October 12, 2010 / 11:52 AM / 9 years ago

Special report - Mongolia's fabled mine stirs Asian frontier

ULAN BATOR (Reuters) - A feeling of expectation hung in the air early one September morning as a group of bankers emerged from the aging, Soviet-era chic of Ulan Bator’s Chinggis Khaan Hotel en route to a two-hour flight deep into the Gobi Desert, which blankets Mongolia’s southern frontier.

A freshly produced bar of gold is cleaned at the Boroo gold mine in Boroo, about 150 km (93 miles) north of the Mongolian capital of Ulan Bator, July 5, 2006. REUTERS/Nir Elias

Their destination, about 80 km (50 miles) from China’s northern border, was Oyu Tolgoi, which bankers, geologists, journalists, and the mine’s main developer Ivanhoe Mines Ltd (IVN.TO) routinely describe as one of the world’s largest untapped copper and gold deposits. Ivanhoe, led by the colourful American-born billionaire Robert Friedland, owns 66 percent of the mine, and the Mongolian government the rest.

“This is going to be among the top five mines in size around the world,” Keith Marshall, president and CEO of Oyu Tolgoi LLC told a conference in Mongolia’s capital, Ulan Bator. “The only way to describe it is that it is just an awesome deposit. I have been 30 years in the mining industry and I haven’t seen anything quite like this.”

Landlocked Mongolia lingered in isolation for 70 years as a Soviet satellite state, serving as a sleepy buffer zone between its giant neighbours, Russia and China. Now, a young democratic government, in power since the early 1990s, is trying to pull its 3 million citizens out of poverty by exploiting vast amounts of untapped mineral wealth underneath the country’s deserts and grasslands.

Oyu Tolgoi, or “Turquoise Hill,” is named after the colour of the copper oxide leaching to the surface. The project is Mongolia’s crown jewel, a massive ore body with a lifespan of 40-50 years that Ivanhoe says contains approximately 81 billion pounds of copper and 46 million ounces of gold — not including estimates from a new vein discovered late last month. The mine will have a major impact on the supply of global copper. The copper reserves alone would be second only to Chile.

Much of the mine’s treasure will be sold to China to satisfy the Middle Kingdom’s voracious appetite for natural resources.

Mongolia’s emergence as one of Asia’s premier frontier markets is rarely discussed without reference to the Oyu Tolgoi site, a modern-day El Dorado that analysts say could account for roughly 30 percent of the country’s GDP once it is fully operational.

Bankers and fund managers from Citi (C.N), ING ING.AS, Morgan Stanley (MS.N), Aberdeen Asset Management and other financial powerhouses flew in on September 6 to take a closer look at the famous mine.

“Obviously, people wanted to know what would drive Mongolia’s economy going forward and (Oyu Tolgoi) is a testament to where it is heading,” Alisher Ali Djumanov, chairman of Hong Kong-based investment bank Eurasia Capital, which organised the trip told Reuters. “We felt it important for foreign investors to see for themselves the transformations taking place so they feel more confident about the entire Mongolian story.”

The visit came at a challenging time for Ivanhoe. The Canada-based miner is trying to fend off a possible takeover by its biggest shareholder, global mining giant Rio Tinto (RIO.AX)(RIO.L) — a deal that could be as compelling for Rio as its Australian rival BHP Billiton’s (BHP.AX) $39 billion (24.6 billion pounds) pursuit of Canada’s Potash Corp POT.TO.

SEEKING WHITE KNIGHT?

Analysts say Friedland is maneuvering to prevent Ivanhoe from being acquired too cheaply by the much bigger Rio, which posted a profit of $5.8 billion for the first half of 2010 on earnings of $25 billion.

“Ideally, Robert (Friedland) wants to be bought out and he wants a fair price,” said UBS analyst Glyn Lawcock.

Rio holds about 35 percent of Ivanhoe and can steadily increase that stake to a limit of 47 percent. That “standstill agreement”, however, expires in October of next year, at which point Rio could make a run for a majority stake.

Ivanhoe, which posted revenues of $31.6 million and an operating loss of $146 million in the first half 2010 — typical of a mining company in the exploration phase of its projects — has devised a shareholder rights plan known as a “poison pill” to protect itself against what it called “coercive and creeping takeovers”.

In July, Ivanhoe opened the door to other buyers by terminating a clause in an agreement with Rio that restricts it from issuing shares to other “strategic investors”. (Oyu Tolgoi is the most prized of Ivanhoe’s assets. But it also has controlling interests in Mongolia’s Ovoot Tolgoi coal mine, the Cloncurry copper, gold and uranium project in the Australian state of Queensland and a gold project in Kazakhstan.)

