In my recent articles on Rio Tinto's (RIO) company profile and adventures in Mongolia, primarily at its great site at Oyu Tolgoi in the South Gobi region just 50 miles from China, I warned investors that while the twice-delayed first export of copper concentrate on July 9 was a welcome sign, it would take two years of stable production to allay investor fears and uncertainty about GOM (government of Mongolia) eruptions regarding more revenues and control of the project.
It took one week for my cautionary words to be borne out by events. On July 17, GOM stated that it has "22 points of dispute" with RIO about higher pay for Mongolian workers, RIO's purportedly inefficient site development, cost-overruns, more GOM review of tax payments and repatriation of profits to Mongolia.
In short, the situation is a mess. Plus ca change, plus c'est la meme chose for RIO and Turquoise Hill Resources (TRQ) in Mongolia and all investors and potential investors in the nation need to take note.
Early in 2012, RIO acquired 51% of TRQ (formerly Ivanhoe Mining) and TRQ co-owns OT (Oyu Tolgoi) 66-34% with the GOM. The mine is a fabulous treasure: if operations ever get up to speed, and at this point the timeline on that is fuzzy, annual production should be stunning: 1.2 billion lbs Cu (copper)/year, 650k oz. Au, gold / year and 3 million oz. Ag, silver/year. This is phase one above-ground production into which RIO has poured about $6.6 billion. Phase 2, the underground section of operations will cost about $5 billion to develop. RIO already has secured c. $4.5 billion funding pledges from the EBRD (European Bank for Reconstruction and Development), a host of European and Australian banks, and the US Ex-Import Bank to achieve Phase 2. TRQ CEO Kay Priestly had just announced on July 15 the 80k ton 2013 copper ore concentrate production when the latest brouhaha hit.
One cannot understand RIO's situation at Oyu Tolgoi without following Mongolian politics. It also helps to have some familiarity with how business is conducted in East Asia ("beware of 11th hour surprises" a former colleague told me. From personal experience I would add, "beware also of 12th hour surprises." A friend, an Indian businessman who has traveled the region for decades added, "there's always a problem and it's never their fault"). The current snafu falls into the category of 12th hour surprises.
How so? On June 26, Mongolia completed a six-week Presidential campaign. It was a 3-way contest with the incumbent, Tsakhia Elbegdorj of the "Democratic Party" facing former wrestling champion Bat-Erdene and Health Minister, Dr. Natsag Udval. Some observers suggested that Dr. Udval's candidacy may have been designed to split the opposition vote and help Elbegdorj. Perhaps: in any case, the incumbent won a bare majority of 50.2% which obviated the need for a run-off election, further posturing and turmoil. RIO, TRQ and Mongolia's take from OT was a big issue in the campaign and RIO twice acceded to requests from President Elbegdorj that it delay export of its first copper concentrate till silly-season ended.
On July 9, the first concentrate export occurred to general joy and shareholder relief. Some opined that a new day was dawning for TRQ's share price. I wrote my cautionary piece a week ago and here we are back to the same old. TRQ shares leaped on the announcement that export would occur and then subsided even before the latest GOM gambit. Where does that leave us? TRQ closed July 18 at $5.70, 12% above the four-year low it set in mid-April.
As it does in these periodic incidents, the GOM professes lack of clarity about the extent of Ivanhoe - TRQ's initial investment at OT and declares the investment agreement of 2009 is misleading, unfair and generally inadequate for their desires. They did acknowledge that they let initial exports of concentrate proceed because they need the $100 million in royalties this year. RIO has noted repeatedly that capex rose in the past 4 years as development costs have increased the world over. RIO also has agreed to notify GOM of all bank accounts anywhere into which it deposits proceeds from OT. Other than that, it had no comment on the latest eruption.
In recent years, patent and copyright infringement and product re-packaging in China have occasionally been a leading story in America. My experience is that in East Asia there is extreme suspicion about such matters (bank deposits, actual capex costs, validity of diplomas) because they themselves are lax: there is a lot of forgery and routine violation of copyright laws to a degree that would shock Westerners. It is possible that this is what RIO is going through in regard to OT. It looks that way from here and that's a pity.
OT Executive Director Tserenbat Sedvanchig declares that if RIO does not reimburse GOM for elevated and purportedly wasteful capex (to which Mongolia contributes a %) then "21 other points of dispute" will come to the table, that is, the entire project will "be hindered": implicitly, the entire leasing agreement will have to be re-drawn or there will be no phase 2 development. This is familiar stuff, but it is unclear how much is posturing, how much is real and in any case how much the delays, hassles, ruffled feathers, threats in the media, etc. will cost. Again, what a pity it is. Please look for the other articles on RIO-TRQ and Mongolia in my archive for details of the past year of this story for the merry-go-round appears to be accelerating as happened at the end of Hitchcock's "Strangers on a Train." Jon Springer's blog is useful for earlier events in the saga.
The mining.com July 17 piece linked above notes that "Mongolia has long coveted a bigger slice of the mine and has twice in the past couple of years floated proposals to take majority control." That well may be what is happening now. Based on experience and RIO's new management team put into place beginning mid-2012, this entire exercise will merely delay revenues for deficit-spending Mongolia, harm GDP growth, discourage foreign investment and postpone any gains for TRQ's hopeful, often disappointed and long-suffering shareholders. Again I suggest that $5.50 is a good entry level, but patience is essential if one is to taste any of the project's long-term potential. OT could be one of the five great mines in the world along with Freeport-McMoRan's (FCX) Grasberg Minerals District in West Papua, Indonesia, Escondida in Chile, Barrick Gold's (ABX) Pascua Lama when it gets built and ABX - NovaGold's (NG) 50-50% site at Donlin Creek in Alaska that ABX will fund. Donlin Creek and NG are waiting on other ABX developments (e.g. progress on addressing water issues at Pascua Lama) and the price of gold for development to proceed.
Some who follow the RIO-TRQ-Mongolia saga closely have suggested many interesting theories for the recurrent crises and outcries. Some suggest that Robert Friedland, CEO and founder of Ivanhoe Mines and OT and still a major shareholder in TRQ wants to regain some control. Some suggest that RIO wants to flush out Friedland and increase its stake and control. Both views have some plausibility. Some say it is mainly, but not only Mongolia doing what it does: that is clear. The upshot is that OT is a great story, a fascinating, promising and frustrating site and that tempests there are among the last things a world going through the birth pangs of new monetary and socio-political arrangements needs. But that's how it is.
Please review my previous pieces on RIO for perspective on the economic, financial and diplomatic resources: also their heft and patience with what at this point is a recurring and irritatingly familiar and wasteful situation. Like other observers, I believe this project will go forward and produce great wealth for all involved as well as life-enhancement for Mongolians. When there is an end to these periodic demands, usually following long-awaited progress and expressions of gratitude and pleasure, Oyu Tolgoi will achieve the greatness and contribution to world industry, company and Mongolian prosperity that is within view.
Shareholders, be patient and newcomers may enter. If, after a nice period of gains you see quickly declining price action don't hesitate to exit while green. Such has been the history of this fabulous but ill-starred project. My hope and belief is that it will be in due course a blessing to all involved. Its ripening will be hastened if the GOM can relax its demands for a "do-over."
Additional disclosure: I own precious metals companies in two mutual funds.