Identifier
Created
Classification
Origin
08ULAANBAATAR527
2008-12-08 06:18:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy Ulaanbaatar
Cable title:  

REFLECTIONS ON A SLAG HEAP: WINNERS AND LOSERS CONTEMPLATE

Tags:  EINV PREL PGOV ETRD EMIN ENRG MG 
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RR RUEHCN RUEHGH RUEHVC
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ZNR UUUUU ZZH
R 080618Z DEC 08
FM AMEMBASSY ULAANBAATAR
TO RUEHC/SECSTATE WASHDC 2588
RUEHOO/CHINA POSTS COLLECTIVE
RUEHUL/AMEMBASSY SEOUL 3596
RUEHKO/AMEMBASSY TOKYO 3260
RUEHMO/AMEMBASSY MOSCOW 2458
RUEHVK/AMCONSUL VLADIVOSTOK 0344
RUEHOT/AMEMBASSY OTTAWA 0723
RUEHBY/AMEMBASSY CANBERRA 0339
RUEHTA/AMEMBASSY ASTANA 0088
RUEHDBU/AMEMBASSY DUSHANBE 0015
RUEHEK/AMEMBASSY BISHKEK 0153
RUEHAH/AMEMBASSY ASHGABAT 0111
RUEHNT/AMEMBASSY TASHKENT 0006
RHEHAAA/NATIONAL SECURITY COUNCIL WASHINGTON DC
RUEHLMC/MILLENNIUM CHALLENGE CORP WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEKJCS/SECDEF WASHINGTON DC
UNCLAS SECTION 01 OF 05 ULAANBAATAR 000527 

SENSITIVE
SIPDIS

STATE PASS USTR, USTDA, OPIC, AND EXIMBANK
STATE FOR EAP/CM AND EEB/CBA
USAID FOR ANE FOR D. WINSTON
USDOC FOR ZHEN-GONG CROSS

E.O. 12958: N/A
TAGS: EINV PREL PGOV ETRD EMIN ENRG MG
SUBJECT: REFLECTIONS ON A SLAG HEAP: WINNERS AND LOSERS CONTEMPLATE
MONGOLIA'S CURRENT MINING POLICIES

ULAANBAATA 00000527 001.2 OF 005


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

REF: A) ULAANBAATAR 521; B) ULAANBAATAR 474; C) ULAANBAATAR 382; D)
ULAANBAATAR 068;
E) 2007 ULAANBAATAR 652; F) 2006 ULAANBAATAR 870

UNCLAS SECTION 01 OF 05 ULAANBAATAR 000527

SENSITIVE
SIPDIS

STATE PASS USTR, USTDA, OPIC, AND EXIMBANK
STATE FOR EAP/CM AND EEB/CBA
USAID FOR ANE FOR D. WINSTON
USDOC FOR ZHEN-GONG CROSS

E.O. 12958: N/A
TAGS: EINV PREL PGOV ETRD EMIN ENRG MG
SUBJECT: REFLECTIONS ON A SLAG HEAP: WINNERS AND LOSERS CONTEMPLATE
MONGOLIA'S CURRENT MINING POLICIES

ULAANBAATA 00000527 001.2 OF 005


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

REF: A) ULAANBAATAR 521; B) ULAANBAATAR 474; C) ULAANBAATAR 382; D)
ULAANBAATAR 068;
E) 2007 ULAANBAATAR 652; F) 2006 ULAANBAATAR 870


1. (SBU) SUMMARY. Failure to establish a fair and stable regulatory
environment for the mining sector, coupled with the global economic
crisis and commodities market crash, have come back to haunt
development of Mongolia's minerals sector. Small exploration firms,
already hammered by dropping commodity prices and tight capital,
hesitate to invest more into Mongolia with a government that
maintains the right to expropriate their deposits and ignore their
legal rights. Absent significant short-term changes, these firms
may depart Mongolia for regions with better business climates.
Large multi-national mining companies, on the other hand, are
prepared to use their deep pockets to protect their investments,
waiting for sense to prevail among the GOM leadership. For its
part, the GOM seems to realize finally that the legal and regulatory
problems may be chasing away or delaying mining investment -- and
so, have begun sincere reforms. Unfortunately, these reforms may be
too little and too late to keep most mining companies in Mongolia.
END SUMMARY.