Rio, which has invested $1.7 billion in Ivanhoe and its Oyu Tolgoi mine since 2006, is not backing down either, and has launched arbitration proceedings against Ivanhoe for scrapping the shareholding agreement.

Friedland, meanwhile, has been flogging the mine’s fabulous potential to potential investors. He told the Diggers and Dealers mining conference in Kalgoorlie, Australia in August that the estimated present value of the copper and gold at the project was about $US350 billion, and could, if the project expanded, be worth up to US$1 trillion.

Terminating the agreement with Rio “has opened us up to some very interesting discussions with third parties”, he told the conference without elaborating.

Rio ultimately wants to swap its Ivanhoe stake for a direct holding in Oyu Tolgoi and bring in one of its largest shareholders, China’s Chinalco, as a partner.

“Chinalco has indicated an interest in acquiring a minority equity stake in the company (Ivanhoe) or acquiring, from the company, a direct minority ownership interest in the OT project,” Rio said in a July 7 filing to the U.S. Securities and Exchange Commission.

“At the end of the day, you’re dealing with one of the shrewdest investors in the mining space,” said James Bruce, portfolio manager at Perpetual Investments, which owns a stake in Rio Tinto. “It’s a very difficult negotiation, but one that, presumably, Rio Tinto are keen to have.”

Both Ivanhoe and Rio, meanwhile, have profited from a 68 percent rise in Ivanhoe’s shares between mid-July, when Ivanhoe announced it had scrapped the shareholding agreement, and September 28, when the company disclosed it had discovered the new vein in Oyu Tolgoi containing an estimated 10.2 billion pounds of copper and 15 million ounces of gold. The surge has also coincided with a 25 percent increase in copper prices during the period.

DOMINATING THE DESERT

The nearly $5 billion Oyu Tolgoi development project is expected to begin commercial production in 2013. A road to China is under way and, eventually, an airport as well. A huge construction site is already leaving its mark on the Gobi’s flat, barren landscape.

“It is the equivalent of a 20-story building,” Marshall said, referring to a 110-meter ore extraction shaft in the middle of the Oyu Tolgoi site. “It is going to dominate the Gobi desert — probably from 50 or 60 kms away, you are going to see this shaft.”

The deal between Ivanhoe and Mongolia’s government took six years to hammer out, and was finally signed in October 2009. Ivanhoe made commitments to build local schools and infrastructure and provide jobs and training to Mongolian workers.

The prospect of employment, however, has done little to allay the resentments of ordinary Mongolians, many of whom follow the same nomadic habits that prevailed when Genghis Khan swept across Asia 800 years ago. Some believe their government was too quick to cede control over Oyu Tolgoi to foreigners.

The mine has been the subject of heated parliamentary meetings, editorials, and street protests in Mongolia. In the last six months, two organised trips to Oyu Tolgoi for international journalists were canceled at the last minute.

“This is the government’s policy — that only experienced foreigners can build these projects,” said S. Avirmed, professor of Economics at the School of Geological Studies, National University of Mongolia, adding many Mongolians have criticised the government’s handling of the project.

In 2006, protesters took to the streets in Ulan Bator and burned Friedland’s effigy and those of several other government ministers and leaders.

“The Canadian lobby is prevailing and no one in the government listens to ordinary Mongolians,” Avirmed said.

Ivanhoe declined to comment on the record for this story.

THE PROMOTER

Robert Friedland’s path to the outer regions of Mongolia has been adventurous. Born in Chicago in 1950 to European immigrants, he attended Bowdoin College in Maine and Reed College in Oregon, where he plunged into the 1960s countercultural movement.

He was arrested in 1970 at the age of 19 in Portland, Maine, for selling LSD to an FBI agent. The conviction, which Friedland has long maintained was politically motivated and amounted to entrapment, was set aside in 1973 and expunged in 1986.

He moved to the other side of the country after the incident to live on an apple orchard outside Portland, Oregon, where he met future Apple founder Steve Jobs. He went on to become president of the student body at Reed, graduating in 1974 with a political science degree.

The future mining magnate spent time travelling around India, studying Sanskrit and Buddhism before forming his first company, Hanuman Mines, in the late 1970s, according to Canadian journalist Jacquie McNish in her book “The Big Score: Robert Friedland and the Voisey’s Bay Hustle.”

Hanuman, named after the Hindu monkey god, acquired rights to an abandoned gold mine in Oregon. Friedland sold the mine in the early 1980s into a little-known firm listed on the Vancouver Stock Exchange called Galactic Resources for cash and shares.

