Oyu Tolgoi: light at the end of the tunnel?

Mongolian mine Oyu Tolgoi is the largest undeveloped copper-gold mine in the world and has finally secured funding to go ahead after years of setbacks. How was the deal struck in a climate of declining copper and gold prices, and could it be a sign of recovery for mining in the region?


Oyu tolgoi

In December 2015, Oyu Tolgoi LLC signed a finance deal for $4.4bn with a group of lenders to expand its copper-gold mine underground. The Mongolian mine, already in its open-cut phase, has shipped more than 1.5 million tonnes of concentrate to date, but a 2014 feasibility study conducted by the company found 25 billion pounds of recoverable copper, 12 million ounces of gold and 78 million ounces of silver able to excavated over a mine life of 41 years. It is the second biggest mine expansion project in the world.

The deal follows an agreement announced in May 2015 between 66% shareholder Turquoise Hill Resources (51%-owned by Rio Tinto) and 34% shareholder, the Government of Mongolia, which ironed out a number of shareholder issues and set out a framework for investment. Rio Tinto Copper and Coal executive Jean-Sébastien Jacques said in a statement that the May agreement "provides a clear and stable framework for the future".

Funding for the deal last December has come from international development funds and commercial banks. This includes Export Development Canada (EDC), the European Bank for Reconstruction and Development (EBRD), the International Finance Corporation (IFC), the Export-Import Bank of the United States, and the Export Finance and Insurance Corporation of Australia ('Efic').

Commercial lenders for the project include heavyweights such as BNP Paribas, ANZ, Standard Chartered Bank and HSBC, and the four loans that make up the total $4.4bn have repayment terms of 12-15 years.

As well as the initial funds, the lenders have agreed a debt cap of $6bn, providing the option for an additional $1.6bn of supplemental debt.

This contract has progressed further than Oyu Tolgoi's first attempt to gain funding. A previous deal from 2013 raised $4.2bn for the underground expansion but wrangling over regulation between Rio Tinto and the Mongolian Government delayed its signing. The agreement eventually collapsed in 2014 after commitments from the banks involved expired.

How will the money be spent?

Oyu Tolgoi LLC estimates that 80% of the mine's value is beneath the surface. It plans to access this haul using block caving techniques, which involves digging tunnels under the deposits and using explosives to disperse the rock, which falls down into a lower level and is transported to the surface. Tunnels constructed over the life of the project will exceed 200km in length, and will be built 5.5m-high and 5m-wide.

"Rio Tinto securing funding for the project in such dire times for the commodities markets would appear to buck several trends."

Turquoise Hill Resources estimates that the site will operate 365 days a year, employing over 3,000 people at peak construction. The mine currently employs a 95% Mongolian workforce and intends to continue in this.

Long-term decline in commodities prices

Rio Tinto securing funding for the project in such dire times for the commodities markets would appear to buck several trends. Copper is at a five-year low and worth less than half that of 2012, according to NASDAQ. Gold is also faring badly; selling for $38,965 per kilo today compared with $59,082 at its peak in 2011.

Lead investment officer for Oyu Tolgoi at the IFC Neil Pereira says its decision to invest $2.2bn in debt and guarantees for the expansion project was based on wider factors than commodities prices and return alone.

"We don't speculate on market prices, we invest continually throughout the commodity cycle," he says. "Our thesis is, is this a low-cost project, and Oyu Tolgoi is definitely in the lowest quartile. This puts it in a competitive position to withstand fluctuations in the market price."

For international development agencies, the most important factor is how a project will affect the community it's based in. This includes job creation, generation of tax revenue for the local government and long-term financial sustainability. To date, Oyu Tolgoi has proven its ability to create work for the Mongolian people, and since the open-cut project began it has paid $1.3bn in taxes and other fees to the Mongolian Government.

Money may have been raised, but the project will only proceed on completion of a feasibility study to confirm the mineral deposits and map out a methodology for their extraction. Rio Tinto declined to give a date for the release of the study, but it is planning to make a firm decision to go ahead in the second quarter of this year, and pre-start activities have already begun.

Mongolia back on the rise?

The start of exploitation of Mongolia's mineral wealth has been directly related to an improvement in the country's economic fortunes. Its proximity to coal-thirsty China helped create the double-digit growth which peaked at a 17.3% GDP increase in 2011. However, China's declining economy and accusations of resource nationalism deterred international investors, slowing growth to 7.8% in 2014, according to the World Bank.

