Oyu Tolgoi To Push Through Despite Headwinds
BMI View: Despite the persistence of several headwinds, we remain sanguine over the future prospects of Oyu Tolgoi and expect the project to provide a considerable boost to copper and gold production in Mongolia. With China consuming over 90% of all Mongolian exports, we see room for further backtracking as the government grows increasingly wary of the country ' s reliance on China and seeks to pursue investment ties with other nations.
We believe regulatory uncertainty will remain a dominant risk to the future prospects of the Oyu Tolgoi mine. With negotiations for a cross-border power supply deal with China's Inner Mongolia Power Corporation completed in November 2012, there is little stopping the Mongolian authorities to turn their attention on the existing agreement with Rio Tinto. Among a raft of other onerous provisions, the government is looking to extract US$319mn in additional royalty payment from Rio Tinto as implied by its latest 2013 budget proposal. We believe the Oyu Tolgoi project is set to face more headwinds over the coming months. In a bid to ensure the re-election of President Tsakhia Elbegdor i in June 2013, we expect the government to step up its rhetoric against foreign miners as they seek to quell concerns regarding the overexploitation of the country ' s mineral wealth.
Furthermore, we believe the government will continue to view the Oyu Tolgoi mine as an easy target to increase state revenue and boost its coffers. Slated for commercial production in June 2013, the Oyu Tolgoi mine is a combined open pit and underground mining project in the South Gobi Desert with the potential to provide industrial scale quantities of copper and gold for at least 50 years. It has an estimated annual production capacity of 450ktpa of copper, 650kozpa of gold and 3moz of silver. Indeed, the Mongolian government has made clear signals that it intends to alter the terms of its current agreement with Rio Tinto. The authorities are seeking to increase their stake in the mine from 34% to 50%, while also looking to change the royalty structure. Rio Tinto has so far rejected attempts to discuss the terms of the agreement.
|Oyu Tolgoi To Boost Output|
|Mongolia - Copper & Gold Production|
Whilst not our core scenario, we believe Rio Tinto will most likely succumb to the proposed amendments should the government persist in adopting a punitive approach towards foreign investment. Rio Tinto has spent billions of dollars to purchase Ivanhoe's stake in the project and construct the much needed infrastructure facilities, of which include a 104km road, extensive water distribution systems and power grids, to support production.
Although we believe more punitive reforms are on the cards, we retain our belief that the government will gradually reach the realisation that it can only afford to push so far with the foreign investment community. T he Oyu Tolgoi project is the biggest economic undertaking in Mongolia ' s history and is poised to transform the country into one of the world ' s top copper and gold producers. Rio Tinto spent approximately US$8mn per day and employed more than 10,000 people from the local community during the construction phase. Most importantly, the Mongolian economy is expected to be 36% larger by 2019, supported by a massive programme of social, educational, training and infrastructure investment from the development of Oyu Tolgoi . Indeed , we note that key mining projects could be held hostage to delays caused by elections cycles, while the risk of parties resorting to nationalism or populism to undermine each other ahead of voting is certainly a concern .
|An Uneasy Relationship|
|Mongolia - Exports To China (US$mn) & Growth|
In addition, we believe the government will remain willing to negotiate with foreign firms due to concerns over the Chinese influence and control of the Mongolian economy. With China consuming over 90% of all Mongolian exports, we see room for further backtracking as the government grows increasingly wary of the country's reliance on China and seeks to steer a more independent path by pursuing investment ties with other nations in its so-called 'third neighbour' foreign policy. Mongolia has long lived in fear of China's outsized dominance of its resources and maybe even the country. After all, China had already acquired what is now known as Inner Mongolia and with it millions of ethic Mongolian.
|Below Consensus Across The Board|
|BMI 2013 Average Price Forecasts vs Bloomberg Consensus (% Difference)|
Over the long term, we remain sanguine that capital inflows into Mongolia's mining sector will be forthcoming and place the sector in good stead. Nevertheless, we caution that the government will face major domestic challenges over the coming decade as the country's mining boom takes off. Chief among these include striking the right balance between gaining a greater share from the mineral sector, while avoiding stoking fears among the foreign investment community. Given our expectation for base metal prices to head broadly lower over the course of 2013 and 2014, we highlight that the threshold of attracting foreign investment might be lower than what the Mongolian government currently anticipates. Moreover, we believe it will face a tough task in managing the social change that the mining boom will create, including immigration and the growing gap between rich and poor. In foreign policy, the government's chief priority will remain avoiding falling too much under the influence of neighbours Russia and China, though we believe the latter in particular will prove almost impossible.