MPs Buying Votes by Nationalizing Mongolia's "Strategic"

UNCLAS SECTION 01 OF 05 ULAANBAATAR 000118

SIPDIS

SENSITIVE
SIPDIS

STATE PASS USTR, USTDA, OPIC, USGS, AND EXIMBANK
STATE PASS DOI/BLM FOR TESS BENNINGTON
STATE FOR EAP/CM AND EB/IFD/OIA
USDOC FOR ITA
USAID FOR ANE FOR D. WINSTON

E.O. 12958: N/A
TAGS: ETRD PREL EAID ECON EFIN PGOV MG
SUBJECT: MPs Buying Votes by Nationalizing Mongolia's "Strategic"
Mining Assets?

SENSITIVE BUT UNCLASSIFIED - NOT FOR INTERNET DISTRIBUTION.


1. SUMMARY AND COMMENT: Mongolia's Parliament and Prime Minister S.
Bayar's administration have, in post's view and that of western
mining firms, embraced a decidedly anti-business set of mining
amendments, likely to be passed during an upcoming recess session of
Parliament. The amendments are poorly drafted, contain hints of
possible expropriation and emerged through an exceptionally
un-transparent process. Faced with the selective nationalization of
key mining assets (vaguely defined "strategic" assets),several
foreign and domestic mining firms have chosen to slow, suspend or
cancel their operations in Mongolia. Aware of these impacts but
facing re-election in June, MPs from both the ruling Mongolian
People's Revolutionary Party (MPRP) and the opposition Democratic
Party(DP) have apparently decided that they can't oppose populist
legislation and survive the elections. So, they believe proving
their love for Mongolia might be the ticket to electoral success.
Post and mining firms have engaged in quiet efforts to lay the
groundwork for a more market-oriented approach following the 2008
Parliamentary/2009 Presidential election cycle. END SUMMARY AND
COMMENT.

KEY CONTROVERSIAL PROVISIONS
--------------

2. (SBU) An extraordinary session of Mongolia's Parliament will be
convened on March 25 to consider a set of amendments to the
controversial 2006 Law on Mineral Resources. The new amendments
contain provisions that have generated intense concern among all
stakeholders. The provisions are as follows. (Although the wording
is rendered in tortured English, Post is loathe to change the text
lest we alter the legislative drafters' intent.)

-- A. A "mineral deposit of strategic importance" means a deposit
with "exceptional impact on national security, independence, economy
and social development considering its reserve quantity, location,
economic benefits and mineral classification."

-- B. "If the Mongolian Government, (a) Mongolian legal person or
Mongolian citizen mines a mineral deposit of strategic importance in
cooperation with a foreign legal entity, the foreign company's
ownership percentage shall not exceed 49% of the equity."

-- C. "In its capacity as the owner of the deposit, and when
granting mineral mining licenses, the State shall take in advance
its percentage of the value of the deposit, according to the
feasibility study on the deposit and the conditions of an
agreement."

-- D. "To establish a National Council consisting of representatives
of the State and civil-society organizations in order to have
transparent mining operations on strategic deposits under public
control, provide advice and assistance on agreements related to
deposits of strategic importance, and to undertake independent
monitoring on mining and tendering of such deposits; and to approve
the National Council Charter."

-- E. "To grant companies that have operated no less than 15 years
the preemptive right to conduct their activities in areas adjacent
to the deposits mined by such companies."

INDUSTRY VEHEMENTLY OPPOSED
--------------


3. (SBU) Western mining companies and many domestic mining firms
have not been shy in conveying to Post their vehement, angry
opposition to these amendments. They argue that the amendments are
poorly drafted and unclear. For example, Provision A does not
clearly define what would or would not be considered "strategic,"

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giving the GOM and Parliament almost unlimited authority to declare
any sort of deposit "strategic" -- meaning that the state gets 51%
right off the top. Mining companies ask: What constitutes a
national-security issue as far as a mining asset is concerned? What
sort of social and (or) economic impact would trigger a strategic
designation? These questions have lingered since the concept was
first included in the 2006 Law, and the latest amendments fail to
clearly define the concept in a way that would enable investors to
gauge the likelihood of the state making a claim on a deposit.


4. (SBU) Adding to the complexity, Provision B seems to provide for
non-state majority ownership of strategic deposits as long as the
owner is Mongolian: GOM, Mongolian legal entity, or Mongolian
citizen. However, as local attorneys have pointed out, current law
requires all mining-license holders to be Mongolian legal entities,
and allows foreign firms to register as Mongolian legal entities for
this purpose. These amendments do not disqualify any Mongolian
legal entity from owning a strategic deposit, no matter nationality
of the ultimate owner, which seems to fly in the face of the intent
to assure Mongolian control over the mining asset. (Note: A reliable
Embassy contact explained that this provision represents something
of an uneasy compromise between the ruling party and the opposition,
both of which have agreed to support the legislation at the
Parliament session that opens on March 25. The opposition
Democratic Party (DP) favors majority non-state
involvement/ownership, so long as it is Mongolian citizen or legal
entity involvement. Given the past behavior of Mongolian mining
interests in complying with existing laws and regulations, the
ruling Mongolian People's Revolutionary Party (MPRP) is less
confident about allowing private Mongolian interests a seat at the
table, and believes that state interests are better secured through
direct state involvement. End Note.)

