Probable resolution of Oyu Tolgoi dispute in H1 2014 highly likely to increase foreign investment in Mongolia
IHS sources indicate that in February Rio Tinto and the government of Mongolia are likely to announce a resolution to their dispute over the Oyu Tolgoi copper-gold mine.
IHS Global Insight perspective
Significance
The dispute between Rio Tinto and the Mongolian government over the second phase of the Oyu Tolgoi copper-gold mine will likely be resolved in mid-February, according to IHS sources.
Implications
The resolution of the dispute is seen as the single most important indicator of the government's willingness to match its pro-investment rhetoric with action.
Outlook
IHS anticipates an increase in foreign direct investment and an improvement in Mongolia's balance of payments as a result of the resolution of the dispute.
The dispute between the government of Mongolia and Rio Tinto centres on the plans for the second-phase expansion project of Oyu Tolgoi (OT-II). The first phase began commercial operation in July 2013 but work on the second phase underground expansion of the mine was halted later that month as a result of the dispute over project financing (see Mongolia: 30 July 2013: New parliamentary hurdle raises risks for major projects in Mongolia). On 1 October one of the three Mongolian representatives on the board of Oyu Tolgoi LLC said the number of unresolved issues was down from 30 to 15, following discussions in London. As of January 2014 the number of unresolved issues is thought by IHS sources in Ulaanbaatar to be between three and five. Likely issues still under discussion include:
water usage and rights for the mine,
the level of royalties the government is requesting
the terms of the project financing agreement for OT-II,
the completion of a new pre-feasibility study for OT-II,
the completion of an audit on overspending on the first phase of the project, and
the ownership of licences adjoining the Oyu Tolgoi project.
An IHS source with knowledge of the two parties' negotiations is increasingly confident of a resolution to the dispute. The source reports that an announcement is likely after Mongolian Lunar New Year, which runs from 30 January to 3 February. According to the OT initial plan, the underground mine should become operational in 2017 and reach its full production capacity in 2018, likely implying that the majority of construction activities will fall between 2015–16.
One potential stumbling block is the Mongolian government's demand that the updated pre-feasibility study for OT-II be completed as part of the resolution of the dispute. Rio Tinto has stated that they will be completed in the first half of the year; however, our source believes that the study will be completed in time for the likely resolution of the dispute in mid-February.
In December, Turquoise Hill Resources Ltd (the Rio subsidiary that holds the majority stake in Oyu Tolgoi) announced that it had received extended commitments from the 15 banks providing the project financing for OT-II (the commitments expired 12 December). Barring a further extension, these commitments run until 31 March. Rio and the Mongolian government are likely to be aiming to resolve the dispute before a renewal is required, although given the apparent ease with which previous extensions were negotiated, this is unlikely to be the main driving factor.
Positive statements about the possibility of a swift resolution have been limited to the Mongolian government and its representatives; Rio has been comparatively silent. Moreover, past deadlines offered for a likely resolution of the dispute have been missed, most recently the prediction by Erdenes Oyu Tolgoi LLC that the dispute would be resolved in 2013. Although this may be a reason to be cautious about the prospects for resolution, the IHS source has suggested that the lack of public pronouncements over the course of December 2013 was an indicator that the negotiations were proceeding well, reflecting growing agreement between the two sides that a resolution should be finalised following the closure of the Turquoise Hill rights offering on 13 January.
Another positive indicator for the successful resolution of the dispute came on 16 January, when the Mongolian parliament approved the country's new State Policy in Minerals Sector. The document was first introduced in July 2013 but has been repeatedly delayed by wrangling within parliament. While the policy does not cover OT, which is governed by a separate Investment Agreement, its passage is indicative of the Mongolian political elite's willingness to put aside disagreements in order to ensure a greater degree of regulatory stability in the mining sector.
The economic impact of OT-II
Although still growing at an estimated 11.5% in 2013, Mongolia's economy faced significant external challenges over the year. The sharp weakening of global commodity prices and the economic slowdown in China, coupled with Mongolia's highly pro-cyclical macroeconomic policy, drove the current account into a deep deficit of USD3.1 billion, according to latest estimates by the Bank of Mongolia. Mongolia's uncertain investment environment, steep currency depreciation, and the rising risk aversion in global financial markets, undermined foreign direct investment (FDI) and contributed to difficulties financing this deficit.
