The Bumpy Path to Sino-Mongolian Cooperation in the Mining Sector

The kabuki-style dance of trade partners Mongolia and China began again in earnest when on January 15 the third meeting of the Mongolia-China Cooperation Commission on Mineral Resources and Energy met in Ulaanbaatar. Mongolia’s Minister of Mining Davaajav Gankhuyag led the Mongolian side and Deputy Director of China’s National Development and Reform Commission Zhang Xiaoqiang headed the Chinese delegation. According to Zhang, “boosting co-operation in mineral resources and energy, which account for the bulk of China-Mongolia economic and trade relations, is in the interests of both countries and can help Mongolia turn its advantages in resources into economic development” (www.business-mongolia.com, January 16). Although China and Mongolia see great benefits in continuing their vibrant trade in minerals, each side has a different vision on how to proceed. This has led to a tense relationship that often, mistakenly, is described by global financial commentators as resource nationalist sentiment in the Mongolian parliament and populace.

Mongolia exported a total of $4.38 billion worth of products in 2012, 89 percent of these being minerals that represented 20 percent of the country’s GDP (Mongolian National Statistics Office, www.nso.mn). All of Mongolia’s coal, iron ore, copper, zinc and tin concentrate as well as much of its gold are exported to China. Chinese state-owned enterprises (SOEs) and private corporations in 2011 were the largest investors in Mongolia’s mineral sector with $2.3 billion FDI—five times the amount China invested in 2006 (The Mongol Messenger, January 18). This close reliance is hardly the definition of resource nationalism.

Two of the prime goals of the Mongolian side during the consultations were to renegotiate upwards the prices the Chinese pay for Mongolian raw minerals and lessen transit tariffs for Mongolian shipments destined for third nations, such as South Korea and Japan. The Mongols also raised the issue of the failure of Chinese mining operations to obey all Mongolian environmental and safety laws, demanded the employment of more Mongolian mine workers and discussed plans for construction of mineral processing plants inside Mongolia. China pressed for more stability in the legal environment regulating bilateral trade and foreign investment. Deputy Director Zhang also suggested that the two countries focus on developing large mining projects and constructing a highly connected railway transportation and coal transport border infrastructure. 

One area both sides agreed has potential for expansion is in oil products. PetroChina’s investment of $1.4 billion in the oil sector made it the biggest investor in Mongolia last year. This oil production is exported to China for refining. Minister Gankhuyag told the Chinese side that Mongolia considered it necessary to make the border checkpoint where the crude oil crosses into China (Bayankhooshuu-Uvdug) a permanent one, to process the raw Mongolian crude in China and return the product, and to make an agreement on implementation of a 2008 memorandum between PetroChina and the Oil Authority of Mongolia to supply 10,000 tons of oil products monthly as well as purchase additional volume (The Mongol Messenger, January 18). Mongolia imports all its refined oil and diesel with more than 90 percent coming from Russia. To overcome this lopsided dependence the government has set a goal of building a state oil refinery with Japanese technology that would be functional in 2015. In the interim, it wants to cooperate with China to diversify its oil imports. 

The Mongols expected the consultations would be open to the public; however, at the request of the Chinese, it was held behind closed doors. Midway through the discussions, Zhang and Gankhuyag issued a joint statement, but refused to take questions from journalists. In their statement they noted that bilateral trade volume in 2012 reached $6.6 billion and announced that negotiations would continue over infrastructure and railroad projects as well as oil cooperation (www.english.news.mn, January 16).

Changes to Mongolia’s Foreign Investment Law Complicate Picture

These bilaterals were influenced by the fact that 2013 began with the foreign investment picture in Mongolia again in turmoil, because of President Tsakhia Elbegdorj’s proposals for revising Mongolia’s Strategic Entities Foreign Investment Law (SEFIL) of May 2012 that imposes tight regulations on investments in mining, banking, finance and media communications. Passed in a rush by Mongolia’s Parliament after the Chinese state-owned Aluminum Corporation of Corporation (Chalco) attempted to acquire majority stake in a privately-held coal mine controlled by South Gobi Resources (owned by Canadian company Ivanhoe, now renamed Turquoise Hill), the law requires Mongolian governmental review of all assets in the affected sectors with foreign state-owned FDI or cross the value threshold of MNT 100 billion (about $70 million). While Chinese mineral assets are hit the hardest by these new regulations, China and western investors are on the same side—although apparently not working together—to counter the SEFIL and moderate its provisions. 

