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

UNCLAS SECTION 01 OF 06 ULAANBAATAR 000119

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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

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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
--------------


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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

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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