The resolution of the OT-II dispute will have several implications for Mongolia's economy in the following year. Regardless of the resolution's timing, the economy will continue expanding robustly, currently projected by IHS at 10.8% in 2014, driven by the rise in copper exports from the now fully operational OT open pit mine.
More immediately, the resolution should encourage FDI, improving Mongolia's external balance. Net FDI over 2013 is estimated to have dropped to around USD2 billion from more than USD4.4 billion in 2012. As the current-account deficit remained onerous despite lower capital imports demand, Mongolia's foreign-exchange reserves were drained to an estimated USD2.5 billion at end-2013 from USD3.9 billion at end-2012 – or only slightly above three months of import payments (a standard threshold used to assess a country's external creditworthiness). The depreciation of the Mongolian tugrik from MNG1,392/USD at end-2012 to MNG1659/USD at end-2013 has also increased the repayment risks on foreign-currency-denominated loans. Consequently, IHS changed the outlook on its sovereign credit rating for Mongolia to negative from stable in December (see Mongolia: 31 December 2013: IHS downgrades Mongolia's short-term sovereign risk rating, revises outlook to Negative).
Outlook and implications
Comments made by the Mongolian government have been optimistic about a resolution to the dispute in January. IHS anticipates an announcement of resolution in mid-February following the Lunar New Year Holiday and no later than March. A resolution would help restore FDI and strengthen Mongolia's balance-of-payments position. This would prompt us to consider changing our current outlook for Mongolia's sovereign credit rating back to stable. However, our view also depends on the amount of associated debt the government would assume under the terms of the resolution agreement, as this could worsen Mongolia's already deteriorating solvency. If a resolution is reached in the first half (H1) of 2014, the start of construction of the underground expansion of the mine is likely to increase our 2014 growth forecast for Mongolia from the current 10.8% to around 13–14%. However, it will be the long-term effects of both phases of the OT mine that are most important, with the mine expected to provide a third of total economic growth once it is fully developed.
IHS Global Insight perspective
Significance
The dispute between Rio Tinto and the Mongolian government over the second phase of the Oyu Tolgoi copper-gold mine will likely be resolved in mid-February, according to IHS sources.
Implications
The resolution of the dispute is seen as the single most important indicator of the government's willingness to match its pro-investment rhetoric with action.
Outlook
IHS anticipates an increase in foreign direct investment and an improvement in Mongolia's balance of payments as a result of the resolution of the dispute.
The dispute between the government of Mongolia and Rio Tinto centres on the plans for the second-phase expansion project of Oyu Tolgoi (OT-II). The first phase began commercial operation in July 2013 but work on the second phase underground expansion of the mine was halted later that month as a result of the dispute over project financing (see Mongolia: 30 July 2013: New parliamentary hurdle raises risks for major projects in Mongolia). On 1 October one of the three Mongolian representatives on the board of Oyu Tolgoi LLC said the number of unresolved issues was down from 30 to 15, following discussions in London. As of January 2014 the number of unresolved issues is thought by IHS sources in Ulaanbaatar to be between three and five. Likely issues still under discussion include:
water usage and rights for the mine,
the level of royalties the government is requesting
the terms of the project financing agreement for OT-II,
the completion of a new pre-feasibility study for OT-II,
the completion of an audit on overspending on the first phase of the project, and
the ownership of licences adjoining the Oyu Tolgoi project.
An IHS source with knowledge of the two parties' negotiations is increasingly confident of a resolution to the dispute. The source reports that an announcement is likely after Mongolian Lunar New Year, which runs from 30 January to 3 February. According to the OT initial plan, the underground mine should become operational in 2017 and reach its full production capacity in 2018, likely implying that the majority of construction activities will fall between 2015–16.
One potential stumbling block is the Mongolian government's demand that the updated pre-feasibility study for OT-II be completed as part of the resolution of the dispute. Rio Tinto has stated that they will be completed in the first half of the year; however, our source believes that the study will be completed in time for the likely resolution of the dispute in mid-February.