Investor complaints about the law in recent months were not unnoticed by President Elbegdorj. On the day after Christmas, he went on Mongolian television to give support to respecting the controversial 2009 Oyu Tolgoi (OT) agreement wherein Rio Tinto and its partner Turquoise Hill hold 66 percent to Mongolia’s 34 percent of a huge deposit in the Gobi projected to contain 31 million tons of copper, 1,328 tons of gold and about 7,000 tons of silver. He cautioned that Mongolia must respect legal documents and warned that the nation’s “reputation for having a favorable investment environment is being tarnished as domestic demand is growing for the government to hold more shares in the project” (Xinhua, December 26, 2012). One day later, the president’s 91-page draft proposals (published on December 5, 2012) to Parliament for amending the 2012 Mineral Law were discussed in a news conference by Minister Gankhuyag, who while serving as a Parliamentarian was known for his demand that Mongolia renegotiate the OT agreement and hold a larger stake in all major strategic mineral resources. The minister announced the government is seeking to revise upward the threshold of FDI that triggers automatic government review to as high as MNT 300-400 billion (approximately $210-280 million) (Xinhua, December 28, 2012). Gankhuyag speculated such changes could be introduced for parliamentary debate in mid-February around the recess for the traditional lunar New Year holiday.

The Business Council of Mongolia (BCM) with some 250 members (although apparently no Chinese ones) sent a letter on January 7 to the Office of the President commenting on the president’s draft law proposals. The BCM’s strongly-worded document had five macro-conclusions:  

Slow Down in Mongolian Coal Exports to China

Mongolia’s overall exports in 2012 fell 8.99 percent—a decrease of $430 million from 2011. The main reason was the drop in mineral exports to China. In 2012, Mongolia exported 20.9 million tons of coal, 574,000 tons of copper concentrate, 6.4 million tons of iron ores, 3,570 barrels of crude oil, 2.8 tons of semi-processed and unprocessed gold and 140,000 tons of zinc concentrate. Coal represented 43.2 percent of the country’s exports, copper concentrate 19.1 percent, and iron ore 12.1 per center. Iron ore exports increased by 10 percent and crude oil exports grew by 40 percent (www.business-mongolia.com, January 17). Despite the downward trend and the slowing of China’s economy, it was predicted by Mongolia’s Mineral Resource Authority that Mongolian coal exports would grow 32 percent this year (www.news.mn, January 16).

During the consultations, it is likely that the Mongols informed the Chinese that development of Mongolia’s 7.5 billion ton coal project of Tavan Tolgoi—300 km from the Chinese border and operated by the state company of Erdenes Tavan Tolgoi (E-TT)—would be further delayed until after 2013. CEO Yaichil Batsuuri, appointed to E-TT last October, had announced in mid-January that E-TT was suspending all coal deliveries to its client, Chalco, because it had run out of funds for overland trucking service fees (it owes $3.6 million) and wanted to renegotiate its supply contract with Chalco (www.news.mn, January 14). E-TT’s finances were drained in 2012 when it was forced to pay $310 million into the Mongolian government’s Human Development Fund, so it could disburse promised monies to each citizen just prior to the June 2012 parliamentary elections.

Chalco had paid Mongolia $250 million in July 2011 for an unannounced amount of coal, but at a price Batsuuri claimed was close to $53 per metric ton—a price analysts agree is considerably lower than international standards. When the bankrupt E-TT recently sought government assistance, it was promised in January $355 million from Mongolia’s Development Bank to resume work, repay its debts and possibly refund in cash to Chalco the contract’s coal obligations. Batsuuri explained that Mongolia wishes to maintain a relationship with Chalco, but change the nature of their cooperation and price formula. Claiming that E-TT loses over $5 on every ton under the present arrangement, he indicated that the government wanted to sell its coal at world prices to other nations if it can dissolve the Chalco agreement: “Paying by coal is not profitable for the company. We are losing on coal trade. That’s why the government made the decision to pay out the remainder. We will pay the remaining $180 million in cash” (www.english.news.mn, January 24). Chalco in a written response to Bloomberg’s Mongolian office regarding the news that E-TT was stopping delivery of its coal maintained the “fundamental terms of the agreement should not be changed,” separately and reportedly including “secret terms” (english.news.mn, January 28; January 24; www.bcmongolia.org, January 24).

