Mongolia, the vast central Asian country, entered into the Oyu Tolgoi Investment Agreement with Ivanhoe Mines (IVN) and Rio Tinto (NYSE:RIO) in October of 2009. This landmark agreement welcoming foreign investment is a long-term comprehensive plan to develop world’s largest undeveloped copper-gold resource, which contains over 81 Billion pounds of copper and 46 million ounces of gold. The construction phase of the project is 50% complete; commercial production starts in 2013. The Mongolian Government acquired a 34% interest in the project and Ivanhoe Mines kept a controlling 66% interest in Oyu Tolgoi. Global miner Rio Tinto, which joined Ivanhoe Mines as a strategic partner three years ago, presently holds a 49% interest in Ivanhoe Mines. This article will provide an overview of each of the partners, of the project and conclude with investment possibilities.
There is great opportunity for all parties involved, including investors. Linked below are a video produced by Ivanhoe Mines and an in-depth Reuter’s Special Report. These resources provide generous servings of information in very palatable formats. Consider them an introduction to the article, or come back to them after reading the article.
- Oyu Tolgoi, the Movie – Ivanhoe Mines, Video 7 minutes. Sound required. CLICK HERE
- Mongolia’s Storied Mine Stirs New Frontier Market – Reuters Special Report consists of slides with text and graphics. CLICK HERE
Mongolia is a landlocked Asian nation sandwiched between China and Russia. Its size, at 603,000 square miles, makes it the 19th largest country in the world, just slightly smaller than Iran and 80% the size of Mexico. With a population of only 2.7 million people, it is the least densely populated country in the world. The capital, Ulaanbaatar, with over 40% of the country’s population, has the lowest average temperature of any national capital, at 0 degrees Celsius. Unusually dry, there are areas of the country, such as the Gobi desert, where it never rains.
Knowledge of the history and culture of Mongolia is useful in understanding the political dynamics and business climate. The founder of the Mongol Empire was Genghis Khan, who forged the semi-nomadic tribes into an empire in the 12th century. Gradually the various groups reverted to their earlier infighting and eventually the Chinese established rule. From the 16th Century onward, Tibetan Buddhism spread throughout the land. This lasted into the early 20th century and when the country became free from China, only to fall under the domain of the Russians a decade later. The Russians quashed the religion eliminating temples and priests in the process. It was not until the fall of Soviet power in 1990 that the country was finally free and in 1992, it ratified a new constitution as a democracy. However, it remains dependent upon Russia, from which it imports petroleum products and other essential supplies and on China, often distrusted, as its largest export partner. Click to enlarge
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Mongolia is very much a beginner in democratic rule and a novice in forging trade and business agreements. The government makes, and then retracts regulations; the rule making process is not participatory or transparent and part of its heritage is the Soviet era state secrets laws. This environment is what makes the Oyn Tolgoi mining agreement of 2009, reaffirmed in October 2011, such an achievement. The recent affirmation countered political opposition, which would renege on the pact and demand a larger share from the miners. The issue is resolved, for the time being at least; however, it is but one-step along the path.
What today are the consequences as Mongolia undergoes its novitiate as an international business partner? At this time, mid-November 2011, the largest concern is that the governments of China and Mongolia have not finalized a bilateral agreement to bring electric power to the Oyu Tolgoi mine. The construction of transmission towers from the mine site, 75 km to the Chinese border, is proceeding on schedule. The negotiations are not. The mine cannot operate without a reliable source of power and some wonder if putting a large part of the Mongolian economy in the hands of the Chinese is wise. As an immediate response, Ivanhoe Mines and Rio Tinto are adding to their diesel generating capability at the site, though this would not be capable of sustaining commercial production. It may be necessary to build a coal fired generation plant at the mine in order to assure reliable power. Rio Tinto and Ivanhoe mining can most likely get bridge financing for this project. Can the Mongolian government expedite the permitting process for the coal plant and transportation of coal to the mine? Will the diversion of resources to build a coal power plant delay production at the mine until 2014?