The election of a new government and Prime Minister last year, following a vote of no confidence in his predecessor seems set to change the situation. Upon settlement of the dispute between Rio Tinto and the Mongolian Government in May 2015, the Mongolian Prime Minister Chimediin Saikhanbileg said, "Our joint agreement clearly positions Mongolia as an attractive country for investment and underscores the fact that Mongolia is open for business."

Mongolia's communist past has been blamed for parliament's inability to lay down explicit policy on foreign investment but Periera says times are changing. "Mongolia is a country in transition," he says. "In terms of its political structure, it is moving more toward a market economy and that is encouraging more investment in lots of sectors."

As well as working with foreign investors to resolve past issues, the new PM has taken unorthodox measures to ensure he has the support of the Mongolian people. Early last year he appeared on national television and announced a 'text message referendum', asking the people to vote for international investment or austerity measures. Saikhanbileg's cause was supported by a return of 56% supporting foreign investment; not exactly a resounding endorsement, but seemingly enough to move forward.

More complex than money

Oyu Tolgoi's woes won't be magically solved by an agreement with the Mongolian Government and pledges of funds. Those who positively responded to the referendum may support expansion of mining operations in the country, but dissenting voices are getting louder.

Oyu Tolgoi Watch is an advocacy group formed specifically to observe Oyu Tolgoi's practices. It published a report in conjunction with Bank Watch in response to the funding news, stating the issues and risks associated with the plans as they currently stand. Its concerns centre on Oyu Tolgoi's water consumption, loss of land which has displaced land-based indigenous people, and power production.

"The cumulative impacts are severe and will continue to increase as mine development proceeds"

A report by the World Bank released in 2010 on groundwater conditions in the Gobi Desert found water demand for domestic use and livestock water was around 42,000 cubic meters per day (m3 /day). This number is equalled by the four biggest mines in Mongolia, which between them used 40,000m3/day in 2011. The World Bank predicted this consumption would grow sharply over the coming years in light of the expansion and new projects to reach 300,000m3/day by 2020.

A report issued in January 2015 by the Office of the Compliance Advisor/Ombudsman (CAO), a body which handles complaints about IFC-funded projects, found the re-routing of the Undai River and the subsequent drying up of the Bor Ovoo spring has impacted local herders. "The loss of the original Bor Ovoo spring has caused longer distances for herders to access water," it stated. "The search for water and pasture and inability to let winter pastures rest, is degrading remaining pastures...the cumulative impacts are severe and will continue to increase as mine development proceeds."

Rio Tinto admitted fault in March 2015, handing over a letter of apology and laying out plans to better engage the community in future. It says the mine will continuously recycle 80% of the water used in operation of the mine, as well as drawing water from an underground aquifer that does not affect surface water.

According to Sukhgerel Dugersuren, executive director of OT Watch, the promise of better communication isn't ringing true right now. He says, "Yet again, phase two is moving forward without consultations with those who will lose access to pasture and water."

Periera argues that the presence of IFC funding will improve the lot of the Mongolian people, saying that, "We have our own standards which are among best practice as far as environmental and social aspects go. We require investees to comply with those standards."

The CAO process would not have been available to herders and their representatives if not for IFC funding. As development agencies require projects they invest in to adhere to their own standards of worker welfare, health and safety and environmental sustainability, they claim the project will be of international standard.

It is hoped that the investigation and resolution of complaints to the CAO and other such bodies will set a precedent that funders mean when they say in term of compliance with their policies. This would ensure the Mongolian Government will go on to use Oyu Tolgoi as a benchmark to rate other projects in the country against, increasing the general standard.

Oyu Tolgoi: the test case

The success of Turquoise Hill's venture with the Mongolian Government could determine the fate of a number of other minerals projects in the country. Tavan Tolgoi, the second largest coal deposit in the world, sits in the South Gobi desert, close to the border with China. It has also been affected by changing regulations and non-committal by Mongolia. The project is currently stalled, but hopes are high that a deal can now be reached, given the government's new stance and the precedent of Oyu Tolgoi.

The investment environment in Mongolia is changing, but with any economy that is based on commodity export, the country need to be careful to diversify. Mongolia may be 'back to business' according to the Prime Minister, but investors remain wary of investing in an economy which could so easily fall victim to fluctuations in pricing.