Part 2 of 2: The U.S. Stake in Developing Mongolia's

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SUBJECT: Part 2 of 2: The U.S. Stake in Developing Mongolia's
Minerals

REF: Ulaanbaatar 0119

Sensitive But Unclassified - Not for Internet Distribution. Contains
proprietary and confidential business information


1. (SBU) SUMMARY: In reftel, we described the sharply deteriorating
investment climate for mining over the last year. Post recommends
raising many of those problems during the forthcoming Trade and
Investment Framework Agreement (TIFA) talks, because the U.S. has a
major stake in ensuring a favorable business climate for development
of and access by U.S. firms to Mongolia's mineral sector. As a
friend of Mongolia's economic and political transformation since
1990, we have an interest in ensuring that Mongolia gets right one
of the most important issues for its economic development, and
handles well the most important public policy challenge the country
faces. The mining sector also remains the most important
opportunity for U.S. commercial interests, both through potential
direct investments by U.S. firms, and through exports of
mining-related goods and services. The Embassy and USG have been
actively attempting to foster favorable trends, and some
international donors are also engaged. END SUMMARY.

Interest 1: Mongolia's Economic Future
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2. (SBU) Since Mongolia's peaceful democratic revolution in 1990, a
key aim for U.S. policy has been to encourage and assist Mongolia's
successful market economic transformation, and to help foster steady
economic growth. Development of Mongolia's mineral resources in
years to come will be essential to ease poverty (35% of the
population is classified as "poor") and bringing development to the
nation. Landlocked and sandwiched between China and Russia,
Mongolia's only comparative advantage is in producing and selling
natural resource commodities to its neighbors. It has very little
else to attract substantial foreign investment interest. However,
for the minerals sector to prosper, Mongolia will have to find a
development model that balances public need with commercial
interests and risks. The last year has seen reversals in this
quest.


3. (SBU) With the boundless optimism of a politician, President
Enkhbayar recently stated that he believes that minerals development
could allow Mongolian per capita incomes to rise to US$15,000 by
2021, an almost 1,500% increase from their current official GDP
levels.
Even the limited mining now occurring has dramatic impacts on the
local economy. The tax revenue generated by the state-owned (joint
venture with Russia) copper mine at Erdenet alone is the prime
support for the new social spending on children and married couples.
Placer gold revenues pump some US$400 million into the economy (or
at least they did before miners started withholding gold to avoid
the Windfall Profits Tax enacted last May). In a country of 2.6
million people, some 12,000 workers are directly employed by mining
firms. In one early impact of the deteriorating climate for mining
investments, Ivanhoe recently discharged some 1,000 workers because
they could not obtain an investment agreement on the Oyu Tolgoi
deposit from the GOM.

Interest 2: A Key Area for Governance
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4. (SBU) Since 1990, the U.S. also has sought to aid Mongolia's
democratic transformation. Getting mining development right is
among the top two or three most important public policy challenge
facing Mongolia. Because it involves state agencies, members of the
public and the political classes, and many foreign and domestic
businesses, any effective and balanced mining regime is bound to
have a salutary effect on the entire governmental, social, and
cultural fabric of Mongolia. On the other hand, if it gets things
wrong, Mongolia may cripple its economic future by driving away the
most responsible foreign investors. It may also squander government

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revenues derived from mining, and witness a further upsurge in
corruption fueled by mining wealth. The combined effects of such
missteps could endanger political stability and shake the faith of
Mongolians in the wisdom of their political choice in 1990 for
democracy and a market-oriented economy.

Interest 3: Commercial Opportunities
--------------


5. (SBU) Finally, Mongolia's commercial profile for the U.S. is
inextricably linked to mining; mining alone holds the prospect of
substantial U.S. exports. If a large U.S. or Western mining firm
enters Mongolia, a long tail of other U.S. exports are bound to
follow, including but not limited to heavy equipment (CAT,
Ingersoll-Rand, John Deere, etc.),services firms (like Fluor, which
Ivanhoe hired to start developing the Oyu Tolgoi mine, or minerals
trading by Gerald's Metals),financial and insurance instruments,
and the provision of expertise by U.S. consultants.