Despite the problems, there is little doubt that Mongolia will be one of the ten fastest growing countries in the world in the next decade. The country is a veritable El Dorado of mineral and coal resources. Click to enlarge
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Rural Mongolia is very much unchanged by time and an estimated 1/3 of the people are nomadic herdsmen. There is little infrastructure in place, almost all the roads are gravel tracks through the arid and barren countryside. To support the mining project Ivanhoe and Rio Tinto, along with project manager Fluor Corporation, are building paved roads to China and Russia, a power transmission line to China, a 75 km pipe to supply water and an airport large enough to support Boeing 737’s. In additions, a 5-year training program is underway for employees, which will be 90% Mongolian. A goal is to have 50% of the engineers Mongolian in 10 years.
Consider the magnitude of change coming to Mongolia. Back in the Bronze Age, a primitive tribesman noticed a turquoise rock outcropping on a hill. Oyu Tolgoi, the Turquoise Hill provided copper, which with tin makes bronze. The area changed little until recently. The investment in bringing the Oyu Tolgoi mine into production is in the $6 Billion range. When it reaches full production, copper and the other minerals will bring in annual revenue of just about that amount, depending on copper and gold prices.
Jon Springer reports on his Instablog that the U.S. State Department estimated Mongolia’s 2010 GDP at $6.8 billion. Will we see a doubling of the GDP? Yes, at least that much. The new gold rush to develop Mongolia’s resources could make it the world’s fastest-growing economy over the next five years, according to Renaissance Capital, quoted in the above-mentioned Reuters Special Report. Renaissance projects the GDP will almost quadruple to $23 billion by 2013 from $6 billion today.
Ivanhoe Mines, Ltd.
Ivanhoe is a $15 B market cap Vancouver, Canada based miner. They are primarily an exploration and development company. Robert Martin Friedland, the CEO and largest individual stockholder, founded the company in 1994. Friedland, an American born billionaire, has a long history as a successful mining entrepreneur. Part geologist, part showman, he has grown little mining companies into large and profitable saleable assets. Ivanhoe started the exploration work in Mongolia’s Gobi area in 2002. A diagram of the huge Oyu Tolgoi project is below. Estimates indicate that the mineralized band is 23 km long. The open pit mine at the Central Oyu deposits will be the first in production followed by the block-cave underground mine at the Hugo Dummett deposits.
On Monday November 14, 2011 Ivanhoe mines announced financial results and a review of operations for the third quarter of 2011. The headline of the press relief was, “Construction of Oyu Tolgoi Copper-Gold-Silver Mine Expected to be Over 70% Complete by the End of 2011.“
The project is rapidly advancing toward planned start of commercial production in 2013, and production at the Hugo North underground mine will start in 2015. Many key elements of the project are ahead of schedule. However, as we noted above, there is the potential for delays. Total capital invested in the project to the end of Q3 was approximately $3.2 billion.
Pre-stripping for the phase-one open-pit mine at Oyu Tolgoi began in August 2011 with the removal of overburden material. The development of the phase-two underground block-cave mine at the Hugo North Deposit continued. This is lateral mine development of a series of underground ore transportation tunnels 1,300 metres (4,000 feet) below the surface.
Oyu Tolgoi’s site-based construction workforce is approximately 14,760, with approximately 11,680 working on site each day and the balance on leave. Approximately 7,820 Mongolian employees were at the Oyu Tolgoi site, with an additional 3,300 Mongolians participating in offsite training and educational programs. These Mongolian employees will form the bulk of the eventual production workforce.
Ivanhoe Mines reported a net profit of $7.3 M in the quarter up from a loss of -24.9 M for the same period last year.