“In the 1980s, Robert Friedland moved the art of penny-stock promoting from Vaudeville to Broadway,” McNish wrote. “Under Friedland’s direction ... a mining promotion became more like a big-budget musical with a complete cast of characters. Each act opened with a small mine, or property, then large and richer mineral assets were added, as the storyline grew more complicated. Experienced geologists and mining executives became the stars and modern technology, the stage effects.”

But the next act in the Friedland mining show had an unhappy ending. The U.S. and Colorado state governments held Galactic — then under Friedland’s leadership — responsible for one of the worst mining disasters in the United States, after acidic drainage from its mine in Summitville, Colorado leaked into the nearby Alamosa River.

Friedland eventually agreed to a payment of $20.7 million to settle state and federal lawsuits over the accident that saddled him with a nickname that has followed him around the world since: “Toxic Bob.”

He hit the jackpot in 1993 when, searching for diamonds, he discovered the Voisey’s Bay nickel deposit in Labrador, Canada. He used his considerable negotiating skills to drum up a bidding war for the asset, eventually selling it in 1996 to Canada’s Inco Ltd (later acquired by Vale SA (VALE.N)) for $3.1 billion.

“He’s got an enviable track record when you look at what he’s discovered and ultimately monetised,” said Tim Schroeders, a portfolio manager at Pengana Capital Management.

Despite the Voisey’s Bay success, Friedland courted more controversy after the Summitville disaster when he struck a deal with Myanmar’s military dictatorship to mine copper in the Southeast Asian country, to the consternation of human rights and labour groups. Ivanhoe said it divested its business in Myanmar, including its 50 percent interest in the S&K mine at the Monywa copper project, as part of its agreement with Rio to develop Oyu Tolgoi.

Friedland, now based in Singapore, started trumpeting Oyu Tolgoi after Ivanhoe bought the exploration license from BHP Billiton in May 2000. Oyu Tolgoi’s big advantage, he said at a 2005 investor conference in Florida, was its isolation in Mongolia.

“The nice thing about this is that there are no people around, the land is flat, there’s no tropical jungle, there’s no NGOs,” he was quoted as saying n news reports at the time. “We’re only 70 kms from the Chinese border � You’ve got lots of room for waste dumps without disrupting the populations and we are building the biggest new mine in the world.”

Friedland declined to be interviewed for this story.

THE NEW FRONTIER

Mongolia, which spent seven decades subsisting on the fringes of the Soviet command system, sees giant projects like Oyu Tolgoi as a sure-fire way of earning revenues and rejuvenating the long-isolated economy.

With many of its voters still eking out a living, the Mongolian People’s Revolutionary Party has been under heavy pressure to reinvest and redistribute the royalties from the thousands of new mineral deposits buried in its sparse, underpopulated prairies and deserts.

But local critics say it has already handed over too much, not only to Ivanhoe Mines, but to other foreign miners now shipping Mongolian minerals across the border to China.

Given Mongolia’s early stage of development, the success and impact of Oyu Tolgoi will not be felt overnight, some experts say.

“I’m not expecting enormous changes or big revenue jumps for the government from Oyu Tolgoi for some time,” said Graeme Hancock, senior mining specialist with the World Bank in Mongolia. “That’s probably contrary to what everybody else’s expectations here are.”

Mongolia up until recently had been cautious about developing its huge but untapped reserves of coal, copper, gold and uranium. But the government needs cash quickly to provide jobs and education for its roughly 3 million people. Many of them are nomads, who raise livestock and move season to season, living in portable ‘gers’, similar to those used 800 years ago when Temujin — later known as Genghis Khan — united the steppe tribes and founded the Mongol Empire.

The new gold rush to develop Mongolia’s resources could make it the world’s fastest-growing economy over the next five years, according to Renaissance Capital, which projected GDP will almost quadruple to $23 billion by 2013 from $6 billion today.

To profit from its untapped iron ore, coal, copper, uranium, silver, and gold deposits, the government needs to build a vast network of roads and railways to ship the minerals out of the country’s vast interior. More than 10 “strategically important” deposits are in development including the Dornod uranium deposits, the Asgat silver deposit, and the massive Tavan Tolgoi coal site.

Tavan Tolgoi, like Oyu Tolgoi, inspires awe among resources investors. It is a deposit of approximately 7.5 billion tonnes — believed to be the world’s largest untapped coking coal site. Most of its projected 50 million tonnes of production will go to China.

The trick is getting it there. To that end, Mongolia aims to build a massive industrial park in Sainshand, capital of Dornogovi Province, to help transport metals and coal to customers around the world. The facility will include copper smelting and coal processing plants, as well as railroads to and from the park.

