount. Only after such anomalies are resolved can the Government decide whether it would be right to demand changes in the Feasibility Study or to invite investors to fresh negotiation.
It is in nobody’s interest to hinder the project’s smooth development. Oyu Tolgoi LLC is about to take loans using the project as a mortgage and Mongolia looks beyond this one project to keep the investment environment attractive for further foreign investments in its mega mining projects. Neither party benefits from rocking the boat without adequate reason. The OTIA is the benchmark for foreign investors interested in Mongolia and should not be tinkered with casually. For this reason, every effort should be made to resolve the current dispute amicably.
N.Dorjdari, analyst at the Open Forum Society, stresses that the Investment Agreement can be changed only with mutual consent, expressed in writing. McRae has dismissed any possibility of discussing amendments. Even as it makes no sense to blame investors for everything after they took a great risk and invested billions of dollars, talking about problems could be the best way to ensure the project runs successfully for 30 or 50 years.
The least one expects from a responsible global leader like Rio Tinto is that it will strive to run the OT project stably for decades and, in the process, acquire the “social licence” to work in Mongolia. So much conflicting information is being bandied around that the truth is hard to discern. My personal opinion is that the veil of suspicion can be well and truly lifted only if the company reveals accurate and comprehensive information about its investment details.
The pressure on the Government to work towards changing the Agreement will not go away soon, with one-third of the MPs in the ruling coalition vocally demanding such a stand. The Altankhuyag Government may even have to resign if it resists such demands. Even if things gradually calm down, they will flare up again after the next election, which will routinely see everybody criticising the OTIA and demanding 51 per cent ownership.
It is not just the survival of the OTIA which is at stake, the uncertainty also impugns Mongolia’s capacity to get major projects going and its attractiveness as an investment destination. Rio Tinto may one day agree to change the IA on principle, but there are strong doubts on if it will at all agree to the specific changes that our side is seeking. It isimprobable that it will accept 51% ownership by Mongolia or pay royalty at 20 per cent. The Government should not stick to such rigid numbers if meaningful negotiations are to be held.
Constant communication is important to dispel suspicion and create trust among partners. Neither party should be allowed to feel its interests are being violated and the implementation of the agreement should be regularly reviewed. Mutual acrimony leads us nowhere and discontent must not be allowed to fester. It is imperative that all matters relating to the amount spent so far are made clear. It might also help if both parties decide on a date when the Agreement will be reviewed. Nothing will be gained by politicians destabilising the Stability Agreement as the world is watching how Mongolia honours its international commitments.
