Mongolia's New Mining Law: Many Concerns

UNCLAS SECTION 01 OF 08 ULAANBAATAR 000870

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USAID FOR ANE CALISTA DOWNEY

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TAGS: EINV PREL ETRD EMIN ENRG PGOV MG
SUBJECT: Mongolia's New Mining Law: Many Concerns

REF: Ulaanbaatar 832

Sensitive But Unclassified -- Not for Internet distribution.

Summary and Comment
--------------


1. (SBU) Mongolia's new mining severely disrupts an industry that
will and must be Mongolia's economic engine for many years to come.
Most worrisome to miners are new provisions for the government to
take equity stakes in a long list of "strategic" mines, provisions
that leave unclear how much the state will pay for what it might
take -- or even whether the state will pay anything at all. Other
provisions grant considerable discretion to authorities under murky
guidelines, a combination fostering corruption and arbitrary
regulation. Foreign miners already cite early evidence of these
problems. However, the news isn't all bad: tax changes were
welcomed, and miners can live with other amendments. This detailed
report on Mongolia's new mining law is meant to act as a resource
for USG agencies involved with formulating and executing aspects of
the US-Mongolia bilateral trade relationship. End summary and
comment.

Strategic minerals and GOM participation
--------------


2. (U) Under amendments passed by Mongolia's parliament in July,
the most important change from the 1997 Minerals Law of Mongolia is
the creation of the concept of a "strategically important deposit"
in which the Government of Mongolia has the right to obtain up to a
50% share of any mine. The amended law, Article 4.1.11, defines
"mineral deposit of strategic importance" as "a mineral
concentration where it is possible to maintain production that has a
potential impact on national security, economic and social
development of the country at national and regional levels or
deposits which are producing or have potential of producing above 5%
of total GDP per year." Ultimately, the power to determine what is
or is not a strategic deposit is ultimately vested in the State
Great Hural (SGH) (see Article 8.1.4).


3. (U) Article 5.1-5.6 describes state-ownership. If a mineral
deposit is determined to be strategic, the GOM may claim: up to 50%
if the state has contributed to the exploration of the deposit at
some point (Note: this means exploration conducted during the
socialist era primarily by Soviet geologists); or up to 34% if the
deposit was developed with private funds.


4. (U) State participation (or share) "shall be determined by an
agreement on exploitation of the deposit considering the amount of
investment made the state; or, in the case of a privately-explored
strategic deposit, by agreement between the state and the firm on
the amount invested by the state.


5. (U) Article 8.1.7 states that the SGH may determine the state
share using a proposal made by the government (executive branch) or
on its own initiative using official figures on minerals reserves in
the integrated state registry.


6. (U) Article 9.1.1-8 lists the GOM's powers regarding state
ownership. It provides a list of strategic deposits to the SGH for
approval; proposes how much the state might claim on such strategic
deposits; and "resolves matters concerning the investment of
Mongolia for a joint venture to develop a deposit of strategic
importance."

(Note: The 1997 law had no concept of "strategic deposits" or state
equity in mines.)

Comment on State Equity Provisions
--------------


7. (SBU) It is not explicit in the statute that the state will pay
for its equity share, though many MPs tell us that was their intent.
Across the board, western miners have made clear that while other
provisions of the law might be onerous and corruption prone, state
expropriation would drive them away for years to come. It also is
unclear that the state would pay what the industry would regard as a
fair value. Current best practice places a value on in-ground
economically recoverable resources at no more than 10% of the total
mine's value (This is what royalties pay for). Based on our talks

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with the MPs responsible for this law, we believe they conceive of
the GOM's contribution of an in situ deposit as if it were smelted
and ready for industrial purposes, rather than as raw ore that needs
a whole lot of investment to get it to market -- gold bullion versus
gold ore, which needs quite a lot of work and investment to turn
into ingots.


8. (SBU) As set out in the new law, "strategic" is so open-ended
that any deposit might fit the definition. The GOM has submitted a
list of forty-nine deposits it claims as strategic; but it remains
unclear why these forty-nine were chosen, because most of them have
not been thoroughly explored and all lack basic infrastructure.
Government sources tell us they used a weighted scale that ascribe
points to determine each deposit's economic, social, cultural,
environmental, and regional impacts on Mongolia. However, no one
outside the government has apparently seen the criteria, nor has the
government allowed stakeholders to officially vet this process.