THE LANDSCAPE HAS CHANGED
--------------


2. (SBU) As discussed in ref A, the global financial crisis has
shocked the Government of Mongolia (GOM) into the realization that
it needs to act immediately on mining. Many private mining
companies, service providers, and other observers, however, find
that this change of heart has come too little too late. Few, if
any, private companies active in Mongolia's mining sector praise the
GOM's recent approaches to legislating and regulating mining.
Across the board there is bitter criticism, bordering on contempt,

from players large and small about Mongolia's approach to crafting
and executing mining policy, and words such as "chaotic,"
"capricious," and "amateurish" are not uncommon. (NOTE: For
reporting on Mongolia's legal and regulatory frameworks over the
last three years consult refs A, C, D, and F. END NOTE.)


3. (SBU) Taking stock of a complex set of political and economic
factors, firms are making decisions about continued engagement with
Mongolia's mining sector. Individual company responses vary,
depending in large part on a firm's size (i.e., ability to weather
the storm),investment in-country to date, and their
mineral-of-interest. Often with market capitalizations of less than
USD 50 million, junior exploration companies have been walloped by
collapsing commodity prices, strangled capital, and the dizzying
policy gyrations of the GOM. The giant miners with deeper USD
multi-billion pockets can play more of a waiting game, but will
certainly proceed more slowly than if deals had been struck even six
months ago. Finally, the coal mining sector brings up a whole
different set of issues, since, unlike other "strategic deposits,"
the GOM holds clear ownership of the mammoth Tavan Tolgoi deposit,
meaning that mine will develop much differently than other key
deposits. The balance of this cable will discuss these three areas
in more detail.

JUNIORS REACHING THE BREAKING POINT
--------------


4. (SBU) The situation is not the same for all junior firms. The
standing 2006 Minerals Law allows companies to discover, delineate,
and then sell off their Mongolian mining prospect to a major mining
company, and many firms have done so successfully in Mongolia. The
problem arises when a deposit emerges as -- or is suddenly labeled

ULAANBAATA 00000527 002.2 OF 005


-- "strategic." The 2006 Minerals Law defines a "mineral deposit of
strategic importance" as a "concentration where it is possible to
maintain production that has a potential impact on national
security, economic and social development of the country." It
further defines a "strategic investment" as a "strategically
important deposit" in which the Government of Mongolia has the right
to obtain up to a 50 percent share of any mine. In addition, the law
sets no limit on when a deposit can be claimed as strategic; and so,
in theory, the GOM could label and grab a deposit at any point in
its life cycle.


5. (SBU) This effectively means that a junior company can engage in
expensive, time consuming exploration, discover a deposit of
substantial economic value, then see that deposit suddenly labeled
"strategic." Even if this never happens, the threat of
expropriation looms over the exploration firm. This reality has
made junior exploration companies very conservative in their public
statements of results in order to stay under the GOM radar. In
addition, observers say that having a Mongolian prospect in your
exploration portfolio can be poison for share values. Junior firms
active in Mongolia are reporting that stock values decline 80 to 90
percent generally, no matter the commodity in play -- even gold.
Consequently, companies (especially those staying in Mongolia) tell
us that they are restructuring these investments so that they do not
have to be reflected on publicly reported balance sheets. In short,
the GOM has reduced transparency, raised the perception of risk, and
sent skittish investors running for cover. Their fear has cut off
the speculative investment that is the life blood of exploration,
forcing junior firms to decide between drawing down irreplaceable
cash reserves to continue in Mongolia or to close down for good


6. (SBU) Juniors also accuse regional and local authorities of
"creeping expropriation." For example, provincial authorities can
claim specific areas as being of special historical, cultural, or
social importance to the people of the province and ban activities
on that land for five years. In Bayankhongor and other provinces,
such special-use takings have proliferated without any
justifications for such takings. Both junior and major firms have
privately told us that representatives from regional and local
authorities often use this power to their own advantage, labeling a
mining area as special-use, then approaching the company that holds
the mining rights, offering to remove the classification in return
for cash, a piece of the mine, development funds/projects for the
locality, or some other payback. Although the 2006 Minerals Law
allows for compensation for possessing land taken for special uses,
no one owning such designated land has reported receiving
compensation from cash-strapped local governments.


