Part 1 of 2: Investment Climate in Mongolia's Mining Sector

UNCLAS SECTION 01 OF 06 ULAANBAATAR 000119 SIPDIS SENSITIVE SIPDIS STATE PASS USTR, USTDA, OPIC, AND EXIMBANK STATE FOR EAP/CM AND EB/IFD/OIA USAID FOR ANE FOR D. WINSTON MANILA AND LONDON FOR ADB, EBRD USEDS TREASURY FOR USEDS TO IMF, WORLD BANK E.O. 12958: N/A TAGS: EINV PREL ETRD EMIN ENRG MG SUBJECT: Part 1 of 2: Investment Climate in Mongolia's Mining Sector Deteriorated Sharply in 2006 Ref: (A) 06 Ulaanbaatar 773, (B) 06 Ulaanbaatar 875 Sensitive But Unclassified - Not for Internet Distribution. CAUTION: Contains proprietary and confidential business information ¶1. (SBU) SUMMARY: Nationalist and populist politics on mineral resources have led to a sharp deterioration of the investment climate in the mining industry over the last year. With support from both major political parties, the legislature abruptly passed a confiscatory Windfall Profits Tax on copper and gold last May, and enacted a major revision in July to what here-to-fore had been hailed as a model, investor-friendly Mining Law. Foreign and domestic miners recently took the unusual step of publicly airing a long litany of problems they have encountered since passage of the new law. Moreover, the new law provides the government the legal right to "take" between 34-50% of large mines, representing a major conceptual reversal from what had been an ever-shrinking state share since 1990 in the market economy. Based on the first negotiation on a new mining investment, it seems that the state would like to pay nothing at all for its mining stakes, a stance which will make commercially sensible deals difficult or impossible for some prospective investors. In our second cable in this series, we describe the U.S. stake in Mongolia's mineral development. END SUMMARY. Mining Politics: Nationalism and Populism -------------- ¶2. (SBU) Mining is the core topic of discussion among the Mongolian public and political classes with respect to future prospects for Mongolia's economic development. While tourism and agriculture have also done well in recent years, the reality is that over 90% of Mongolia's exports last year were minerals, a share which has risen sharply (against an admittedly small base) in recent years as commodity prices have hit record highs and a few new mines have come on stream. For better or for worse, Mongolia's future development will largely depend on extraction and processing of its rich mineral resources. On the one hand, the Mongolian public writ large accepts this need to develop its mines and wants responsible mining to occur. In practical terms, "responsible" means: (a) royalties and taxes paid; (b) the best environmental and reclamation practices used; (c) Mongolians trained and employed; and (d) downstream processing capacity (meaning more value added for Mongolia) for mineral and hydrocarbon resources developed. Most of post's interlocutors would recognize that the best way to obtain these results is to work with the best commercial operators, who happen to be largely from the West. ¶3. (SBU) On the other hand, these same interlocutors -- from 80-year old grandmothers to the westernized business people -- believe that Mongolia is being robbed of its resources by rapacious miners bent on selling its treasures to China without Mongolia getting its fair share of the benefits. The visceral dislike of almost all Mongolians for China complicates the politics of mining, since Mongolian's booming neighbor to the south is the obvious customer for the most of the minerals, and an intensely interested potential investor. A popularized image of this rape of Mongolia is the Chinese-operated Tumurtiin Ovoo zinc mine in Mongolia's south east. The mine is a joint venture company (JVC) between a Chinese state owned enterprise (SOE) (49%) and the GOM (51%),where mostly Chinese laborers work. There seems to have been no attempt to protect or environmentally reclaim any of the land so far, and the state, aimag (province) or soum (county) appear to be getting little revenue. The mine operators have reputedly refused to provide any support to the local soum or country. An extra irritant: China's flag flies over the mine site. ¶4. (SBU) Sensationalized, true, or somewhere in-between, politicians from all parties have increasingly criticized perceived "poor" mining, demanding that Mongolia get its fair share. A proliferating ULAANBAATA 00000119 002 OF 006 set of relatively small new civil society movements have often further pushed the public discussion of the issue in nationalist directions -- even