9. (SBU) GOM claims that the process was free of political
interference are difficult to believe. For example, Boroo Gold
Mongolia reported to emboff that politically influential MP and
business man Su. Batbold (the former Minister of Industry and Trade
until January) told them that their new gold mining project was on
the "strategic deposit" list, but that it could be removed if they
thought its presence would halt their negotiations with the
government on revising their tax status on current projects. They
agreed and their follow-on project was removed from an earlier
list.

Exploration License Timelines and Local Approval
-------------- ---


10. (U) Article 19 lays out an elaborate process for getting an
exploration license. Under it, the Mineral Resources and Petroleum
Authority of Mongolia (MRPAM) has 20 working days to issue its
approval, followed by a 30 working day approval process for the
Aimag governor to approve or disapprove of the exploration rights.
There are two working weeks for MRPAM and two working weeks for the
provincial governor to comment on the license. In total, the new
system will take up to two months. (Note: By contrast, the old
process required and allowed for no more than 20 business days.)

Tender Process for Some Exploration Rights
--------------


11. (U) In article 18.2.5, the law lays out a new procedure for
obtaining exploration rights on land explored with state funds or
lands where the current holder has forfeited exploration rights.
MRPAM will tender such exploration rights only to firms technically
qualified to conduct minerals work. The new tender procedure neither
requires nor allows for a cash-bid. Only the technical merits of
the exploration proposal are now supposed to determine who wins
exploration rights. The MRPAM staff will have the authority and
responsibility to assess the merits of proposals to determine who
wins the tenders. (Note: The old law awarded exploration rights on
a "first come, first served" basis, a process that gave little
discretion to government officials to intervene.)

Comment on the new tender process
--------------


12. (SBU) The SGH had long been offended that so many tenements were
licensed to people, mostly Mongolians, who did no exploring. MPs
complained to us that that all these people were mere speculators
intent only on selling their rights to Westerners, Russians,
Chinese, etc., who would then explore after spending hundreds of
thousands or even millions of dollars on choice sites. The SGH
thought exploration and mining would be more likely to occur if
licenses went only to mining experts. However, no evidence from any
other mining nation proves that this type of limitation produces
more mining.


13. (SBU) The older system, by providing a financial incentive
through sale of tenements, motivated thousands of Mongolians into
the mining game to make money by promoting thousands of tenements to
firms able to mine or more thoroughly explore them. The most
obvious victims of the new law are these same Mongolian citizens who
once profited by speculating on tenements, but are now barred from
entry. Ironically, the state is also a victim, because fewer
tenements will now be presented to well-funded exploration firms.

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The winners are those well financed private western concerns and
Chinese and Russian state-owned firms able to pay for the expertise
required under the new law.


14. (SBU) The other winners are the MRPAM and Ministry of Industry
and Trade bureaucrats, who now have broad discretionary authority to
select who will and will not get tenements. This new authority
disturbs miners, who fear this power will be the source of
corruption and arbitrary decisions by MRPAM. Evidence suggests that
local mining guilds will define an expert in Mongolian mining as a
person who received a degree from a Mongolian institution, such as
the National University, rather than an internationally recognized
institution. While this enforced employment program for Mongolian
geologists would be an annoyance, the discretionary power MRPAM now
has is most worrisome. If the MRPAM rejects experts and mining plan
as un-qualified, no recourse is spelled out under the new law.


15. (SBU) Industry sources report that MRPAM is already interpreting
its discretion over expertise broadly. MRPAM is telling firms that
it will "take into consideration" companies' past exploration
activities when it comes time to transfer licenses from the 1997
format to the new law's license format. The new law sets out a
procedure in which only the completeness of the application and the
qualification of the company's technical staff determine if the
license will be granted, extended, or transfer from the 97 format to
new regime. Nothing in the new law provides regulatory or statutory
justification for revoking current rights based on past behaviour
that was in accordance with the old law. Miners criticize the
arbitrary, improper use to the new law to "expropriate" their
rights.


16. (SBU) Finally, the law has the potential to limit the ability of
rights holders to seek financing, because it forbids transfer of
licenses and exploration rights to non-qualified individuals.
Consequently, a miner will not be able to offer his licenses as
secured collateral to banks or to any lender lacking the
professional qualifications to receive these rights if the miner
defaulted on his debt obligations. MPs to whom this implication has
been pointed out have expressed surprise.

"Exclusive" Removed from Exploration Rights Article
-------------- --------------


17. (U) In Article 21.1.1, the SGH removed the Mongol word
"ontsgoi," which means exclusive in this context, from the new
article. The old article read, "To conduct exclusive exploration
for minerals within the boundaries of an exploration area in
accordance with this law." The new article reads, "To conduct
exploration for minerals. . . ."

