The specter of resource nationalism in Mongolia has come to
haunt Rio Tinto (
) once again. The Mongolian government has announced its
cancellation of the decision made in 2009, under which it converted
the Shivee Tolgoi and Javhlant exploration licenses held by Oyu
Tolgoi and Entree Gold, into mining licenses. The licenses now
stand suspended, pending review of the decision.
Oyu Tolgoi owns 80% interest and Entree 20% interest in
production from the mining licenses. Oyu Tolgoi is controlled
by Rio Tinto through its Turquoise Hill Resources unit. The
Mongolian government has a 34% stake in Oyu Tolgoi, which it is
keen to increase to 50%.
The government's move is being seen as a tactic to exert
pressure on Rio, ahead of key talks over funding for the mine which
will run out in three days. The two sides are slated to meet on
February 27 and 28, to hash out problems and find a compromise. The
larger dispute is about ownership in the mine. The Mongolian
government is desirous of increasing its stake to 50% immediately
in violation of the agreement signed with Rio, which only provides
for incremental government ownership over time.
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Impact On Rio
Rio stands to lose from the cancellation of the mine licenses
because it is Entree Gold's biggest shareholder, with 23.6% of the
shares. The area covered by the license contains 25% of the
inferred mineral resources of the Oyu Tolgoi vein, according to
calculations based on technical reports.
What the Mongolian government ostensibly intends to do is to
transfer Entree Gold's licenses to Oyu Tolgoi, in order to boost
its own revenues since it owns a part of Oyu Tolgoi. While Rio
Tinto is obviously a stakeholder in Oyu Tolgoi as well, its overall
revenue share will go down if licenses are cancelled.
The Larger Issue
Financing for the $6.6 billion Oyu Tolgoi copper and gold mine,
which will become the world's five largest once it reaches full
production, runs out in three days, and talks to extend its funding
are being held on February 27 and 28. If an agreement is not
reached, either the mine will have to suspend operations or Rio
will be forced to extend it a credit line.
The outcome is crucial to both sides. At full capacity,
production from Oyu Tolgoi will account for nearly a third of
Mongolia's economy, while Rio Tinto is dependent on the mine to
drive growth outside its massive iron ore business. Having suffered
massive writedowns in its aluminum business for two consecutive
years, Rio is looking for avenues to allow significant yet
profitable diversification from iron ore. Also, almost all of Rio's
iron ore production is tied up in the Pilbara region of Australia,
where cyclones are quite common and lead to production outages.
While the main grouse of the Mongolian government is budget
overruns, we wonder why Rio wouldn't want to control costs. It has
been a stated objective of the company to reduce costs, reaffirmed
in its latest earnings release and presentation through quantified
cost saving targets for the next three years. The step is essential
to stabilize the company's financials and shore up its balance
If the two sides fail to reach an agreement in talks and Rio
decides not to extend a credit line to Oyu Tolgoi, we see
international arbitration as its only option. But that would delay
production beyond June 2013 - Rio's stated target. This will have
an impact on the company's performance for 2013. Also, arbitration
proceedings are not enforceable, so little may be gained in the end
even if Rio wins.
We have a
Trefis price estimate for Rio of $45
, which will be revised now that the fourth quarter earnings
results are out.
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