Mongolia Wants Mine Stage 2 Funded by Cash Amid Talks

(Corrects headline in story published yesterday to clarify the proposed funding arrangement would be an interim measure while talks continue.)

Mongolia wants the planned $5.1 billion expansion at Rio Tinto Group’s Oyu Tolgoi mine to be financed from cash flow until a dispute over the cost of the biggest foreign investment in the nation is resolved.

Cost overruns at the copper and gold mine, 34 percent owned by Mongolia, are increasing the debt the government owes to Rio’s Turquoise Hill Resources Ltd. (TRQ) unit, which operates the project, Minister of Mining Davaajav Gankhuyag said on Aug. 9.

Rio delayed work on the underground expansion last month amid the dispute over financing that contributed to production delays at the first stage of the mine. Outstanding issues that need to be resolved include taxes and the right to a royalty stream from the project.

“The positions are still far away from each other, there is still a lot of work to do,” said Dale Choi, the founder of Independent Mongolian Metals and Mining Research. “There needs to be substantial political will to reach an agreement but at the moment there are a lot of arguments against the project financing,”

Oyu Tolgoi, located 550 kilometers (340 miles) south of Ulaanbaatar in the Gobi Desert, began shipping concentrate last month and is forecast to be a key revenue earner for Mongolia, where foreign direct investment slumped 43 percent in the first half.

‘High Risk’

“Until the project financing is resolved I think it is proper to continue the underground mine with revenues from concentrate,” Gankhuyag said in a letter to Rio Tinto that he showed reporters on Aug. 9. “The costs specified in the feasibility study are creating a high risk of reducing profits to the Mongolian side,” he told reporters.

David Luff, a Melbourne-based spokesman for Rio Tinto, declined to comment on the mine minister’s letter, and referred to last week’s remarks by Chief Executive Officer Sam Walsh, who said both parties “want phase two to go ahead.”

Since deliveries began last month, Oyu Tolgoi has shipped 4,000 metric tons of concentrate, Gankhuyag said. The company plans to export 300,000 tons of concentrate this year with revenue of $1 billion, Gankhuyag said.

The project finance package, with funding from the International Financial Corporation, among other lenders, must be approved by the Oyu Tolgoi board of directors, which includes three Mongolian nationals.

Royalty Dispute

Another point of dispute is a royalty on production to be collected by Rio Tinto, he said. “Mongolia believes that only the state has the right to take a royalty,” he said.

When construction is complete, including the tunnels that will make up the underground portion of the mine, the total cost to build Oyu Tolgoi may exceed $24 billion, significantly higher than the $14 billion that Mongolia had first anticipated, Gankhuyag said.

To pay for its 34 percent stake, Mongolia borrowed $800 million from Rio Tinto and pays interest of 7 percent to 8 percent a year, said Chuluuntseren Otgochuluu, the Director-General of the Mining Ministry’s Department of Strategic Policy and Planning.

Mongolia is also concerned about cost overruns on infrastructure for the mine which Otgochuluu said have topped $1 billion. A planned power station for the project hasn’t yet been built, he said.

“We don’t understand why the main jobs are not yet done but the financial overrun is so high,” said Otgochuluu.

A task force is currently conducting an audit of $2 billion spent during the first phase. The results of the audit will be available in two to three weeks, Otgochuluu said.

To contact the reporter on this story: Michael Kohn in Ulaanbaatar at mkohn5@bloomberg.net

To contact the editor responsible for this story: Jason Rogers at jrogers73@bloomberg.net

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