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    Greater China
     May 25, 2012

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Mongolian coal's long road to market
By Peter Lee

Mongolia's national transition from a communist regime to a democratic, free market state has been a rocky one.

The loss of Soviet support following the collapse of the Soviet Union was an economic and demographic catastrophe for Mongolia.

As recently as 2008, a third of Mongolians lived below the poverty line. Mongolian democracy is a violent, murky business even today and dominated by successors to the Mongolian Communist Party.

Recently, the ex-president of Mongolia, Nambaryn Enkhbayar, was arrested on corruption charges and freed on bail after he


embarked on a hunger strike that attracted the concern of Western governments and activists.

His arrest was widely viewed as part of a political vendetta by current President Tsakhia Elbegdorj, who himself faces accusations that he vaulted into the presidency by orchestrating a riot protesting Enkhbayar's alleged vote fraud in 2008.

Despite democracy, despite free markets, what has kept Mongolia from recapitulating the experience of Kosovo as a failure for Western nation-building, indeed what is setting the nation on a pace to become the fastest-growing economy in the world, is the fortuitous existence of a trillion dollars' worth of minerals beneath the under-populated surface of the country, and the insatiable appetite of a gigantic, capital-rich authoritarian neighbor, China, for these treasures.

In Mongolia today, hunger for coal, copper, gold and uranium wealth is at odds with democracy as the demands of international resource giants collide with a stubborn political culture of resource nationalism.

In time for the June 2012 parliamentary elections, Mongolia's grand khural is expected to pass a law subjecting the purchase by "state-owned entities" of controlling interest in strategic Mongolian mining enterprises to government approval (as well as a host of other key industries).

The immediate provocation for the legislation was the sale by a Canadian company, Ivanhoe Resources, of its controlling interest in SouthGobi, an operator of coal mines in Mongolia, to a Chinese resource giant, the Aluminum Company of China, known as Chalco.

The legislation overtly targets China. Vice Finance Minister Ganhuyag Chuluun Hutagt told Bloomberg that the country needed new investment laws to diversity its exports to countries other than China, which consumes a lion's share of Mongolia's coal and copper:
We don't want to be faced with one sovereign ... Our struggle to get political freedom was a long one and we cherish that. We will not let foreign government-owned entities control strategic assets in Mongolia.
This is not an unambiguous win for non-Chinese international resource companies.

After all, there are two ways to make money from ownership of a mining concession. One is to engage in the arduous, expensive, long-term and risky enterprise of operating the mine. Another is to sell it.

And the people who are willing to pay top dollar for a mine are the people who are already buying the product and have a powerful economic incentive for making a go of it ... like the Chinese.

So the Mongolian government's involvement in strategic industries can be looked at in two different ways.

On the one hand, it might hobble a deep-pocketed, overweening competitor to the benefit of other, grateful players; on the other hand, it might be seen as increasing the risk and diminishing the liquidity of investments in the so-called strategic industries, shaving precious points off the value of the assets, be they hard rock or financial paper.

Unsurprisingly, the investment community, which is politely slavering at the prospect of profitable deal flows from Mongolian mining initial public offerings (IPOs) and mergers and acquisitions, is not amused by the strategic industry law.

Dale Choi, of the pre-eminent Mongolia resource play investment firm Frontier Securities, told Bloomberg:
Investors don't like it when the rules of the game are changed after the game has started, and changed often at that ... It would be in the interests of Mongolian people to make a decision based on commercial factors, rather than geopolitical factors. [1]
The uncertain progress of the Tavan Tolgoi project illustrates the headaches facing Mongolia as it tries to reap its resource bonanza on behalf of its citizens even as the remorseless economic logic of globalization demands marginalization of their interests.

Tavan Tolgoi, in the Gobi Desert less than 300 kilometers from the Chinese border, contains over six billion tons of coal reserves, including 1.8 billion tons of coking coal, a premium and profitable item used in the iron and steel industry.

Nothing about Tavan Tolgoi is simple, except perhaps the physical process of digging the coal out of the ground (albeit with the usual environmental and cultural trauma).

Chalco is already buying all the coking coal that Tavan Tolgoi produces. But it has to truck the coal to China since the Mongolian government can't bring itself to approve the 300-kilometer railway that would connect to the Chinese rail system, thereby making China the only feasible buyer.

Mongolia's current anxiety about Chinese domination of its international trade channels (China accounts for perhaps 80% of Mongolia's export and import trade) is buttressed by a significant element of historical xenophobia.

The Mongolian republic's foundation myth dates back to the eviction of a detested Manchu viceroy in 1911 and China's political and ethnic domination of the parts of Mongolia it did hang on to - now the Inner Mongolia Autonomous Region - is an affront and warning to Mongolian nationalists.

Standing up to Chinese economic penetration is, therefore, good politics and probably smart geopolitics. Economics, however, is another matter.

Instead of simply linking Tavan Tolgai to the Chinese railway system, Mongolia is trying to cobble together a coalition of Chinese, Russian, South Korean and Japanese concerns that will develop part of the mine jointly with Mongolia and, most importantly, build an integrated transport network 5,000 kilometers from Tavan Tolgoi to the Russian export facility at the port of Vanino.

The objective is for Tavan Tolgoi to will find a home in Japanese and South Korean steel mills, and to get to those mills through Russia without being captive to the necessity of moving the product overseas through the shortest and most economical route-through Chinese railroads and ports.

Total projected cost: US$5.2 billion. Additional transport cost per ton: perhaps $100.

To bootstrap this diversification extravaganza, the Mongolian government already requires that Chalco resell 30% of its current Tavan Tolgoi purchases to three Japanese and South Korean trading companies. Reportedly, this portion is delivered to Chinese ports for export. Somebody is enjoying a windfall, as Mongolian coking coal is apparently selling for a third of the price of the Australian product currently fueling Japanese and South Korean steel mills.

Tavan Tolgoi itself is divided into east and west zones, East Tsankhi and West Tsankhi, each with its own challenges.

West Tsankhi is the joint development mega project based on foreign operators investing in and operating the mine and paying royalties to the mine owner, state-run Erdennes Tavan Tolgoi.

This is the piece wrapped up in the multi-national/railroad to Russia consortium idea which, it appears, only the Mongolian government loves.

The Mongolian government announced a jumbled up award to an unwieldy collection of companies but has been unable to work out the deal it is trying to impose - which probably requires a hefty up-front payment that somehow has to be divvied up between the disparate partners, each of whom has different roles, profit expectations, and willingness and capacity to pay.

In a recent display of bravado, the Mongolian government stated it might go it alone on West Tsankhi, while failing to address the question of how it would come up with billions of dollars needed to fund development.

East Tsankhi is the part of the mine that is already selling its output to China under the ownership and operation of state-owned Erdennes Tavan Tolgoi. Per government plan, Erdennes TT will go public in a multi-billion dollar global IPO that will sell a 30% share to fund the further development and exploitation of East Tsankhi by some combination of foreign and domestic construction, equipment, and service vendors. 

Continued 1 2  

Mongolian core to Russia's nuclear bid
(Oct 29, '11)

Mongolia hands it to a cast of neighbors
(Oct 1, '11)

Pakistan hoist by its own petard

2. Syria and Lebanon stare into the abyss

3. Russia sends sea signals as China blusters

4. Singapore, Hong Kong unite against 'locusts'

5. We're all zombies in the

6. Spend, spend, spend

7. Lingualism: Changing the names of the game

8. The 'limitless horizon" of capitalism

9. What if Facebook is really worth $100 billion?

10. North Korea's 'organizational life' in decline

(24 hours to 11:59pm ET, May 23, 2012)


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