- The Mongolian government and Rio Tinto are locked in a
dispute over high management fees, cost overruns and
transparency in the Oyu Tolgoi project.
- The two sides held talks for two days to thrash out
differences but failed to break the deadlock. Meanwhile they
have approved a temporary budget to run the Oyu Tolgoi
- Higher mining costs imply a longer wait for the Mongolian
government before it can start receiving royalties.
- If the mining operations had been halted, production would
have been delayed beyond the original target of June.
- Doesn't make sense for Rio not to keep costs in check when
it has been stated as a top priority in this year's earnings
report after a dismal performance last year.
- If dispute is not resolved soon, arbitration may be the
Mining giant Rio Tinto (
) and the Mongolian government failed to reach an agreement over
various disputes after two days of marathon talks on February 27
and 28, but the Oyu Tolgoi project was spared any adverse impact.
The two sides will continue the talks in March and, in the
meantime, have agreed on a temporary budget to keep Oyu Tolgoi
The two sides had been locked in talks for two days over issues
like management fees, cost overruns and transparency. The
Mongolian government is not happy with the quantum
of management fee paid to Turquoise Hill, and the mine's cost
to date of $6.6 billion, which is 15% greater than the forecast
cost of $5.7 billion. The Mongolian government representatives on
Oyu Tolgoi's board had refused to approve the mine's budget in
January this year, demanding an explanation for a cost inflation by
A higher cost would mean that the government would have to wait
much longer before it starts receiving royalties. This is because
the existing agreement calls for Turquoise Hill to recoup its
investment before commencing royalty payments.
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%.
See Full Analysis for Rio Tinto Here
Halting Operations Would Have Been A Lose-Lose
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
It is thus clear that halting operations at the mine in absence
of an agreement would have been a losing proposition for both
sides. Production would most probably have been delayed beyond
Rio's original target of June.
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
The situation has been complicated by the upcoming presidential
elections in June because no politician wants to be seen selling
out to Rio Tinto, especially when they all have promised to garner
a greater share of profits for the country.
If the two sides fail to reach an agreement in talks and
operations eventually come to a halt, we see international
arbitration as the only way to break the impasse. But that would
delay production beyond June 2013. 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
We have a
Trefis price estimate for Rio of $45
, which will be revised now that the fourth quarter earnings
results are out.
a Company's Products Impact its Stock at Trefis