Mongolia's Coal: Dispelling That Old Black Magic

UNCLAS SECTION 01 OF 06 ULAANBAATAR 000002

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MANILA AND LONDON FOR USEDS TO ADB, EBRD

E.O. 12958: N/A
TAGS: ENRG EMIN PREL ELTN ETRD MG
SUBJECT: Mongolia's Coal: Dispelling That Old Black Magic

Ref: a)Ulaanbaatar 712, b)Ulaanbaatar 652

SENSITIVE BUT UNCLASSIFIED - NOT FOR INTERNET DISTRIBUTION


1. (SBU) SUMMARY. A few Mongolian officials claim that Mongolia's
coal deposits stretch west to east in an unbroken (and
unsubstantiated) 170-billion ton belt of untapped hydrocarbon
wonder. However, Western firms actively prospecting for both
thermal and coking coal argue that Mongolia's coal reserves, while
respectable, are deposed in discrete basins rather than a titanic
belt. But there are some major nuggets among these deposits, such as
the exceedingly fine and well-situated six billion ton coking and
thermal coal Tavan Tolgoi (TT) deposit near the Mongolia-China
border, for example. Moreover, no matter the size of the deposits,
companies warn that coal is only valuable if, and only if, it can be
brought to a market economically, which in Mongolia's case must be
China. What makes some Mongolian coal marketable is its high
quality, good location, and fit with the needs of Chinese and
regional demand. The key point is that Mongolian coal offsets demand
elsewhere in China and Asia, making it a very fungible asset. This
market-driven truth has led most of those exploring Mongolia's coal
reserves to concentrate their exploration investments in the Gobi
desert coal reserves bordering China. Firms remain highly critical
of the Government of Mongolia's (GOM) tendency, in recent years, to
sometimes be arbitrary, un-transparent, or inconsistent with respect
to the implementation of its mining laws. END SUMMARY.

A Rhapsody in Black
--------------


2. (SBU) Experts say Mongolia has lots of coal, some exceedingly
fine and well-situated: The six billion ton coking and thermal coal
Tavan Tolgoi (TT)deposit near the Mongolia-China border comes to
mind. However, hard-nosed questions about the nature, quality,
size, and marketability of Mongolia's deposits remain unanswered. No
matter, a few in the GOM rhapsodized about its titanic reserves,
officially claiming that a vast, wide belt of at least 170-billion
exquisite tons of coking and high-Btu thermal coal stretches from
the Altai Mountains in the west to the south eastern wastes of the
Gobi desert. Add to these deposits substantial coal reserves in the
eastern steppe provinces.. However, in their private moments many
GOM officials concede that they really do not know how much they
have or much about its quality-let alone how it might be mined and
marketed.


3. (SBU) (Note: During a recent meeting with executives from U.S.
coal miner Peabody Energy, a senior Mongolian official noted that
everyone was enthusing about Mongolia's wonderful coal reserves.
The official recounted how the former Minister of Industry and Trade

B. Jargalsaikhan told him that Mongolia had over 170 billion metric
tons of coal. "Really? So much?" said the official. Then
Jargalsaikhan hesitated -- well, perhaps, more like 100 billion
tons, may be less. It seemed, noted the official, "that
Jargalsaikhan wanted to negotiate the amount of coal in the ground,
but the truth is that we really don't know how much we have got."
For reference and comparison, the Department of Energy's
International Energy Outlook 2007 report put the world's recoverable
coal reserves estimate at 998 billion tons, including U.S. reserves
of 207 billion tons. End Note.)