Rio Tinto is one of the three largest miners in the world. BHP Billiton (NYSE:BHP) is by far the largest with a market cap of $201 B and $72 B in revenue. Vale has a market cap of $132 B and revenues of $58 B. Rio Tinto trails in market cap at $104 B but has revenues larger than Vale at $61 B.
Rio brings a couple of important things to the table. Their size and economic power is important as is their proven record of bringing in large projects. They have a high level of technical and operational expertise and are an innovator. A November 2, 2011 press release described the purchase of 150 driverless mine trucks from heavy equipment manufacturer Kumatsu.
"Autonomous haulage is an important component in our Mine of the Future program. These 150 new trucks will work with our pioneering Operations Centre that integrates and manages the logistics of 14 mines, three ports and two railways. These technologies are revolutionizing the way large-scale mining is done, creating attractive hi-tech jobs, and helping us to improve safety and environmental performance and reduce carbon emissions."
Mr. Noji said "Komatsu is extremely excited to sign the MOU [memorandum of understanding] with Rio Tinto to expand the fleet to at least 150 Komatsu Autonomous Haulage System trucks in their Western Australian Pilbara operations by the end of 2015.
As a corporation, Rio Tinto concentrates on the development of first class ore bodies into large, long life and efficient operations, capable of sustaining a competitive advantage through business cycles. Rio Tinto's interests are diverse in both geography and product. Most of their assets are in Australia and North America, but they also operate in Europe, South America, Asia and Africa. Businesses include open pit and underground mines, mills, refineries and smelters as well as a number of research and service facilities.
The Oyu Tolgoi mine fits their model of resource development. It currently has a projected life of about 60 years and more discoveries in the area will extend that life. There is an option to renew the lease for up to 100 years.
The way accounting is done in copper-gold mine, the cost to remove the ore is calculated on a per pound or per tonne basis, and then revenue from any silver and molybdenum recovered is deducted from the cost of producing the copper. Because of the large amount of gold, silver and molybdenum at Oyu Tolgoi, this may bring the cost of copper production down to 45 cents a pound, and depending on the price of gold and silver, it could go lower. This will make the mine a very competitive and profitable venture.
Time to Act
You can participate in the profitable partnership with Mongolia by buying stock in Ivanhoe Mines and Rio Tinto. While they are partners at Oyu Tolgoi, Ivanhoe and Rio Tinto are very different companies. Rio is a large well-capitalized operator of mines. Their global presence enables them to serve many markets. They have great reserves of energy and metal resources.
Ivanhoe Mines' forte is exploration and development. It is a business with ups and downs, wins and losses. It appears that their success will continue in Mongolia, and that they will sell their interest in Oyu Tolgoi at an opportune time; that is Robert Friedland’s plan. The logical prospect is Rio Tinto. Ivanhoe and Rio are in arbitration now over an existing “standstill” agreement that temporarily limits Rio’s purchase of additional stock.
Ivanhoe is a good short to intermediate term investment, with moderate to high risk, but tremendous upside potential. How much of the future bounty is already priced into the stock? When will the buyout happen?
Rio Tinto is a smart and experienced operator of large mines, which benefit from automation and economies of scale. They are an able negotiator and enjoy ongoing business with China. They are a low to moderate investment risk, suitable for long-term holding. I believe that the large miners, priced at around 6 times earnings, are greatly undervalued. If you calculate intrinsic value, if you look at historic valuation, if you consider global macroeconomic resources, I believe that you will conclude that Rio Tinto is worth twice its current stock price. The question is, when will the market put that price on it?
All mining stocks are volatile and have wide swings. My opinion is not investment advice but a statement of the available information, as I perceive it, and what I see as logical and possible outcomes. Anyone thinking of purchasing either company should do their own due diligence and consider how one of these companies might fit into their investment goals.
I am in partnership with Mongolia by virtue of stock ownership in both Ivanhoe Mines and Rio Tinto. I plan to participate in the profits from the “El Dorado” in the Gobi Desert, both now and in the future.