Mongolia, Rio Tinto/Ivanhoe Reach Deal on Oyu Tolgoi Copper

UNCLAS SECTION 01 OF 02 ULAANBAATAR 000216

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SUBJECT: Mongolia, Rio Tinto/Ivanhoe Reach Deal on Oyu Tolgoi Copper
Mine

Ref: a) 05 Ulaanbaatar 0266; b) Ulaanbaatar 0119,

c) Ulaanbaatar 0123

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1. (SBU) SUMMARY AND COMMENT: Mongolia and Rio Tinto/Ivanhoe broke
through a four-year long negotiating logjam to reach a deal which
will allow development of the world class Oyu Tolgoi copper mine.
To try to counter reflexive public criticism by opposition MPs and
civil movement populists, and to help ensure the deal will receive
the necessary parliamentary endorsement, the Government of Mongolia
(GOM) underlined the economic advantages to Mongolia, including tax
revenues which will amount to at least 13% of the country's current
GDP. While details of the deal have yet to be fully revealed, both
sides appear to have compromised. The GOM agreed to pay for its 34%
equity stake with its share of the future profits from the mine,
rather than its original request to receive the equity for free.
Rio Tinto and partner Ivanhoe agreed to smelt the copper in
Mongolia, rather than ship it out as concentrate, which avoided the
government having to exempt the project from the Windfall Profits
Tax on concentrate and also met the government's wish for more value
added. GOM officials involved in the negotiations hope this will
set a positive, useful precedent, and calm growing investor concerns
about Mongolia's investment viability. END SUMMARY AND COMMENT.


2. (U) Ministry of Finance State Secretary Kh. Hurelbaatar
announced in an April 10 press conference that the Government has
Mongolia has reached an agreement with mining giant Rio Tinto and
Ivanhoe Mines of Canada that will allow the western commercial firms
to develop the world class copper-gold Oyu-Tolgoi (OT) deposit
located in the South Gobi desert. The deal, or investment agreement
as it is termed in Mongolian law, has not been fully publicized yet,
but Khurelbaatar stated that outstanding details on state equity,
the windfall profits tax, financing, and other developments at the
OT had been settled. Under Mongolian law, the agreement will need
to be approved by Parliament.


3. (U) Khurelbaatar said that the Ministry of Finance estimates
that over the life time of its operations the GOM will receive some
US$15.5 billion in revenues or about US$340 million per year. By
contrast, Ivanhoe has projected that government revenues would
conservatively be some US$26 billion or nearly US$600 million/year
for the 45-year life span of the mine. OT development costs are
estimated at around US$2.1 billion dollars over the next three
years, meaning that Rio-Ivanhoe FDI will raise the Mongolian GDP --
hovering around US$2.6 billion -- by some 25% year-on-year during
development. (Ref A describes the development and refs B and C
overview U.S. interests in Mongolia's mining potential.)


4. (SBU) The agreement followed four long years of often tortured,
on and off again negotiations. Rio Tinto and Ivanhoe executives
close to the negotiations had always told us that the key stumbling
block had been the GOM's demand for an equity stake in OT,
apparently without paying for it. Ivanhoe and RT have always held
that the mine would not be commercially viable with a 34% free
carry. For its part the GOM had painted itself into a corner by
claiming that it would not pay for resources that already belonged
to Mongolia, and could not face the public unless it could claim
that it received some equity for free. A breakthrough in principle
seems to have come last week when the Minister of Finance, in his
capacity as acting Minister of Industry and Trade, told foreign and
domestic miners that the GOM would pay for any equity share it chose
to take under recently amended mining law of Mongolia. Compensation
would be from: (a) state funds; (b) international financial markets;
(c) tax exemptions.


5. (SBU) At the press conference, Khurelbaatar stated that the
Mongolian Government would receive 34% of the "Oyu Tolgoi" project

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free of charge and that RT-Ivanhoe will finance the project
entirely. However, although vested in the project fully, the GOM
will earn its share by deferring profits from its share. Based on
available information, it seems as if the government has not
exempted the mine from corporate taxes and royalty payments nor
walked back from receiving a piece of the mine without paying
anything up front, but it still has committed to paying for what it
gets.


6. (SBU) The other detail that has come out is a work around for the
Windfall Profits Tax (WPT),which caused major consternation among
miners when it was abruptly enacted in May 2006. Rio-Ivanhoe had
always told emboffs that a 68% tax on copper profits for copper
concentrate for all copper over US$2600 per metric ton imperiled
OT's commercial viability. The GOM's position -- based on a clear
and consistently expressed desire adding value in Mongolia -- was to
note that the WPT does not apply to smelted ore. RT-Ivanhoe had
always held that smelting in Mongolia would not be commercially
viable. The GOM and several other mining industry experts
questioned this position, wondering why it would be cheaper to ship
out huge amounts of copper concentrate with its high percentage of
money-loosing dross than it would be to send out value-added cathode
or even copper wire or other copper products.


7. (U) Rio-Ivanhoe has acceded to the GOM's policy in this area to
get its WPT waiver. Under the agreement, the company has apparently
agreed that from initial operations projected to begin in 2010 and
run till 2055, that it will smelt copper from open pit and shaft
operations at a mine-mouth, state of the art smelter. Such a
decision will require development of energy, road, rail, and other
related developments to service the mine and ore concentration and
smelting facilities.


8. (U) Post will continue to monitor and report on details of this
pivotal agreement as they unfold.

Goldbeck