6. (SBU) Despite the generally deteriorating investment climate,
these desirable commercial outcomes have become more likely over the
last year with the advent of two major U.S. players into Mongolia.
U.S. coal and energy firm Peabody Energy and copper miner and
processor Phelps Dodge (PD) have respectively opened official
offices to pursue coal and copper opportunities. Peabody, which has
received extensive USG advocacy support, is interested in the Tavan
Tolgoi coal project among others, while PD is involved with
state-owned Erdenet copper mine on exploration projects. Both firms
have expressed the unambiguous desire to "do something" in Mongolia,
particularly because of its proximity to China. While expressing
some concern about whether projects will be commercially possible in
the current Mongolian political environment, they are confident that
they can work in Mongolia, if the Mongolians allow their legal and
regulatory environment for mining to mature transparently,
predictably, and fairly. Both firms have extensive records of using
the best practices and working with problematic governments in tough
locations; their involvement in Mongolia would help encourage
responsible, uncorrupt mining, while prospective Chinese and Russian
investors likely would have the opposite effect.


7. (SBU) Although Mongolia's political and economic environment
remains in turmoil, there is every reason to expect that American
players would find varying degrees of favor with the Mongolian
public, the GOM, and the politicians. Most Mongolian public
officials and politicians have expressed an unambiguous desire for
American firms to invest into Mongolia. National security concerns
(with U.S. investments working to underscore Mongolia's sovereignty
and increase bilateral ties, while avoiding economic control of
Mongolia's mineral wealth by neighbors China and Russia),the desire
for top technology, employment, tax revenues, and need for clean
environment, and a belief in the good faith of Americans, are the
stated reasons for this preference. In short, the Mongolians see
U.S. firms as key that might unlock to the door to their
development.

USG Efforts
--------------


8. (SBU) Recognizing the crucial role that U.S. firms and the USG
might play in development of mining in Mongolia, the Embassy has
sought to promote sensible policies on the mining sector and to
coordinate support activities with the various players -- donors,
businesses, and civil society and environmental NGOs. These efforts
have been boosted by the mining industry's newfound (albeit belated)
willingness to speak publicly and concretely about the deterioration
in the business climate. Our principles are:

-- First, we provide generic support for the mining industry writ
large. We regularly and consistently urge the Government of
Mongolia at various levels to move forward transparently and in good

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faith to strike deals following international best practices that
balance Mongolia's needs with commercial realities and risks. We
will also encourage the GOM and a wider Mongolian audience to move
prudently but expeditiously, or risk missing current opportunities
to benefit from Mongolia's resource endowments.

-- Second, we also stress the importance of good outcomes to the
first specific major projects discussed under the revised minerals
law -- real talks on real mining projects, most likely the Oyu
Tolgoi copper-gold prospect or the Tavan Tolgoi coal deposit --
because these will undoubtedly set the model for negotiations that
follow and provide the visible benchmark for all concerned, from
mining companies and the Mongolian government to the Mongolian
public. While our focus is wider than this specific aim, we also
provide particular advocacy efforts on behalf of firms whose
projects are identified by our U.S. Department of Commerce as
yielding material benefits to U.S. economic interests. To date, DOC
has endorsed advocacy for Peabody's efforts to be involved in
development of Tavan Tolgoi, and has provided very helpful advocacy
letters to senior GOM officials from Commerce Under Secretary
Lavin.

Other Foreign Efforts
--------------


9. (SBU) The World Bank (WB) and the International Finance
Corporation (IFC) have joined with the European Bank of
Reconstruction and Development (EBRD) to support Mongolian efforts
to develop responsible mining in Mongolia. The WB's Mongolia
Country Representative recently explained the nature of the
WB/IFC/EBRD efforts to Commoff. The three donors have undertaken to
produce a "Scoping Study on Mining in Mongolia," which has been
recently released to senior GOM officials. The study is a broad and
deep argument that Mongolia needs to adopt a holistic approach to
dealing with mining that accounts for the implications of specific
projects in their industrial, local, regional, and national
implications. The WB Rep noted that IFC and EBRD would look after
the commercial aspects of the technical assistance, while the WB
funds technical assistance for all other non-commercial areas,
including but not limited to labor issues, environment, social
impacts, cultural implications, etc.

Goldbeck