7. (SBU) According to the World Bank, exploration expenditures from
all junior companies were down 50 percent in 2007, with most firms
shifting exploration to other nations. Observers assert that this
decline has serious implications for Mongolia's development. The
most immediate impact will be on employment of Mongolians in the
mining sector. The Oyu Tolgoi (OT) project, operated jointly by Rio
Tinto (RT) and Ivanhoe, recently laid off 300 workers, and rumors
continue to circulate that other firms are close to cutbacks.
Representatives of junior firms hesitate to provide specifics for
fear of upsetting their workers and shareholders, but many are
contemplating serious cutbacks in employment and equipment
purchases, possibly in the very near-term. Mining equipment and
service suppliers also report a small but perceptual drop
(approximately 5 percent) beyond what they expect during the winter
lull.


8. (SBU) Some junior companies are doing more than downsizing; in
fact, they may close completely and move to better climes. Industry
observers and players explain that while they would no doubt suffer
the same tough economic conditions in other mining destinations,

ULAANBAATA 00000527 003.2 OF 005


they would prefer to suffer in a country whose government is
predictable and consistent. One local attorney serving many junior
companies lamented, "The companies see the Mongolian government as
just too risky. I never would have imagined that clients would see
Africa a safer bet than Mongolia, going to Lusaka of all places!"
(NOTE: The same attorney observed that if the mining business
continued to slide, she would have to discharge eight of her eleven
Mongolian employees. END NOTE.)

THE GIANTS PLAY A WAITING GAME
--------------


9. (SBU) Among the major multi-national mining companies, the impact
of current GOM activities varies with the project in prospect.
Expressing "disgust" with a regulatory and legal environment that
seems to change daily, giant BHP Billiton seems set to suspend all
exploration and perhaps close its Mongolian offices permanently.
For RT and Ivanhoe, however, prospects seem to have improved. The
GOM and the State Great Hural(SGH),or parliament, want to secure a
deal ASAP so that development can proceed, and on December 4
unambiguously confirmed this desire through a formal decree of the
SGH that authorizes the GOM to negotiate investment agreements on
both Oyu Tolgoi and Tavan Tolgoi. (NOTE: Although the decree
designates February 1, 2009, as the day the GOM must send agreements
to the SGH for approval -- probably too ambitious a deadline for two
such complex, multi-billion dollar projects -- both Rio Tinto and
Peabody have told us they are satisfied that the Mongolians have
formally committed to a negotiation process at long last. END
NOTE.) OT is the most advanced of all the projects. Its ownership
status is clear and the private companies have significant assets in
place to move development forward quickly (see ref A). Motivating
factors for the GOM include replacing declining revenues from the
Erdenet copper mine (see ref B) with royalty advances, tax revenues
from jobs, fees, redeeming campaign promises, and forward-looking
development schemes.


10. (SBU) Ivanhoe and RT have quietly suggested to the GOM that it
should move as expeditiously as possible. However, Ivanhoe, a
junior explorer with controlling interests in OT, is desperate to
get the deal done immediately. Tapped out and unable to entice cash
into the current environment, Ivanhoe has all but mothballed its
operations, discharging 300 of its 600 employees (and that down from
1,500 in December 2006) and halting all development at the OT site.
These recent layoffs include high-paid expatriate technical experts,
lower-paid Mongolian skilled labor, and unskilled Mongolian labors
as cooks, housekeepers, and drivers.


11. (SBU) RT also wants a deal but is in no particular hurry to
conclude one. Depressed markets for base-metals, tight capital,
debt accumulated from previous mergers (primarily RT's acquisition
of Canada's Alcan),and cost of fending off BHP Billiton's failed
hostile takeover attempt have all exacted a toll on RT's cash flow.
While RT remains committed to the OT project in the mid-term, the
firm is content to wait for capital and commodity markets to recover
a bit before launching an estimated USD seven billion project. More
positively for Mongolia, RT tells us that the failure of BHP's
takeover is significant for OT's future, because the failure
definitively settles the question of project ownership. If BHP had
succeeded or the takeover attempt lingered without resolution, the
OT project would have likely languished for several years as BHP
would have no doubt delayed acting on OT as it dealt with the
consequences of the merger.