Comment on Removing "Exclusive"
--------------


18. (SBU) It is unclear what, if anything, this deletion means.
However, the deletion would seem to allow the government to
apportion mineral rights per metal or mineral rather than as a
whole, which has been the standard practice. Sources tell us that
the SGH Speaker Nyamdorj deleted the word from the final draft after
it had been re-inserted by other MPs, a fact that increases the
likelihood the deletion is meant to be significant.

Pre-mining Agreement, Exploration Timelines, Fees
-------------- --------------


19. (U) Article 22 now allows for exploration rights to be extended
up to nine years. The first period is three years, followed by two
possible extensions (subject to MRPAM approval) of up three years
each. (Note: The old law allowed only 7 years for exploration,
after which the firm had to move to mining or give up the claim.)


20. (U) Article 23 allows for a pre-mining license period of three
years. This recognizes that nine years may not be enough to go from
exploration into feasibility and then production on some major
projects. Granting of a pre-mining license requires the miner to go
into commercial production no later than three years after the end
of the exploration license.


21. (U) Exploration fees (Article 32) have risen:
-- 1st year goes from US $.05 to US $.10 per hectare
-- 2nd year goes from US $.10 to .20 per hectare

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-- 3rd year goes from US $.10 to .30 per hectare
-- 4th-6th years rise from US $.10 to US $1.00 per hectare.
-- 7th-9th years are US $1.50 per hectare


22. (U) Article 33 imposes a new work performance requirement on
all exploration right's holders that rises each year and is subject
to annual verification by MRPAM. Miners must submit annual report
to MRPAM, and MRPAM will have the power and right to inspect the
exploration site to verify that work is being done:

-- 2nd and 3rd years miners must spend no less than US $.50 per
hectare on exploration
-- 4th to 6th years miners must spend no less than US $1.00 per
hectare on exploration
-- 7th to 9th years miners must spend no less than US $1.50 per
hectare on exploration

Comment on new timelines and work requirements
-------------- -


23. (SBU) Miners approve the new longer exploration license period
and the pre-mining period, because it gives them more time to
conduct required feasibility and development work to bring
complicated mines into operation. There is some concern about the
time-frame between the expiration or cessation of the exploration
license and the conversion to a pre-mining license. Nor are the
miners comfortable with the lack of clarity regarding how one enters
such an agreement with the GOM.


24. (SBU) Miners grumble about the fee increases but accept them.
They presume that under normal circumstances they would return
unpromising areas each year to keep total costs down. So the GOM
and SGH's aim to get land into real exploration may be served,
although this aim could have been achieved by simply raising fees
and imposing work requirements through regulation rather than by a
new law. There is some concern that the MRPAM lacks the capacity to
verify work requirements. MP Oyun noted that this lack of capacity
was the reason for not including this provision in the 1997 law, and
that neither she nor others think MRPAM has increased its ability to
monitor work plans since 1997. We agree with this assessment and
share miners' fears that this requirement will turn into another
rent-seeking opportunity for MRPAM staff.

Higher mining license fees and investment agreements
-------------- --------------


25. (U) Mining license fees increase for most metals and minerals
(copper, gold, silver, fluorspar) depending on the metal; the fee is
now US $15 per hectare. Coal and other common metals (lead) are
raised to US $5 per hectare fee.


26. (U) Article 29 provides for the crafting of a long term
investment agreement between the GOM and the mining firm. The base
of this agreement is the amount to be invested. These rules apply to
all actors in the mining sector.

-- If the investment for the first five years is between US $50-100
million, the state can negotiate a 10-year investment agreement
-- If the investment for the first five years is between US $100-300
million, the state can negotiate a 15-year investment agreement.
-- If the investment for the first five years is over US $300
million, the state can negotiate a 30-year investment agreement

(Note: Under the old law, companies which invested $15 million could
conclude a "stability agreement" which exempted them from profit
taxation for 5 years. The only Western firm to take advantage of
this was Boroo Gold, whose 5-year tax free period has one more year
to run.)


27. (U) The Ministries of Finance, Trade and Industry, and
Environment shall collectively negotiate agreements between the GOM
and the mining firm. These agreements will list the conditions that
a firm needs to provide a stable business environment for mining
over the term of the agreement. This includes: regimes for
taxation; sale of products; income disposal; term of agreement;
environmental responsibilities; social and industrial impacts; and
benefits to accrue from mining activity, etc.