though the movements seem to muster at most 300 adherents for rallies. Those politicians who do not agree with the nationalist tenor of debate and legislation on the mining sector find it politically unwise to voice such reservations in public. Privately, members of the minority Democratic Party (DP) and the ruling Mongolian People's Revolutionary Party (MPRP) assure post that their respective parties have no deep-seated antagonism against mining as such. Indeed, they say they would love to have American firms lead the way for Mongolia's mining sector, but opine that Mongolian public needs, rather than shared commercial returns and risks, must be considered first. ¶5. (SBU) This d%gMQ \ is the ongoing negotiation between the government and Ivanhoe/Rio Tinto (RT) on the copper-gold prospect at Oyu Tolgoi. Rio Tinto-Ivanhoe officials have told CommOff that negotiations are hung up on the GOM's instance that it must receive its 34% share as a "free carry," with no exemptions on taxes, fees, other requirements to compensate the commercial miner for giving up the slice. RT's rep suggests the state has painted itself into a political corner: The GOM must claim that it stuck it to the foreign investors, or risk being savaged by its political opponents as selling out Mongolia. RT wonders if the state can negotiate in good faith, burdened as it is with this threat of political annihilation. Nevertheless, Ivanhoe is under considerable pressure to reach a deal, having spent $400 million on OT so far, but needing a further $1 billion it doesn't have and three years before any minerals are produced. In its deal with Ivanhoe last October, Rio Tinto left itself a conspicuous out, with a large additional investment in Ivanhoe contingent on striking a satisfactory deal with the Mongolian government on Oyu Tolgoi. Text of Miners' Letter of Complaint -------------- ¶16. (U) Begin text of MNMA/MMDF letter: Mr. Ts. Nyamdorj, Chairman of the State Great Hural Although it has not been a long time since the adoption of the Minerals Law, lately, our economic entities and organizations have been continuously filing complaints and vehemently expressing concerns with respect to the unlawful actions of the relevant Ministry (of Industry and Trade),its Agencies and local administrative organizations from the first day of effect of that Law. In summary, complaints include the unjustified use of improper pressures beyond legal jurisdiction, arbitrary judgments, decisions being delayed without any grounds and bureaucratic, preferential treatment. This is resulting in the emergence of an environment conducive to corruption and bribery. Indicative complaints are: ¶1. Exceptionally slow progress to renew licenses to special permit certificates and many are not being renewed without clear legal grounds. In some cases Cadastral Office officials are explaining to the license holders that the refusal for the renewal of licenses is on the basis of a verbal decision of the Minister for Trade and Industry; ¶2. License transfer applications for some entities have had to wait for 6 months, instead of 5 days, as prescribed by the Law. That type of practice is continuing as of this date; ULAANBAATA 00000119 003 OF 006 out the non-discretionary obligations required of both the GOM regulators and the miners. ¶10. (SBU) The new minerals law substantially changed the regulatory environment for mining investments, drastically altering the process and timelines for regulatory steps. It also featured the vaguely defined concept of a "strategically important deposit," in which the Government of Mongolia has claims a right to obtain up to a 50% share of any mine explored with state funds and up to 34% of deposits explored with private funds. The amended law defines a "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 finally vested in the SGH, which has the authority to name, and therefore take a share, of any deposit it wants. In February, the SGH ratified an initial list of 17 "strategic deposits," which contained both Oyu Tolgoi and Tavan Tolgoi, the two largest commercially exploitable deposits currently under consideration for development. The GOM had asked the parliament to designate 49 deposits as "strategic." Miners Object to Abuses After New Law -------------- ¶11. (SBU) The new mining law has created two different sets of problems. The first is that the GOM has extended new legal discretionary powers to itself in regard to the conduct of mining, but has not attempted to balance these powers to prevent abuses. The actions of recently dismissed Minister of Industry