The third stage of negotiations between the working group established by the Government and the consortium selected as the strategic investor in the Tavan Tolgoi deposit has been postponed temporarily to allow the latter to study in detail the implications of the agreement made between Erdenes Tavan Tolgoi and China’s Chalco. The working group Secretary, S.Javkhlanbaatar, who is also head of the Investment Authority, recently briefed media on the negotiations so far. A summary of his account is given below.
The group had come to the talks with a clear idea of the issues to be discussed with the investors, on the basis of guidelines provided by the State Great Khural and the Government. The project has been in a limbo for many years now, and the Government and the State Great Khural have made a number of decisions and issued several decrees to move it forward. The latest of these, the Government’s Decree No. 268, set out the criteria for choosing from among the bidders and also the main principles for negotiation. Thus the group was clear about what to discuss and what Mongolia wanted. On the one hand, this has made it easy for the group to take a clear position on every issue, but on the other, it is hard to ensure that the negotiations would lead to the expected result.
The project is a complex one, going beyond being about just a coal deposit, and involving two State-owned companies – Erdenes Tavan Tolgoi and Mongolian Railway. More than 30 experts in several disciplines, divided into teams, are providing inputs to the Mongolian side.
The terms of three major agreements -- the investment agreement, the cooperation agreement, and the concession agreement -- have to be finalised. Apart from these, there will be a property transfer agreement with the two State-owned companies and some subsidiary agreements. The sheer complexity of the project makes it impossible to include everything in one single agreement. We have also classified relations and regulations into three broad types and stages: technical, inter-company, and Government-investor. The three major agreements mentioned before will be approved only at the Government-investor level.
In any bilateral negotiation, both parties have their own interests, priorities, and expectations. Whatever the final results of the talks the working group is determined that everything will be unamuous, and perfectly legal. We have made this clear to the other party. It helps that Decree No.268 is so direct and straightforward.
Investors, of course, have their own priorities, and will invest only if they consider the project to be sufficiently profitable. Because of the complex inter-relations, they are against dividing the project into separate parts. We agree that Tavan Tolgoi is a project that should compete in the world market. The initial investment is estimated to be $4 billion, but the investors can draw their investment back in the middle of the project. This can happen in any project. All aspects of the project, including project document, logistics, and business principles, should appeal to investors and banks.
We have been asked if Sumitomo Bank is an investor or not, and it seems many, including several in high positions, are not so sure about the terms consortium, project company and investment. As far as the current structure of the financing of the project is concerned, Project SPV is the Project Company. It has two owners with stakes of 49 and 51 per cent respectively. There will be two daughter companies, one for regulating the railway issues and the other to handle the trade part. Sumitomo is involved in the latter. As for the railway part, there will be a daughter company 100% owned by the Project Company.
When we say the project is a complex one, it’s more related to the consortium. The executor will of course be the Project Company. Sumitomo will work more in the area of raising funds than in marketing the coal.
The Investment Agreement as it stands now has 31 chapters and 6 appendices. We have basically reached agreement on the contents on issues of taxes, terms, special licences, the project company’s rights and duties, conflict pre-emption and resolution mechanisms, etc.
Five licences now cover the area to come under the investment agreement. The investors will lease the 4 licences owned by Erdenes Tavan Tolgoi. The other licence is the one on Ukhaa Khudag deposit owned by Energy Resources. The investors will be in charge of mining, transportation and sales activities on the territory of all 5 licensed areas of Tavan Tolgoi.
The law is that an investor who invests more than MNT500 billion has to work under an investment agreement signed with the Government of Mongolia. The initial Feasibility Report says that the investment in Tavan Tolgoi will be $4 billion. $1 billion of this will be spent on railway construction, $620 million on plant construction, $640 million on buying equipment and $710 million on mine construction. So all the $4 billion will not be spent in the first year itself, but over time, as construction and other works progress.
Broadly speaking, the Project Company will raise the money for investment and will thus bear all risks, keeping the Government totally out of the picture. We can call the investment a form of loan. Both sides agree that the the minimum revenue from potential sales will be $44 billion. This is calculated on the assumption that coal price will be between $70 and $120 per ton. If the price is $120, total amount of taxes paid to Mongolia will be $10 billion. Needless to say, these figures will change if tax rates change and prices do not stay within the estimated range.
Of the $4 billion, MMC will invest $1 billion, Shenhua $650 million, international banks $1.2 billion, other banks $1 billion (for the railway). The Trading SPV to be established under Sumitomo will raise $300 million-$500 million.
Recently Mongolia entered into an Economic Partnership Agreement with Japan. This kind of agreement usually relates to bilateral investment issues. When a company is set up, the company‘s licence itself becomes an investment, giving the investor the right to go to the International Court of Arbitration if it feels its rights under the Company Law have been infringed. An investment can be made in many forms, and Erdenes Tavan Tolgoi is investing in the Tavan Tolgoi project by leasing out the licence it owns.
Stability clauses in regard to 4 taxes in issuing licences and any new tax have to be incorporated in the Investment Agreement. As an investor, Erdenes Tavan Tolgoi is leasing out its 4 licences, with the payment for them coming in the form of royalty. If the coal market improves, Erdenes Tavan Tolgoi will receive 7-16 per cent of the sales income which is substantial.
Our lodestar is Decree No. 268 of the Government. This authorizes us to lease the licence without transferring ownership. This is a complex process and we considered several options. There is no one law that will regulate the whole process, so we are setting up a system where different laws, including the Law on Taxation and the Minerals Law, will regulate things like who will submit which reports, who will pay the taxes, what kind of account will be created, and what kind of transactions can be made through that account. Responsibilities will be shared between the Project Company and Erdenes Tavan Tolgoi.
Many different issues need to be clearly set out and each side’s responsibility clearly mentioned. We have already reached agreement with the investors on several issues including mining and additional exploration. The Decree also calls for setting up within 2.5 years a coal processing plant with a minimum capacity of 30 million tons.
The Government is pressurising us to move faster, and the investors also understand the value of time. But it’s not easy to raise funds in real life.
In any case, the Tavan Tolgoi project should proceed speedily and be completed in time. Then the people of Mongolia, the Government and the investors alike will enjoy the profits. A coal processing plant within 2.5 years will be a fine achievement, but it is not our final goal. We have agreed with the investors that we must have at least two regular and large markets. Among the targets are China, Japan, S. Korea, Taiwan and India. This won’t be easy, though.
So far in the negotiations, agreement has eluded us on the Chalco debt issue. We need to adopt principles to govern our way of dealing with already existing agreements.
As for the railway from Tavan Tolgoi to Gashuunsukhait, we are going by the conditions mentioned in Decree No.268. The Mongolian Railway Company has spent more than $200 million on this project, but only about 20% of the total work is complete.
Among other conditions made mandatory in the decree are that the project company must have more than 5 years of work experience in coal mining, processing, transporting and export, must be owned by a Mongolian citizen, and must hold at lest 51% stake. In something commonly called the agreement cycle, both the Government and the Project Company will have their own respective responsibilities in the 2.5 years before the coal washing plant is ready. We shall instal a mechanism to ensure neither fails in its duty.
In the worst case scenario that the present talks end in a deadlock, they will be suspended and the agreement held in abeyance, but the mechanism will be kept alive. We shall give each other some time to find a solution to the issues in contention. Delay will mean considerable financial loss for both the Government and the other side. Cancelling the talks and final failure to reach an agreement will thus be the very last thing either side would want to do.