NO REFLECTION OF BEST PRACTICES
--------------


5. (SBU) According to international investors, the amendments do not
reflect commercial best practices in any way, shape or form. Most
Mongolian mineral deposits lack even the most basic infrastructure,
forcing rights holders to expend significant resources to extract
any deposit. The GOM relies on mining companies to supply
much-needed resources and expertise, but at the same time seems
determined to limit their rights. Some GOM sources tell us that
mining companies will be expected to finance the GOM's investment,
but will not receive operational or managerial control commensurate
with their contribution. Furthermore, companies have pointed out
the GOM's inherent conflict of interest in regulating and enforcing
mining, tax, environment, health and safety laws, while being the
majority owner of an ongoing operation. Western firms have rejected
the 51% claim outright as absolutely unworkable in its current form,
claiming that they will not enter into any agreement under such
conditions.

ADJACENT PROPERTIES
--------------


6. (SBU) Mining companies have also taken exception with the
amendments' granting of exploration and mining rights on adjacent
properties to holders of strategic deposits. They argue that this
new power would give special rights to the holders of strategic
deposits -- which under the proposed law could be a state-owned firm
or a Mongolian-owned firm -- to take expropriate whatever land it
wanted near any strategic deposit. GOM officials have been publicly
asked by the business community whether adjacent holdings were at
risk, and have stated categorically that exploration rights have
been formally delineated and are not for the GOM's taking. This
provision seems to contradict such statements.


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OPAQUE PROCESS
--------------


7. (SBU) The entirely un-consultative and un-transparent nature of
the amendment process has come under heavy criticism. Both Post and
businesses have gotten their hands on updated revisions of the
amendments, but only in the strictest confidence from key contacts
on the GOM minerals law working group who fear retribution from the
GOM if their activity became public knowledge. Given the
atmosphere, it has been impossible to verify whether the information
we have been receiving is up to date and complete. As one long-time
Mongolia-based mining expert noted, there still is no requirement
that Mongolian legislation be publicly vetted.

COMPANIES DISCOURAGED; A FEW MINOR PLAYERS EXIT
-------------- --


8. (SBU) Many mining companies say these amendments have had the
most discouraging impact on their investments to date. Generally,
those already on the ground have not pulled out, but they have
limited their exploration and development investments until matters
clarify. Some prospective western players have decided to forego
entry for now. One western equity investor told Commoff that it had
cancelled plans to invest US$100 million in a coal prospect because
of this amendment process. The mine did not seem to be a strategic
deposit, but with the amendments so vague and the GOM so
inconsistent, the risk was too high. A few firms (Blue Rock and
Fortress -- strictly protect) are selling out and departing for
good.

RIO TINTO: 51% GOM STAKE A DEAL-KILLER
--------------


9. (SBU) For major players like Rio Tinto (RT),a 51% GOM stake
would kill any deal, but RT tells us that rather than pulling out
altogether now, they will move to care and maintenance operation
(CMO) -- no mining activity, just barebones development -- until or
unless the GOM provides terms that reflect commercial realities. RT
tells us it has already canceled US$400 million in contracts for
equipment to be used at the massive Oyu Tolgoi (OT) copper and gold
deposit, and that other cancellations will occur in upcoming
months. This will cost RT and its partners sizable financial
deposits in advance of fabrication and, more importantly, RT's place
in the manufacturing cue. It may be two or three years for the
firms to get their places back in line, at which point costs will
almost surely have risen. For U.S. export interests, these
cancellations may cost US$200 million up front. Another victim of
this amendment process is employment; the number of RT's OT-based
jobs has dropped from 1,500 employees a year ago to a 600-person
skeleton crew.

LEGAL DEFENSE BEING PREPARED
--------------


10. (SBU) Although Mongolian law and the current amendments seem to
allow for a CMO, RT and others fear that demagogic and populist
politicians might use a CMO as an excuse to expropriate RT's mining
licenses. Consequently, RT is preparing legal defenses allowed
under their right to seek international adjudication and under the
current Bi-lateral Investment Treaty between the U.S. and Mongolia.