28. (U) The license holder must submit a feasibility study and
investment plans to MRPAM, which submits them to the responsible

ULAANBAATA 00000870 005 OF 008


ministries. These ministries have three months to review the
proposal, send it around the GOM for comments and clarifications and
send a counter response to the industry. An additional three months
is allowed for responses, making the process three months in total.
Mongol Bank is listed as the prime repository of all such
agreements.

Comment on investment agreements
--------------


29. (SBU) Most miners argue that the GOM's six month timeline for
striking a deal is too ambitious given the GOM's lack of experience
and capacity. The Ministry of Finance is already hard-pressed by
the need to negotiate several agreements with China and Russia, not
to mention the long-delayed Millennium Challenge Account proposals
-- and now it must embark on negotiating at least two multi-billion
dollar mining deals (the Ivanhoe/Rio Tinto Oyu Tolgoi copper mine,
and the Tavan Tolgoi coal mine). Doubts about ministerial capacity
aside, miners want to know if a mining operation can renew or
renegotiate its investment agreement upon expiration of the initial
agreement. Miners are not pleased that fees have risen and that
new, undefined burdens have been imposed, but believe that they can
deal with them.

Environmental Protection key requirement for mining
-------------- --------------


30. (U) Article 2 makes environmental protection a key part of the
mining legislation. The new law also makes the mining law and
environmental provisions listed elsewhere consistent with one
another. Articles 39 and 38 explicitly require miners to submit
environmental protection before licenses issuance. In addition, the
GOM requires that firms to deposit half of the funds for each mine's
annual reclamation budget in a bank account in the soum (county)
where the mining activity occurs. Failure to deposit funds or
fulfill environmental obligations can result in license revocation.
Local authorities are apparently given wide discretion, along with
the Ministry of Nature and Environment (MNE) and the State Special
Inspection Agency (SSIA) to assess firms' compliance with
regulations and statutes. Failure to comply can result in revocation
or suspension of licenses and mining rights. The law does allow the
licensee to go to court against such decisions, but the license will
be suspended or revoked during that period. (Note: There were
environmental requirements in the old law, but they did not occupy
the key position they do in the new law.)

Comment on environmental provisions
--------------


31. (SBU) SGH Speaker Nyamdorj pushed the environmental aspect of
the new law quite aggressively, making extremely emotional appeals
about stopping the rape of Mongolian land by miners who consistently
ignore environmental provisions. However, these ambitious
provisions are not matched by any training or support to localities
and agencies expected to enforce the law. It is not part of this
law, but the law on environmental impact assessments requires that
they be done by Mongolian experts, certified locally, who ironically
enough do not meet the MNE environmental standards on mining
activities. The power to revoke and suspend are likely sources of
corruption, giving officials the opportunity to blackmail miners.

New local employment requirements
--------------


32. (U) Article 43.1 states that license holders cannot employ more
than 10% foreign workers. If they do exceed the 10% limit, they
will incur a monthly penalty of 10 times the minimum monthly salary
as specified in Mongolia law. Fines are to be paid monthly to local
governments for distribution into education and health sectors.
(Note: This provision is not inconsistent with current labor law
regarding foreign employees, but was not in the old minerals law.
The payment of the fee to the locality is new, and the new fee will
be about $600, versus $80 currently.)

Comment on employment requirements
--------------


33. (SBU) Western firms do not have anything against this, as they
prefer to use Mongolians, who usually cost less than expatriate
employees. This provision is probably aimed at Chinese, Mongolian,

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and Russian firms that would use cheap foreign labor to lower their
respective costs.

Royalty Rates, Distribution of Revenues to Localities
-------------- --------------


34. (U) Article 47.3.1-2 sets the following rates for royalties in
Mongolia.

-- Royalties for Domestically sold coal for energy and common
mineral resources shall equal 2.5% of the sales value of all
products extracted from the mining claim that sold, shipped for
sale, or used.
-- Royalties for all other extracted products (excluding coal) shall
equal 5% of the sales value of all products extracted from the
mining claim that sold, shipped for sale, or used.


35. (U) Article 59 specifies that licensing fees shall be deposited
in the budgets of the provincial capital, soum, and district where
the activity is taking place, as well as the central budget.

-- 25% to the soum
-- 25% to province
-- 50% to the central budget


36. (U) Royalties payments are distributed as follows:

-- 10% to the soum or district
-- 20% to the province
-- 70% to the central budget

(Note: Coal royalties remain the same, but rates for all other
products rise. Under the old law, the central government took all
revenues.)