In December, Turquoise Hill Resources Ltd (the Rio subsidiary that holds the majority stake in Oyu Tolgoi) announced that it had received extended commitments from the 15 banks providing the project financing for OT-II (the commitments expired 12 December). Barring a further extension, these commitments run until 31 March. Rio and the Mongolian government are likely to be aiming to resolve the dispute before a renewal is required, although given the apparent ease with which previous extensions were negotiated, this is unlikely to be the main driving factor.
Positive statements about the possibility of a swift resolution have been limited to the Mongolian government and its representatives; Rio has been comparatively silent. Moreover, past deadlines offered for a likely resolution of the dispute have been missed, most recently the prediction by Erdenes Oyu Tolgoi LLC that the dispute would be resolved in 2013. Although this may be a reason to be cautious about the prospects for resolution, the IHS source has suggested that the lack of public pronouncements over the course of December 2013 was an indicator that the negotiations were proceeding well, reflecting growing agreement between the two sides that a resolution should be finalised following the closure of the Turquoise Hill rights offering on 13 January.
Another positive indicator for the successful resolution of the dispute came on 16 January, when the Mongolian parliament approved the country's new State Policy in Minerals Sector. The document was first introduced in July 2013 but has been repeatedly delayed by wrangling within parliament. While the policy does not cover OT, which is governed by a separate Investment Agreement, its passage is indicative of the Mongolian political elite's willingness to put aside disagreements in order to ensure a greater degree of regulatory stability in the mining sector.
The economic impact of OT-II
Although still growing at an estimated 11.5% in 2013, Mongolia's economy faced significant external challenges over the year. The sharp weakening of global commodity prices and the economic slowdown in China, coupled with Mongolia's highly pro-cyclical macroeconomic policy, drove the current account into a deep deficit of USD3.1 billion, according to latest estimates by the Bank of Mongolia. Mongolia's uncertain investment environment, steep currency depreciation, and the rising risk aversion in global financial markets, undermined foreign direct investment (FDI) and contributed to difficulties financing this deficit.
The resolution of the OT-II dispute will have several implications for Mongolia's economy in the following year. Regardless of the resolution's timing, the economy will continue expanding robustly, currently projected by IHS at 10.8% in 2014, driven by the rise in copper exports from the now fully operational OT open pit mine.
More immediately, the resolution should encourage FDI, improving Mongolia's external balance. Net FDI over 2013 is estimated to have dropped to around USD2 billion from more than USD4.4 billion in 2012. As the current-account deficit remained onerous despite lower capital imports demand, Mongolia's foreign-exchange reserves were drained to an estimated USD2.5 billion at end-2013 from USD3.9 billion at end-2012 – or only slightly above three months of import payments (a standard threshold used to assess a country's external creditworthiness). The depreciation of the Mongolian tugrik from MNG1,392/USD at end-2012 to MNG1659/USD at end-2013 has also increased the repayment risks on foreign-currency-denominated loans. Consequently, IHS changed the outlook on its sovereign credit rating for Mongolia to negative from stable in December (see Mongolia: 31 December 2013: IHS downgrades Mongolia's short-term sovereign risk rating, revises outlook to Negative).
Outlook and implications
Comments made by the Mongolian government have been optimistic about a resolution to the dispute in January. IHS anticipates an announcement of resolution in mid-February following the Lunar New Year Holiday and no later than March. A resolution would help restore FDI and strengthen Mongolia's balance-of-payments position. This would prompt us to consider changing our current outlook for Mongolia's sovereign credit rating back to stable. However, our view also depends on the amount of associated debt the government would assume under the terms of the resolution agreement, as this could worsen Mongolia's already deteriorating solvency. If a resolution is reached in the first half (H1) of 2014, the start of construction of the underground expansion of the mine is likely to increase our 2014 growth forecast for Mongolia from the current 10.8% to around 13–14%. However, it will be the long-term effects of both phases of the OT mine that are most important, with the mine expected to provide a third of total economic growth once it is fully developed.
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