11. (SBU) Rio Tinto's approach has been to talk softly in public,
showing all due respect for Mongolian laws and customs, but to make
clear in private that any mine must operate according to
international best practices, which the GOM has said it wants to
institute in Mongolia. As a carrot, if some solution could be
found, RT has indicated a willingness to deliver advance payments to
the GOM, in lieu of future revenues in the neighborhood of US$120

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million. The GOM, Parliament and the various parties have already
promised voters rewards from mining, and the advance payments would
certainly be needed to honor election commitments (a point not lost
on any of those involved in this dispute).

"LARGE AND IN CHARGE"
--------------


12. (SBU) The GOM and Parliament, and particularly powerful
officials of the ruling MPRP, are anxious to show voters that when
it comes to mining, they are "large and in charge." All regular
Embassy contacts at the Ministry of Industry and Trade, the State
Property Committee and the Prime Minister's Office have been blunt,
emphatic, and consistent about the Bayar Government's aims in the
run-up to the June 29 parliamentary elections:

-- Pass legislation that shows that this Government is decisive on
issues of special interest to the public: mining, taxes, alcohol
sales, etc.;

-- Prove that the MPRP loves the nation and will protect its
interests against acquisitive foreign interests, especially those in
the resource-extraction sectors;


13. (SBU) Consequently, our sources say, even if the GOM officials
think a piece of legislation is poorly drafted and/or too
nationalistic for commercial success, the MPRP will ram it through
Parliament, regardless of immediate consequences to investors,
public interest, or the long-term impacts on the sector, because it
wants to win and thinks this sort of legislative activity is the
path to electoral success. The sources add that this populist
agenda is driven, in part, by the very real fear that without it,
Mongolia's sovereignty would be jeopardized by China or Russia.

MPRP, DP REACH CONSENSUS
--------------


13. (SBU) The amendment debate has brought the MPRP and DP to a
bipartisan commitment to pass the amendments in the upcoming
Parliament session. During the week of March 10, DP Chief
Elbegdorj appeared on TV with PM Bayar, and both announced that
their parties would join forces to pass the mining amendments. This
agreement headed off what could have been a murderous debate in
Parliament. MPs might otherwise compete against each other to woo
voters with offers of cash and development (while hurling charges
that their opponents were selling out the nation) . Seasoned
observers of Mongolian politics noted that regardless of whether the
uncommon bipartisanship favored one party or the other, it was
probably better for both sides to show that on this issue, they
could work together for Mongolia rather than rehash charges that
might inspire voters to curse both parties.

SOME DP MPS MIGHT NOT PLAY BALL
--------------


14. (SBU) However, post has received information from a dissident
element within the DP, who claims that not all members will support
Allegory's bipartisan approach. They apparently do not like ceding
leadership on mining to the MPRP, which Elbegdorj seems to have done
by agreeing to support Bayar's amendments. In addition, they
believe that the 51% figure is anti-business and un-workable, and
want to find a way to short-circuit next week's legislative process.
They have apparently not spoken out against the bill for fear of
being labeled as traitors to Mongolia's national interests. They
say their strategy will be to question each and every word, figure
and sentence, consuming so much time that the bill will not be able
to pass during the session.


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COMMENT
--------------


15. (SBU) 'Tis the (election) season, and the GOM and Parliament
seem hell-bent on getting the amendments passed. We see no
indication that any amount of criticism from mining companies or the
diplomatic corps would deter the MPs from the swift completion of
their appointed rounds. For the international community, post
believes the proper course would be to encourage the GOM and
Parliament to proceed with great care and caution - following
international norms and best practices, but the sad political
reality is that the current climate favors reckless speed, rather
than thoughtful consideration. When the subject has been raised
with GOM and Parliamentary interlocutors, Post has calmly but firmly
noted that the inequitable, anti-business path down which
Mongolia's mining sector is headed will not yield the development
and revenues that Mongolian so desperately needs. In addition, post
has been working with GOM and Parliament officials, providing
information on how the USG deals with similar issues in its own
mining sector. Although post has not sought out opportunities to
comment on these amendments, we believe when asked we can not remain
silent but reflect back what the business community has said about
risks and damage done to international corporate perceptions of
Mongolia's business climate. One component of this approach has
been efforts by the Department of Interior's Bureau of Land
Management (BLM) to consult with those Mongolians charged with
crafting the amendments. These expert-to-expert consultations (via
Digital Video Conferencing hosted by post) have gone some way toward
correcting the willful mischaracterizations of USG mining practices
used by some Mongolian officials and politicians to justify these
amendments. (Post thanks BLM for these efforts and for future
support.) Post will leverage these and other consultations to create
relationships with those Mongolians whose opinions have affected
this set of amendments and will likely affect future legislation and
regulation, laying the groundwork for reconsideration of a more
commercially-based approach to regulating the sector after the
2008/2009 political season. END COMMENT.
Minton