Comment on new royalty provisions
--------------


37. (SBU) Miners grumble about the higher rates, but accept that the
5% rate is about mid-range for most jurisdictions. More important
is the distribution of revenue to the provinces. On its face, we
and other stakeholders agree that a guarantee that the countryside
will see some monies from mining activities that occur within their
jurisdictions is a positive step. However, the presence of the
article in the mining law may have no legal force on allocations
from the state budget, as the Ministry of Finance may be able to
ignore a provision not appearing in the law on state budget, which
controls allocation of state funds. If revenues do flow to the
localities, local administrations are ill equipped to administer
what in some areas may be huge revenue streams.

New public reporting requirements
--------------


38. (U) Articles 48.9 and 48.10 impose the following reporting
requirements on royalties and sales on mining firms.
-- A license holder must prepare a quarterly report in a form
approved by the tax office accounting for the sum of each quarter's
royalties and an annual report for the entire year's royalties, also
for submission to the relevant tax office.
-- A license holder shall annually report to the public the amount
of their product sales for that year and the amount of taxes and
payments paid to the central and local budgets.

(Note: The old law required no public disclosure of tax receipts,
royalty payments, and sales data.)

New tax provisions
--------------


39. (U) Articles 61.4, 61.5, and 61.6 discuss revised tax
provisions.

-- Article 61.4 states that a loss incurred in any tax year may be
deducted from taxable income during the 2 tax years following the
year in which loss was incurred.

-- Article 61.5 states that costs incurred in developing industrial
and social infrastructure shall be depreciated on a straight-line
basis over the useful lives of the facilities constructed. All

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costs of maintaining and operating such infrastructure facilities
shall be expensed in that particular year.

--Article 61.6 states that costs of absolutely necessary maintenance
incurred in connection with mining operations shall be included in
the operating costs

(Note: These tax provisions were essentially in the old law;
however, the Tax Authority of Mongolia routinely ignored them
because they were not in the implementing tax legislation. New tax
legislation passed last summer has these mining tax provisions.)

Comment on new tax provisions
--------------


39. (SBU) Miners are very pleased with these changes, although they
would have preferred even more generous provisions in view of high
costs and long development lead times. The previous terrible tax
situation was one major impetus behind tax holidays in stability
agreements; in turn, such holidays proved a political albatross for
foreign mining companies, feeding into the argument Mongolians did
not receive their due from the companies' profits.

Restrictions, Burdens on License Transfer, Pledging
-------------- --------------


40. (U) Article 49 describes the increased documentation required
to transfer a license. For instance, the documentation must show
that both environmental protection and professional qualifications
concerns are being accounted for. The phrasing grants authority to
MRPAM's Chair to refuse a transfer even it complies with the state
requirements.


41. (U) Article 52 makes clear that a license-exploration or
otherwise-can only be pledged to a transferee eligible to hold such
a license.

Comment on increased restrictions on license transfer
-------------- --------------


42. (SBU) As with exploration rights, these new requirements to hold
a license imperil the security and transferability of mineral
rights. Strictly read, a holder of rights could not pledge those
rights as an asset to a bank or other investor who otherwise was not
eligible to hold a license. A given bank is unlikely to set up a
"qualified" mining firm just to receive a pledged license offered as
collateral. At a stroke the law limits the investment pool that a
mining firm might tap to finance its mine.


43. (SBU) Mining firms also are very wary of the authority granted
to the MRPAM to approve transfers of existing licenses. Although
Ivanhoe has complied with all the new requirements, MRPAM has
refused to shift Ivanhoe's coal assets from its copper mining
company to a new entity dedicated to coal mining exclusively.
Ivanhoe is now murmuring about international legal action to fight
what it views as expropriation.

Reimbursement for state funded exploration costs
-------------- ---


44. (U) Article 60 requires mining firms to reimburse the state for
costs incurred to explore deposits on tenements. These expenses are
booked and documented in the State integrated registration. Miners
are to strike repayment agreements with set schedules for repayments
prior to commence of formal mining operations. If the State is not
reimbursed, failure to do so will incur a 0.1 % penalty per day on
the total amount. If after 30 days payment of fines and the
principle is not completed, the mining license holder will have his
rights revoked and the holding tendered by bid. (Note: The old law
also contained this provision but without the penalties imposed in
the new law.)

Comment on reimbursement of state exploration cost
-------------- --------------


45. (SBU) This requirement has always irritated miners. Most
countries perform such services gratis or with a nominal fee; or
they do not conduct such explorations at all, seeing this activity
as more suitable to private enterprise. The GOM is still having
trouble extracting itself from functions best left to private firms.

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Its soviet-era geology in no way matches the current state of the
art, and it is somewhat galling to miners to have to reimburse the
GOM for work that does not really determine the nature and quality
of a given deposit

Minton