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4. (SBU) What is known is not discouraging, however. All but two of
Mongolia's 21 provinces have coal deposits, which locals mine. As
to the actual amount in the ground, it might be the fabled 170
billion tons, but in any case conservative estimates based on the
activities of western exploration firms and current coal miners
suggest that proven or inferred coal resources currently reach some
15 billion tons. While most western miners privately tell us they
believe that actual deposits are substantially higher. While these
miners say the 170 billion ton figure is not out of the ballpark,
they are unwilling to go on record beyond what their respective
assessments have revealed. Most of Mongolia's deposits are "brown"
(brown meaning dirty, high-sulfur),low thermal value coal, which
can be economically mined and shipped short distances for winter
heat. Basically, Mongolia's known coal deposits range from dirty,
high-sulfur, low (3,000-5,000) Btu coal to fine thermal and coking
(metallurgical) coals of 7,000 Btu and above. Approximately four out
of approximately eight million tons of brown coal annually produced
from local mines goes to domestic use, the remaining four million
tons is exported, primarily from mines located in Omengobi province
near the China-Mongolia border (Little Tavan Tolgoi, see ref; and
Naran Sukhat). About half of domestic production, most of which
powers Ulaanbaatar and its satellites, the state-owned copper mine
at Erdenet, and the city of Darkhan, comes from two mines,
Sharyn-Gol and Baganuur, both privately held but with substantial
GOM interaction. Incidentally, both mines are part of discrete coal
basins that fall well out of the fabled coal belt.

They're Dreaming of a Black Christmas
--------------


5. (SBU) Coal's ubiquity has led GOM boosters to latch on to the
notion of a coal belt. GOM mining experts have discreetly explained
that in an effort to promote Mongolia and, out of willful ignorance,
their appointed colleagues as well as some politicians, have assumed
and asserted that the presence of coal in most provinces reflects a
certain sort of deposition of the resource in Mongolia.
Specifically, because it's everywhere in Mongolia, they surmise that
coal must have been laid down in one monstrous slab during a single
geological epoch, and that this hydrocarbon mother-load must be of
the best quality -- good enough quality to make companies throw
economic realities to the wind and strike any sort deal the GOM
demands.


6. (SBU) One concept, broached before industry by former Ministers
of Industry and Trade Jargalsaikhan and Davaadorj respectively, had
the GOM reclaiming (expropriating?) many of the coal exploration and
mining rights, consolidating these tenements into lots, and
tendering those lots to strategic investors, who would join with the
GOM in joint venture companies in which the GOM maintained majority
positions. That now largely discredited breath-stealing vision --
requiring a large investment in a small piece of a very big pie --
would see mining conducted along the entire length of the coal belt
to the tune of one (1) billion tons a year, with western, Chinese,
Russian, Korean, and Japanese firm each tending their own gardens of
coal, with their respective state-owned Mongolian JVC. This vision
was proffered without reference to the lack of infrastructure in the
coal-bearing regions, the quality of coal in each region along the
so called belt, the economics of getting to a viable market, or any
other consideration that should attend embarking on such ventures.


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7. (SBU) These ministers have gone, but their concepts persist in a
somewhat less-fevered incarnation. They certainly inform the model
the GOM is considering for Tavan Tolgoi. According to the new
Minister of Industry and Trade Narankhuu, the new government has
already begun steps to take back the privately held TT licenses
(reftel) in preparation for GOM exploitation of TT in some sort of
JVC arrangement with a private strategic investor (and maybe
operator) expert in coal mining.

We Won't Dance, GOM, With You
--------------


8. (SBU) Publicly, the local and foreign mining industry has
responded coolly to the coal belt concept, reserving most of their
heat for promoting their respective prospects. There is no question
that firms from all over the world of various sizes are actively
exploring Mongolia--from smallish Mongolian, Canadian and Hong Kong
juniors with small market caps, to huge private and state-owned
giants-BHP Billiton (BHPB),Rio Tinto (RT,) Peabody Energy, Chinese
SOE Shenhua, and the Russian public-private consortium of Renova,
Severstal, and Basic Element. Beyond expressing interest in
developing Mongolia's large deposits in concert with the GOM, the
major players keep their own counsel about what the GOM does and
says. The smaller players, fearing that GOM talk of re-claiming or
expropriating coal licenses will drive share prices down, focus on
the prospective size of their respective holdings and the possible
markets for them.