The January consultations with the Chinese covered the topic of expanded Sino-Mongolian rail construction for Tavan Tolgoi to replace the present truck transport of coal. Zhang said “the Chinese side will give support to construct a railway to be built in southern Mongolia and pay attention to transporting products at cheaper prices after the railway is constructed. The Chinese side is willing to render support to construct a railway from Tavan Tolgoi to Sainshand [the linkage point to Mongolia’s rail south] based on an economically profitable basis” (The Mongol Messenger, January 18).

A finalist bid list, consisting of China’s Shenhua Group Corp. Ltd, Peabody Energy Corporation of the United States, and a Russian Railway-Mongolian consortium, for foreign investment rights to Tavan Tolgoi’s western section has been held up for two years by protests over the selection process, particularly from Japanese and South Korean companies. Shenhua had put up $200 million as a good faith gesture to secure its finalist position. Shenhua Energy has not made a statement on the situation but the Mongolian Ambassador to China, Tsedenjav Sukhbaatar, revealed discussions are ongoing (english.news.mn, January 28). How to proceed with this western field bid list has delayed Mongolia’s plan this year to raise up to $3 billion in funds in an initial public offering (IPO) for development of Tavan Tolgoi’s eastern field, to be handled by BNP Paribas, Deutsche Bank, Goldman Sachs and Macquarie. Batsuuri explained the IPO cancellation by saying: “We decided to wait until the market recovers, the price of coal increases, and until E-TT starts regular construction of its wash plant. Plus we need to increase our exports” (english.news.mn, January 24).

Strategies Going Forward

The Chinese government has been very circumspect in commenting on recent trade disputes with the Mongols. This posture is far different from the 1990s when rail freight traffic often was severed to punish Mongolian actions or influence Mongolian decision-making. This change in strategy may reflect the realization that a hard-line approach with Mongolia politically was counterproductive and that Inner Mongolian factories have become more dependent on Mongolian minerals with each year. The Chinese have used Mongolian news outlets to voice disappointment during this third round of Sino-Mongolian consultations about what they see as Mongolia’s uncertain legal regime and changeable mineral sector regulations. These same media sources claim that the Mongols had “high expectations” for negotiations on the big issues, such as the unprocessed coal price that were not met and concluded that “many questions are still left without answers” (english.news.mn, January 17).

Meanwhile, the Chinese could not fail to note that on the same day as the Sino-Mongolian consultations, Mongolian Minister of Foreign Affairs Lu Bold started his official visit to India with meetings in Mumbai with Indian Chamber of Commerce businessmen to encourage more investment in the already burgeoning Indo-Mongolian mineral relationship (www.news.mn, January 16). On January 24, it was announced in Beijing that after attending the 21st Annual Meeting of Asia-Pacific Parliamentary Forum in Vladivostok, Wu Bangguo, chairman of the Standing Committee of the National People’s Congress, will pay an official goodwill visit to Mongolia from January 27 to February 1 at the invitation of Mongolian Parliamentary Chairman Zandaakhuu Enkhbold (china.org.cn, January 24). These visits are signs that Sino-Mongolia relations will continue to be played out in Asia at the very highest levels as 2013 progresses. The lack of clarity on how bilateral mineral trade will proceed, however, reflects both Mongolian domestic political sensitivity over Chinese predominance among foreign investors and a growing Mongolian desire to develop mineral deposits more slowly under their own auspices. China has been mostly reactive, trying to parry Mongolian moves. It seems to understand that with Mongolia’s new assertiveness, political and strategic factors are as important as economic ones, so for now Beijing remains calm and relatively tolerant.

[CORRECTION: The original article mistakenly asserted the law firm Hogan Lovells wrote  an analysis that was the basis for the Business Council of Mongolia (BCM) report referenced in the piece. Hogan Lovells was not involved in the drafting of the BCM report and does not agree with the report’s conclusions.]