PEABODY AND TAVAN TOLGOI
--------------


12. (SBU) Peabody Energy remains interested in the Tavan Tolgoi (TT)
coal mine and other coal prospects. They remain in regular contact

ULAANBAATA 00000527 004.2 OF 005


with us and are quietly increasing their activity in the Mongolian
market. But the problem is that Peabody will not enter Mongolia in
force until the GOM clarifies just how it sees TT evolving. That
evolution also must be commercially viable for Peabody. Regarding
that resolution, no clear answer exists. We consistently encourage
both the GOM and Peabody to talk with each other more actively,
because it seems to us, based on what the GOM and some MPs are
saying that Mongolians are looking for ideas on how to proceed at TT
and would welcome some discrete concepts at this point.


13. (SBU) Peabody's reticence has been difficult for the GOM to
fathom, as most other suitors for TT make lavish gestures, ranging
from alleged bags of cash to members of parliament to generous
praise in local and international press. A senior official from the
Ministry of Minerals and Energy, skilled in both politics and
business, recently complained to us that the GOM doubted that
Peabody was really committed to the TT project because the firm had
not yet responded to a request from the GOM to reveal how Peabody
would finance the project. In response, we asked the official how
the GOM thought Peabody could offer a financing plan when the GOM
had yet to set the parameters of the project, noting that Mongolia
should see Peabody's hesitation as a sign of professionalism and
good faith rather than as disinterest. (COMMENT: Mongolian
institutions and individuals simply have little experience reading
corporate behavior or framing requests that companies can fulfill in
good faith. All of this suggests that Mongolia needs the services
of professionals to act as intermediaries in negotiating with
international mining companies, as discussed in ref A. END
COMMENT.)


14. (SBU) The GOM owns 96 percent of TT and wants to move ASAP;
however, there remains no consensus on what approach to take.
Everyone with whom we speak mentions a variety of options without
signaling a favorite. However, certain aspects of the ideal deal
seem to bubble to the surface. First, in the long run (say 20-30
years),the GOM would like to become the operator and majority owner
of the property, like state-owned CVRD of Brazil. In the near term
the GOM recognizes that it cannot afford to build the sort of TT
that it wants -- an operation that would produce tens of millions of
tons of coal annually in relatively short-order -- and so would
accept private involvement, perhaps by issuing a 20-plus year
operating license. In this scenario, the GOM would hold a majority
stake of at least 51 percent and perhaps sell off 49 percent to the
private operator and others.


15. (SBU) Another loosely affiliated group of Mongolian politicians,
officials and business people wants the state to develop TT without
foreign involvement. They propose starting TT off very small, using
the currently operating state-owned Little Tavan Tolgoi mine,
adjacent to TT, as an example (see ref E). In this case TT would
start out with a scant few million tons a year, then expand as funds
became available. (COMMENT: Given Little TT's poor record on paying
the state its rightful share of the revenues, corruption, horrible
environmental reputation, and health and safety violations, skeptics
note that the latter model seems most popular with politicians whose
focus appears to be on lining their own pockets. END COMMENT.)

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


16. (SBU) Ironically, Mongolia appears to have seen the error of its
ways and may be willing to change. But the turnaround may be too
late to retain the junior firms and to spur Rio Tinto into early
action on the desperately needed OT project. However the real
problem is not that OT will not start, because it will, although a
year or two later, after RT has stabilized. The real problem is
that government policy gyrations, which have discouraged or are
driving junior companies out of Mongolia, make it next to impossible

ULAANBAATA 00000527 005.2 OF 005


for Mongolia to expand the mining sector beyond the current high
profile OT and TT.


17. (SBU). In the long run observers agree that the departure of
junior firms could cripple mining in Mongolia, for Mongolia's recent
discoveries of strategic deposits came from privately held firms
uncovering completely new deposits or revisiting deposits previously
explored by the GOM but left undeveloped because the GOM lacks the
hundreds of millions of dollars needed to explore. (NOTE: For
example, Oyu Tolgoi, the world's largest undeveloped copper-gold
deposit was unknown to the GOM. It was not until the Canadian
junior Ivanhoe spent USD 800 hundred million on exploring the site
that the true magnitude of the deposit was determined. END NOTE.)
OT and TT are world class deposits to be sure, but to keep revenues,
jobs and infrastructure developments going, a mining nation needs
explorers constantly running all over Mongolia's valleys, deserts,
and mountains. If the GOM persists in pursuing a chaotic legal and
regulatory regime the only running will be that of explorers and
investors to competitor countries.

MINTON