and Trade Jargalsaikhan demonstrate this key weakness. The former minister ordered, without any legal basis, that all licensing be halted. The law provided no check on this improper order. There was and is no intervening government agency or authority to review and sign off on the decisions of this ministry, the MRPAM or of the countless provincial and municipal regimes that have a say over mining. There is no formal process to even appeal the decision to the Cabinet or the Prime Minister, and Cabinet discipline is conspicuously absent. To all accounts, on the rare occasions Prime Minister Enkhbold sought to order Jargalsaikhan to do anything on any subject, the minister flatly rejected the PM's requests. As a result, the only miners had in response to abuses is a lengthy and problematic recourse to Mongolia's courts. ¶12. (SBU) Throwing off what had been a deep reticence to speak publicly about industry problems, miners recently sent a letter of complaint about the implementation of the new mining law sent to the SGH Speaker and Prime Minister (full text of the letter in final para). Widely publicized, this letter summarizes and frankly conveys the industry's collective "pull-no-punches" view of the situation: "In summary, complaints include the unjustified use of improper pressures beyond legal jurisdiction, arbitrary judgments, decisions being delayed without any grounds and bureaucratic, preferential treatment. This is resulting in the emergence of an environment conducive to corruption and bribery." ¶13. (SBU) The letter was sent by The Mongolian National Mining Association (MNMA) and its foreign funded think tank, the Mongolian Mining Development Foundation (MMDF),which represent the interests of the largest foreign and domestic mining firms in Mongolia. With the letter being the first salvo, the MNMA/MMDF has embarked on an aggressive program, which in words of the MMDF Executive Director is intended to "claw back from the hands of the politicians the mining environment." Mines for Free -------------- ULAANBAATA 00000119 004 OF 006 ¶14. (SBU) The other problem created by the new mining law is the prospect of the state taking equity stakes in key mines, a step which represents a major retreat from the privatization of assets since the advent of the market economy in 1990, but which is endorsed by both of Mongolia's major political parties. There is no explanation so far regarding how the GOM plans to pay for its share of the substantial mine cost and investments needed to produce a working mine. The MPRP-led Cabinet has created a government holding company to administer and control all the returns from mining, which it promises will go to the people. DP Party Chief Elbegdorj has stated that Mongolians must be given stock or regular payouts. To some, the new law does not go far enough. Just before Tsagaan Sar, President Enkhbayar called for changed the Minerals Law so that the state can take more than 50% of Tavan Tolgoi, and thus allegedly bring even more benefits to the people. In addition, the President said, the state should take the maximum it can on any and all deposits. ¶15. (SBU) A real question exists as to whether foreign mining companies can any time soon strike commercially viable agreements with the government on mining investments. The first test is the ongoing negotiation between the government and Ivanhoe/Rio Tinto (RT) on the copper-gold prospect at Oyu Tolgoi. Rio Tinto-Ivanhoe officials have told CommOff that negotiations are hung up on the GOM's instance that it must receive its 34% share as a "free carry," with no exemptions on taxes, fees, other requirements to compensate the commercial miner for giving up the slice. RT's rep suggests the state has painted itself into a political corner: The GOM must claim that it stuck it to the foreign investors, or risk being savaged by its political opponents as selling out Mongolia. RT wonders if the state can negotiate in good faith, burdened as it is with this threat of political annihilation. Nevertheless, Ivanhoe is under considerable pressure to reach a deal, having spent $400 million on OT so far, but needing a further $1 billion it doesn't have and three years before any minerals are produced. In its deal with Ivanhoe last October, Rio Tinto left itself a conspicuous out, with a large additional investment in Ivanhoe contingent on striking a satisfactory deal with the Mongolian government on Oyu Tolgoi. Text of Miners' Letter of Complaint -------------- ¶16. (U) Begin text of MNMA/MMDF letter: Mr. Ts. Nyamdorj, Chairman of the State Great Hural