Rio’s Mongolia Copper Dream Awakens 20-Year-Old Nightmare

Rio Tinto Group’s Mongolia copper and gold mine looks a dream location sitting next to China, the biggest market. Yet, Mongolia’s bid for more control of the project draws comparison with a Rio mine that went badly wrong.

Mongolia’s government is ratcheting up criticism of Rio’s management of the $6.6 billion project, the landlocked country’s single biggest investment. Lawmakers have argued for a bigger share of profit, while President Tsakhia Elbegdorj wants more management control. He faces elections in June with a fifth of the nation’s 3 million people in poverty despite world-beating economic growth of 17.3 percent in 2011.

Rio has refused government overtures to rewrite the agreement on the mine known as Oyu Tolgoi, raising tensions and comparisons with another Rio copper mine more than two decades ago. That project known as Panguna on the island of Bougainville in Papua New Guinea was shut by local protests and is still the subject of a U.S. court case.

“In Bougainville the community felt, rightly or wrongly, they weren’t compensated adequately for the various impacts of mining they were having to absorb,” said Jeffrey Neilson, a senior lecturer in economic geography at the University of Sydney. Governments in emerging economies “have to be seen to be taking a strong stance and making sure that the benefits of their resource wealth are being shared.”

Mining companies also need to consider wealth distribution in countries where they invest as a matter of course, said Michael Bush, who now heads credit research at National Australia Bank Ltd. and formerly worked as a geologist at Triad Minerals Inc.

‘Fingers Burned’

At Panguna, which was closed in 1989 after protests turned violent, the company “got its fingers burned more than many” of its peers, Bush said.

The unrest at Panguna, led by Francis Ona a former Bougainville mine worker, revitalized an independence movement on the island. That prompted the Papua New Guinea government to declare a state of emergency and send in troops in a conflict in which thousands died.

Bougainville landowners later filed a U.S. lawsuit alleging Rio conspired with the PNG government in acts of genocide, human rights abuses and environmental damage. Rio lost an appeal to have the lawsuit thrown out on Oct. 25, 2011. In November the same year, Rio sought to appeal the ruling to the U.S. Supreme Court. No decision has been made, according to the court’s website.

‘Serious Risks’

The company has argued that as the case has no connection whatsoever to the U.S. it shouldn’t be heard in the country and that the U.K. and Australia object to the litigation.

Rio cited a U.S. government filing that supported the company’s view: U.S. courts passing judgment on the conduct of a foreign sovereign, the government warned, pose “serious risks to the United States’ foreign relations with foreign states.”

Mongolia’s Oyu Tolgoi, set to start production in July, has about 25 million metric tons of recoverable copper and an expected life of 50 years. That’s about three-times the size of Panguna, which produced about 3 million tons of copper from 1972 to 1989 and holds another 5 million tons, according to a recent study amid discussions about reopening the mine under Rio unit Bougainville Copper Ltd.

“Bougainville Copper Ltd. has a long-term vision of returning to mining and exploration on Bougainville, which Rio Tinto supports,” said Rio spokesman David Luff in an e-mail response to questions. “Any eventual return would be subject to the support of landowners and the government.”

The project will be discussed at Bougainville Copper’s annual general meeting in April, he said.

Resource Nationalism

Rio Tinto fell 3 percent to A$67.30 at the close of trading in Sydney. BHP Billiton Ltd., the world’s biggest mining company, declined 3.8 percent. The S&P/ASX 200 index lost 2.3 percent.

Resource nationalism -- government demands for higher taxes, royalties or stakes -- was the top concern among mining executives in 2011, according to Ernst & Young LLP’s annual risk survey published in August 2012.

“I don’t think nationalism is growing, it’s always been here” in Mongolia, said Vidur Jain, an analyst at the Ulan Bator-based Monet Capital Investment Bank. “The government has an eye on the upcoming elections. Foreign investors don’t vote so the government could be aiming its rhetoric and actions at the electorate.”

The politicians that offer to squeeze the most from foreign investors are likely to win the most public support, Jain said. Government corruption and inefficiencies are the main reasons foreign investments don’t trickle down, “but that’s not something the locals are aware of.”

Losing Pit

A disconnect with local people led to the troubles at Rio’s Panguna mine, with the company not doing enough to mitigate the effect of its project on local inflation or the environment, Sydney University’s Nielsen said.

Nielsen formerly served as a community liaison officer for Aurora Gold Ltd., which had its mine overrun by locals in central Kalimantan, Indonesia, over how mining proceeds were shared.

“All of a sudden the local community cut down these massive trees and put them across the access road to the pit,” Nielsen, who worked for Aurora between 1999 and 2000, said.

“About 5,000 illegal miners took over the asset and started mining the pit. They were mining themselves, digging shafts. Then the company had to slowly renegotiate access to the pit.”

Who Blinks First

President Elbegdorj said this month the nation should have more control of Oyu Tolgoi, adding to calls from lawmakers in the last 18 months to push Rio to cede equity control in the mine. Mongolia, which is almost three times the size of France, owns 34 percent of Oyu Tolgoi and Rio the rest through its Turquoise Hill Resources Ltd. unit.

Mongolia is criticized because of “the absence of respect by the Oyu Tolgoi management toward the government,” Ochirbat Chuluunbat, vice minister at the Ministry of Economic Development, said in an interview. “A lot of decisions and resolutions of the OT management came without any prior consultation with the Mongolian government.”

As Elbegdorj appeals to voters in a nation where about a fifth of the people get by on $1.25 a day, he’s setting up a face-off with Rio’s Chief Executive Officer Sam Walsh, who has his own stakeholders to worry about.

Walsh, less than two months into the job, has to appease shareholders angered by a $14 billion writedown in Rio’s coal and aluminum operations that cost the previous CEO Tom Albanese his job.

Back-Door Deal

“I don’t think Rio will renegotiate the agreement,” said Jain at Monet Capital. If they do, there’s a risk other countries will want the same, so eventually there’ll be some kind of back-door deal, he said.

Lawmaker complaints in Mongolia have centered on cost increases at the mine, which they claimed had jumped almost $10 billion to $24.4 billion. Rio set costs so far at $6.6 billion, according to the Oyu Tolgoi website.

“The two sides don’t even seem to agree on what the cost overruns are for phase I of Oyu Tolgoi,” said Nick Cousyn, chief operating officer at BDSec, Mongolia’s biggest brokerage.

Cost overruns have been used to gain greater state control in a project before.

Russia, the world’s largest energy producer, refused for a year to approve Royal Dutch Shell Plc.’s request to double the cost of investment in the Sakhalin-2 oil and gas project. In 2006, shareholders sold half their shares to state-run OAO Gazprom, giving the Moscow-based company the biggest stake.

No Foreigners

Russia has resorted to tax claims and environmental inspections to pressure foreign investors into relinquishing major oil and gas projects started before President Vladimir Putin first came to power in 1999. First Deputy Prime Minister Sergei Ivanov said June 13, 2007, foreign companies “will never operate” major fields again.

The Mongolian dispute will probably end better than the story of the Bougainville mine.

“The world has changed markedly since the Bougainville situation, both from the global mining companies’ view point and from government angles,” said Tim Barker, investment analyst at BT Financial Group Pty, who owns Rio shares.

What has not changed is where the resources are, said Sydney University’s Nielsen.

“We live on a finite planet and countries are taking a gamble on their resources,” he said. “Perhaps there isn’t a rush to dig it out and sell it now and they can negotiate deals in ten or 15 years.”

Two weeks ago on Feb. 7, about 23 years since Rio closed Panguna, the company announced it may be restarted. The mine still holds more copper and gold than was dug out.

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