9. (SBU) For example, the Mongolian Energy Corporation (MEC) is
listed on the Hang Seng Index, and is primarily owned by a shadowy
set of Hong Kong and Chinese investors out of Urumqi, Xinjiang.
Prior to the listing, the primary shareholders announced that their
exploration site in Khovd Province was situated on over a billion
tons of high quality coking and thermal coals, or so they claimed
they had been told by the Mongolians who sold the tenement to them.
This initial public enthusiasm has cooled, following the hiring of
an American team to manage exploration and mining operations. The
American team down-graded the deposit to about 200 million tons of
low-end coking coal, which the Chinese steel industry could use,
though the Americans note that western steel firms would reject it
in foundry operations. Although MEC's owners plan to mine no later
than summer 2008, the American managers have told us that 2009 is
more likely, but they're hardly sanguine, noting that the decision
to mine still has to overcome such issues as lack of roads and rail,
water supply, power generation, and the fact the coal is perhaps too
far (over 500 km) from any viable market to be economically shipped.
RT, which also has a coking and thermal coal prospect deposed a
discrete basin in a remote northern corner of the western province
of Gobi-Altai, shares MEC's concerns about lack of infrastructure,
transport costs, and marketing.


10. (SBU) Technical specialists at a Canadian firm, South Gobi
Energy resources (SGER),also echo the MEC Americans' conservative
view. SGER was spun off by Canadian Ivanhoe Mines Mongolia Inc
(IMMI) to serve as an operations, management, development,
exploration company for IMMI's coal holdings in Mongolia. Relative
to other coal exploration firms, SGER has the single largest holding
of exploration rights for Mongolian coal prospects. SGER possess 54
exploration tenements. All located in Omengobi province, these
holdings cover some 2.2 million hectares, and currently cost SGER

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some US$4.4 million a year in fees and exploration costs. (Note:
IMMI also holds controlling interest in the giant Oyu Tolgoi
copper-gold project. Rio Tinto is IMMI's partner in this venture.
BHPB is a minority partner in SGER.)


11. (SBU) SGER has rejected GOM claims about a coal belt. Combining
Soviet-era data with their own studies, SGER concluded that
Mongolia's best thermal and coking coal deposits were in the South
Gobi, particularly in Omengobi Province. They believe that the South
Gobi has world class deposits rivaling in quality and quantity
similar deposits found any where else; and so, have focused on that
region exclusively. Because they can find no evidence for its
existence, SGER experts reject the notion of a "coal belt;" rather,
arguing for a series of discrete basins separated from each other
geographically and geologically. This conclusion is shared by every
professional miner with whom we have spoken, including experts from
RT, BHPB, Peabody, and the American management team at MEC, as well
as other Canadian firms actively exploring Mongolian coal and GOM
sources from the Mineral Resources and Petroleum Authority of
Mongolia (MRPAM).


12. (SBU) But the situation presents something of a conundrum for
SGER and others exploring for coal. Many of SGER's exploration
rights lie along the supposed "coal belt," but SGER doesn't believe
such a feature exists. However, not wanting to lose a potential
mother-load, SGER will conduct drilling throughout these holdings
over the next three years to ascertain just what might be present.
In most cases no previous data for coal exists on these holdings,
which were explored for metals but not coal. If nothing shows up on
drill cores, the tenements will be relinquished. SGER anticipates
spending US$10 million over the next three years.


13. (SBU) Cold economics also drives SGER's Gobi fixation. SGER
knows about MEC and RT's respective prospects but asserts that
market forces render both of these and any other western coal
deposits long shots at best. For SGER, Gobi coal-and Gobi coal
alone-is commercial because it is close to a market - China. Based
on this concept, SGER has recently converted an exploration license
on its Ovuut Tolgoi prospect, in south western Omengobi province, to
a mining license. Ovuut Tolgoi has some 150 million tons of thermal
and coking coal, with 100 million tons economically recoverable
through opencast operations. For SGER economically recoverable means
that the firm will derive a minimum return of 10% for each dollar of
coal mined, washed, and exported. The plan is to wash the coal in a
facility that will cost between US$50 to $100 million depending on
the volume of coal to be processed. SGER forecasts annual production
to peak at approximately 5 million tons.


14. (SBU) The target market for Ovuut Tolgoi's coal is China's north
central region, primarily but not limited to the provinces of Gansu
and Inner Mongolia. SGER argues that it cannot economically ship
thermal coal from Mongolia to Chinese markets more than 500KM from
the mine. Coking coal can be economically sent to Japan (or any
other global location for that matter) from Ovuut Tolgoi, but SGER
will have to mine thermal seams for 5-7 years before reaching the
coke seams; and so, must consider China for its thermal coal.
Although the Chinese border provinces have vast thermal coal
reserves, much of this coal needs to go south to meet PRC planning
requirements, leaving Inner Mongolia and other North central
industrial regions with a coal deficit. Mongolian coal, therefore,

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fits into PRC develop plans. 42 km from the Chinese-Mongolian
border, Ovuut Tolgoi will have a rail link built to it that can feed
into Gansu's Jiayuguan industrial complex and Inner Mongolia's
Hohhot and Baotou industrial centers.