Although it has not been a long time since the adoption of the Minerals Law, lately, our economic entities and organizations have been continuously filing complaints and vehemently expressing concerns with respect to the unlawful actions of the relevant Ministry (of Industry and Trade),its Agencies and local administrative organizations from the first day of effect of that Law. In summary, complaints include the unjustified use of improper pressures beyond legal jurisdiction, arbitrary judgments, decisions being delayed without any grounds and bureaucratic, preferential treatment. This is resulting in the emergence of an environment conducive to corruption and bribery. Indicative complaints are: ¶1. Exceptionally slow progress to renew licenses to special permit certificates and many are not being renewed without clear legal grounds. In some cases Cadastral Office officials are explaining to the license holders that the refusal for the renewal of licenses is on the basis of a verbal decision of the Minister for Trade and Industry; ¶2. License transfer applications for some entities have had to wait for 6 months, instead of 5 days, as prescribed by the Law. That type of practice is continuing as of this date; ULAANBAATA 00000119 005 OF 006 ¶3. Whilst in the process of the re-registration, some licenses were not renewed because of the historical late license fee payments in previous years; ¶4. In addition, there have been illegal demands to present a tax clearance certificate from the Taxation Authority; ¶5. Coordinates of the areas were altered during the re-registration process. ¶6. The Minerals and Petroleum Authority of Mongolia (MRPAM) is refusing to conclude Confidentiality Agreements, as specified in the Law; ¶7. It has become impossible to get approved environmental and geological survey plans by the relevant authorities within 30 days, as provided for in the Law, because of the delay of issuing certificates for new licenses by the MRPAM. Meanwhile, the State Professional Supervision Authority and district Governor's Offices impose huge penalties and fines for these delays in the approval of the plans; ¶8. It has become customary for Soum and Aimag Governors to place pressure and to be unsupportive to the applicants' re-registration, unless the applicants satisfy their demand for huge donations and grants. For instance, you are asked to pay 250,000 MNT per license for support by Dornod Aimag, and Khovd Aimag imposes a 20 MNT per hectare "donation"; ¶9. It is becoming common procedure for Aimag and local state institutions to abuse their power and designate large areas for exclusive local needs. They are then using this as leverage for obtaining unjustified and illegal payments, donations, grants, and eventually bribery; ¶10. Soum and Aimag governors do not reimburse environmental reclamation deposits when the area has undergone environmental reclamation and is returned with full certification; ¶10. In addition, the Cadastral Office of the Minerals and Oil Authority acts slowly with regard to its official duties, such as an extension of license; partial return; registration of payment as required by the Law. In fact the Ministry of Trade and Industry has not developed or approved Regulations to the Law, which creates an extremely difficult situation for entities to function normally and in accordance with the requirements of the Law. The above mentioned complaints are just a few examples of the illegitimate actions of the minerals sector and are a clear demonstration of the distortions and deviations from the principles of transparency of State activities. These illegitimate actions impact upon Mongolia's international image and reputation and create uncertainty and doubts amongst foreign investors regarding future investment in our country. Therefore, I earnestly request you to terminate those illegitimate actions of the State government institutions and local administrative organizations by urgently setting up a Joint Working Group of relevant Standing Committees. I request you to execute the monitoring duty bestowed by the Law of the State Great Hural, in order to facilitate an opportunity for the consistent implementation and enforcement of Laws and Regulations of Mongolia. Respectfully, ¶D. Ganbold President ULAANBAATA 00000119 006 OF 006 CC: Chairman of the Standing Committee for Economic affairs; Chairman of the Standing Committee for Legal Affairs; Chairman of the Standing Committee for State Structure Copy to: Embassy: the USA, Germany, Japan, PRC, Great Britain, Russian Federation End text of letter Goldbeck