Why Oyu Tolgoi Probably Doesn't Mean Much For Copper

Includes: FCX, RIO, TRQ
by: Amit Bilgi

It seems that every few days we hear a new update regarding the Mongolian copper mine that has been so heavily discussed amongst the commodities market. For the past few years, the Mongolian government in conjunction with two Western corporations, Rio Tinto (NYSE:RIO) and Turquoise Hill (NYSE:TRQ) has been preparing Oyu Tolgoi for mining, not without its fair share of roadblocks along the way. Most recently, there has been much excitement over the announcement date of June 21st, last Friday, marking the first export of copper concentrate from the mine. However, due to governmental pressures, the date was postponed yet again to an unspecified point in the future. What happened to this gold mine of copper (and of actual gold, to complement the idiom)? It appears that there are potentially multiple reasons behind the inability to access Oyu Tolgoi's vast reserves that extend past the postponement of its export date, to a point where even after Rio and Turquoise Hill begin exporting, there isn't much prospect to look forward to.

Beginning with the primary reason behind the most recent postponement, the Mongolian government isn't exactly gleeful with the current state of affairs. More importantly, with elections coming up, it's likely that the same government will be around for longer, much to the dismay of the copper industry. Incumbent President, Tsakhiagiin Elbegdorj is likely to win re-election against any possible challenger. Both former wrestler, Bat-Erdene and Health Minister, Natsag Udval have been falling behind considerably in the polls with the incumbent leading by 13 percentage points ahead of the closest rival as of May. The implication is that given that it's likely Elbegdorj will stay for another four years, the fate of Oyu Tolgoi is shaky. First, the president is strongly opposed to the potential lack of transparency that RIO or TRQ are pushing. Neither company wants to deal with excessive checks and balances on their actions, drawing away from impending profits. Moreover, the Mongolian leader is questioning further investment given that the project is already over budget, with the estimated cost more than doubling from $4.6B to $10B in three years. Although Elbegdorj recognizes that such a project will influence more than 30% of his country's GDP, he's hesitant on granting so much power to a plan that is 66% owned by foreign companies, leaving his native land to a measly minority. It's likely that much of the recent postponement and support of the project are merely a front for the upcoming election with full intention of shifting gears once he's successfully re-elected, thus yielding further governmental control over the scheme, with the potential of delaying progress or halting it altogether.

However, arguably the largest harm a second term can do to Oyu Tolgoi is the budding legal trouble regarding the government forcing RIO and TRQ to contractually oblige to enforce a rule stating that 90% of employees hired by the mine be Mongolian, which is currently being broken given that foreigners exceed Mongolians by 368. Moreover, there are impending lawsuits with regard to the corporations paying foreign employees double the wage of native workers, which is also against Mongolian law. Additionally, Elbegdorj has stated that he is requiring all transactions go through Mongolian banks, which Rio Tinto has rejected so far. It's clear that such controversy isn't an immediate threat to the copper mine beginning exports, but will rather be a large concern in the near future after re-election and after a system of exporting has begun. It's clear that such a focus will inevitably drive Oyu away from its proposed goals, as its controllers are in the midst of dealing with ample red-tape.

Looking to a more abrupt concern, there is an immediate need for copper exports in the region given the recent accident at Freeport McMoRan's (NYSE:FCX) Indonesian copper mine, which resulted in 28 deaths. Although they are gradually reopening mining, the procedure is at least curbing the oversupply of copper in the area. However, the immediate issue is that of Chinese copper smelters looking for an ample supply of the material to restart processing to full potential. Beginning exports out of Oyu now could have huge benefits for the mine if it can secure contracts with these Chinese corporations before they can regain importing copper from Freeport once their mine is back to 100%.

Ultimately it seems that there are myriad reasons aside from immediate governmental postponement to be worried about Oyu Tolgoi's prospects. Given the likelihood of Elbegdorj's re-election and the amount of federal red-tape and contractual obligations that need to be fulfilled, or disputed, I am not fully convinced that we can expect much good to come out of this for copper market or for Rio Tinto and Turquoise Hill in the near future. Instability is always difficult to predict and the history of delays might be foreshadowing a dreary future to come.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.