Much like the debate around Oyu Tolgoi, controversy has dogged the government’s infrastructure plans from the beginning. In April, Prime Minister Sukhbaatariin Batbold threw his support behind an east-west railway plan, connecting the Tavan Tolgoi coal deposit to the eastern city of Choibalsan via Sainshand, at a cost of around $2 billion, according to one estimate.

Some experts say it would be far more sensible, and half the cost, to build the railway south towards China, which bought 70 percent of the country’s exports last year.

“The biggest risk is government policy — one of the examples is on infrastructure,” said Masa Igata, founder and CEO of Mongolia-based Frontier Securities. “It makes economic sense to connect Tavan Tolgoi to China’s border. However, parliament has decided to prioritise Tavan Tolgoi to Sainshand. By doing so, they sacrifice the economic benefit...”

Feeding into the debate is Mongolia’s determination to shed its historical vulnerability as a landlocked country sandwiched between Russia and China. Mongolia needs both geopolitical giants as investors and customers, but wants to be beholden to neither, preferring to be “the mortar between two BRICs”.

“Mongolia has been quite careful about its sovereignty — we don’t want to be too dependent on one country,” Oyun Sanjaasuren, a lawmaker and former foreign affairs minister said at a conference in Ulan Bator in June. “Theoretically, we want to have a one-third, one-third, and one-third balance,” Oyun added, referring to China, Russia and a third country such as Japan or the United States.

INVESTOR UNCERTAINTY

China’s emergence as the region’s dominant superpower has been accompanied by unpredictable swings in Mongolia’s foreign investment policies.

The government originally planned to sell as much as 49 percent of the Tavan Tolgoi coal deposit to a foreign bidder, and hired JPMorgan and Deutsche Bank to handle the sale. But in February, they canceled the auction in favour of 100 percent state ownership, with plans to sign a development contract without giving any equity away. Chinese coal giant Shenhua (1088.HK) was often named as a frontrunner in the hotly contested deal. Other bidders named in the original auction included India’s Jindal, Vale, and U.S. coal miner Peabody (BTU.N).

The government’s decision to cancel the Tavan Tolgoi equity stake sale to a foreign company frustrated dealmakers, but was seen by some analysts as an astute political calculation — a move to avoid some of the popular anger that followed the Oyu Tolgoi investment agreement.

“They’d given up too much in Oyu Tolgoi,” Frontier’s Igata said. “A few years ago, Mongolia was eager to be financed.”

Corruption may also prove to be a long-term problem. Transparency International rated Mongolia 120th in its 2009 corruption perception index, a fall from 102nd in 2008.

Already whispers persist in Mongolia’s business community that many more workers at Oyu Tolgoi are in fact more experienced Chinese miners, instead of Mongolian nationals as promised in the investment agreement. Ivanhoe, however, says it is adhering to an agreement that calls for 60 percent of the jobs to go to Mongolians during the mine’s development phase. “As of 30 August, we have 4,200 people at site,” Marshall, the Oyu Tolgoi CEO, told Reuters, adding that 2,536 on site were Mongolian.

Environmentalists are concerned that large-scale mining in southern Mongolia would increase desertification. “Both Oyu Tolgoi and Tavan Tolgoi will require huge amounts of water, and from the environmental impact assessment, and from their plans and their feasibility studies, we know they have not demonstrated availability of water for the life of this project,” said Dugersuren Sukhgerel, executive director of an NGO called Oyu Tolgoi Watch. “Mongolia is experiencing higher degree of climate change — over 70 percent of Mongolia’s territory is suffering desertification. That is a big concern.”

The discovery of a new vein at Oyu Tolgoi is bound to offer even more jobs and riches for Mongolia. Ivanhoe said on September 28 the discovery, named the Heruga North deposit, contains an estimated 10.2 billion pounds of copper and 15 million ounces of gold. “It’s possible that Heruga and Heruga North eventually could be developed together as one of the world’s largest underground gold mines,” Friedland said in a statement.

The government hopes to channel some of that wealth to its citizens by privatizing a moribund state-run stock exchange, a move that would finally plug the landlocked nation into the grid of global finance, and channel capital to Mongolian entrepreneurs. The London Stock Exchange is the front-runner to run the new exchange, “building it from scratch”, Prime Minister Batbold told reporters at last month’s U.N. General Assembly meeting.

Even as firms such as Mongolian Mining Corp prepare IPOs in more sophisticated markets such as Hong Kong this year, the government is making plans to take public a portion of Oyu Tolgoi mine. It’s all part of Mongolia’s plans to privatise assets — it is committed to handing a tenth of all proceeds to its citizenry — and to give Mongolians a way to cash in on the dream.

That could go some way toward soothing any leaden feelings over Ivanhoe’s golden deal at Oyu Tolgoi.

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