15. (SBU) Peabody Energy shares SGER's Gobi focus, and is primarily
seeking exploration and mining rights on deposits within 300 km of
the Chinese provinces that border Mongolian provinces. Although
Mongolia does have substantial deposits of coal outside of the Gobi
and in certain border provinces, so far exploration has shown these
deposits as low to middle quality thermal coal, which cannot be
shipped profitably to any international market. Current holders of
rights in Mongolia's central provinces, among them the Canadian
junior exploration firm Redhill Energy Ltd., talk of mining coal for
export to Russia, or for domestic consumption, or for conversion to
liquids or fuels. But Peabody, SGER, and the MEC American team
dismiss such possibilities. Russia with its own substantial coal,
hydro, and petroleum reserves-along with a power generation
infrastructure-is not a customer for Mongolian thermal coal but a
competitor, although it could be an investor as well.


16. (SBU) Coal to liquids (CTL) or coal to fuels (CTF) might be
possible but transport costs still apply as do economies of scale,
which may not exist for CTL/CTF in Mongolia. Peabody, with its
experience as a power generator, certainly considers converting
Mongolian coal to electricity a viable option but notes that doing
so is a long way off, and believes that generating electricity from
mine mouth power plant should be done from border provinces because
of lower infrastructure development costs entailed in establishing
power grids linked to China.


17. (SBU) Japan' is also a driver in the overall development of
Mongolian coal. Japanese foundries need coking coal badly and are
talking with SGER (and other Gobi coal deposit holders as well)
regarding Ovuut Tolgoi and SGER's other prospects. Unnamed Japanese
investors would acquire Ovuut Tolgoi and send it into China,
swapping it for coking coal produced nearer to China's coast. As
coking coal is worth more than thermal coal, Japan would pay a cash
premium to offset the added value of the coke. No decision has been
reached yet. But the key point is that Mongolian coal offsets
demand elsewhere in China and Asia, making it a very fungible
asset.

Let's Misbehave!
--------------


18. (SBU) SGER states that the central government -- not provincial
or local governments -- prevent Ovuut Tolgoi's start-up. First, the
Mineral Resources and Petroleum Authority of Mongolia (MRPAM) must
approve the mining plan before activity can begin; however, MRPAM
has set out no process for doing this; and so, seems to have a wide
discretion over how a mine might be run. There are as yet no
regulations, standards, guidelines, etc., for SGER to follow, and
SGER is concerned that MRPAM might very well apply some socialist
era model of mining production to a 21st Century commercial
activity. So having a mining license does not mean that one can
mine; rather, it means that one can proceed on to another permitting
phase.


19. (SBU) However, another Canadian coal junior, QGX has had a

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somewhat different experience. QGX's prospect is located slightly
north and west of TT, and holds in excess of 500 million tons of
high quality thermal and coking coal, which has attracted the
interest of several U.S. equity investment firms, among them Oaktree
Capital. However, QGX's ability to access its rights have been
muddied by the local soum's (county) surprise re-categorizing a
large swath of the exploration tenement as special use area. There
is no legal basis for this claim, according to QGX, especially as
the soum is asserting the right quite late in the game. QGX
believes that the local is using its special use powers to attempt
to extract some extra legal payment and plans to go to court.
However, as reported in post's 2008 Investment Climate Statement,
the arbitrary taking may stick as the neither the courts nor the
central government may be willing to support QGX's recourse to the
law.


20. (SBU) Another problem is how the GOM registers coal resources.
SGER says that it can economically recover coal in seams as thin as
a third of meter; however, the GOM, using a Soviet-era calculus
based on outmoded technology states that a seam must be two meters
wide or more to be considered recoverable. This ruling has lead to
SGER, which claims that other firms do the same, to file two sets of
resource estimates. One estimate consistent with Canadian
requirements is higher than the one prepared for the GOM, which
requires that the firm explain the discrepancy to investors who are
given both sets of estimates.

Minton




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