January 2011 industrial minerals 1

Mongolia

With a GDP of $5bn. and a third of the population living under the poverty line, Mongolia does not seem like a rich country.

Nor does it look the part. The skyline of Ulaanbaatar is dominated by

Soviet-era apartment blocks, while the outskirts are met with broad stretches of seemingly barren countryside.

“Don’t be fooled,” argues Thomas Flahive of Ulaanbaatar-based investment bank MICC. “Mongolia is a wealthy country. It’s just all underground.”

Mongolia has long been overshadowed by its southern neighbour, as Chinese dominance in the Asia-Pacific region has never been more pronounced in the modern era.

China is the world’s largest producer and exporter of coal, fluorspar, antimony, barytes, bismuth, cement, phosphates, rare earths and many other minerals.

But with the country’s rapid industrialisa-tion, Chinese supply is not keeping pace with booming demand, and nowhere is this more starkly apparent than in coal production.

Even though China’s coal production will top 1,000m. tonnes, the country will be a net importer of coal by over 100m. tonnes. For certain key minerals, China is looking to Mongolia to supplement its supply.

Over the past decade the Mongolian and Chinese economies have become increasingly intertwined.

From 2001 to 2009, China’s share of Mongolian exports rose from 48% to over 80%. China similarly dominated foreign direct investment into Mongolia, accounting for over half of its FDI. More than 60% of this total can be attributed to investments in the Mongolian mining sector.

Mongolia is also making efforts to diversify and strengthen its relations with other north-east Asian nations. South Korea is the third largest source of FDI, and Japan has perennially been in the top five.

At the height of the financial crisis in 2009, Japan pledged $50m. to the Mongolian government to assist with public finances. Recent state visits and strategic partnerships bode well for future economic ties.

Although not fully mapped, Mongolia’s untapped mineral deposits are vast by all accounts. As China shifts its focus from exports to domestic demand-led growth, Mongolia has an opportunity to supply Chinese industry as well as other neighbour-ing countries.

Regulatory concerns aside, Mongolia is well positioned to attract foreign investors and take advantage of its underground wealth.

China’s appetite for coalWhile not defined strictly as an industrial mineral, coal, or more precisely, availability and access to sources of coal, is a crucial factor for many industrial mineral operations in developing regions which depend on coal for fuelling plant operations.

The US Geological Survey estimates that Mongolia has coal reserves of more than 100bn. tonnes, with proven reserves of 12bn. tonnes. The industry is in the early stages of development, so production and exports are still relatively insignificant, but the opening of the Tavan Tolgoi mine will quickly make Mongolia a global player.

Located in the southern Gobi Desert, Tavan Tolgoi is often described as the world’s largest undeveloped coal deposit. The licensed mining area contains 6.4bn. tonnes of proven reserves, including 1.8bn. of high-quality coking coal.

This coking coal is low in ash and volatile matter and integral to the steel production process. At full production the mine will be able to produce 20m. tpa, mostly for export.

Demand for Mongolian coal will come largely from neighbouring China, which became a net coal importer for the first time in 2009. Although China remains the world’s largest coal producer, much of it is lower-grade thermal coal.

Instead, large government-led infrastructure projects in the western and central provinces have created ravenous demand for coking coal imported from far off destinations.

In 2009, 66% of coal imports came from Australia and only 11% from Mongolia. However, 2010 saw Mongolia’s share jump to nearly 40%, while imports from Australia dropped below 50%.

In the race to tap Mongolian coal reserves, China may have to compete with Japan and South Korea.

Nippon Steel, the world’s second largest steel company, recently hosted Mongolian President Elbegdorj Tsakhia during a state visit to Japan. Following the meeting, Nippon Steel demonstrated interest in a closer partner-ship on infrastructure projects to connect Tavan Tolgoi to export markets.

South Korea has also moved to secure a coal supply in Mongolia, with state-run Korea Coal Corp. (KOCOAL) committing $18m. for partial ownership of a northwestern Mongolia thermal coal mine.

A string of successful Mongolian mining-related IPOs on the Hong Kong Stock Exchange reflects investor optimism in the coal sector. Winsway Coking Coal Holdings Ltd, a logistics company that handles shipments from Mongolia to China, raised $472m. in September 2010.

Just a month later, Mongolian Mining Co. (MMC), which controls a small portion of the

as China shifts its focus from exports to domestic demand-led growth, mongolia has an opportunity to supply China as well as neighbouring countries. alexander Czarnecki assesses the country’s industrial minerals potential and its attraction to foreign investors

Mongolia rocks!

“Mongolia is a wealthy country. It’s just all underground.”

2 industrial minerals January 2011

Mongolia

Tavan Tolgoi mining area, raised $651m. in a public offering of 20% of the company’s equity.

Bigger IPOs will surely follow, with the government-owned mining company Erdenes Tavan Tolgoi planning to offer 30% of its equity in late 2011.

Considering that their deposit is ten times larger than MMC’s, the IPO will likely make Erdenes the largest company by market capitalisation in all of Mongolia.

Increased coal production will create many opportunities for foreign investors to provide value-added technology and services. The Ministry of Fuel and Energy lists coal liquefaction, clean coal technology and coal chemicals as possible areas for future develop-ment in Mongolia.

An alternative source for REAs with many mining booms, the first opening usually occurs with energy and precious metals, paving the way for industrial minerals. Mongolia is no exception, and forward-think-ing investors should look beyond coal, copper, and gold to explore the country’s mineral reserves.

Though much of the country is yet to be mapped, significant proven deposits have been found in fluorspar, phosphates, molybdenum, tungsten, in addition to rare earth elements (REE).

Mongolia’s rare earth potential must be understood within the context of China’s stranglehold on global production. China boasts 95% of global REE production, but only 30% of proven global REE reserves.

While China’s deposits are well documented, proven reserves have been found all over the world. In fact, the world’s largest rare earth mine is just 50 miles from the Mongolian

border in northern China. One significant deposit has already been

identified in the western Hovd province. The Halzan Buregtei deposit contains 100,000 tonnes of the heavy rare earth element yttrium as well as 1m. tonnes of other rare earth oxides.

Geologists have further singled out western and southern Mongolia as the most promising regions for additional REE exploration.

Rare earths are essential for the production of green technology and high tech electronics, industries increasingly dominated by China, Japan, and South Korea.

Despite China’s lead in rare earth produc-tion, domestic demand is rapidly catching up with supply. In 2010, the Ministry of Commerce cut rare earth exports by 40% in an effort to support China’s move up the manufacturing value chain. The resulting price increase caused more than outrage, as major international importers began re-evaluating their supply choices, many consider Mongolia as a viable alternative.

China’s recent diplomatic moves have only served to intensify interest in Mongolian rare earths. When the Japanese Coast Guard

arrested a Chinese trawler captain near disputed islands in the East Sea, China responded by blocking the export of these coveted commodities to Japan.

According to Japanese traders, it took two months for shipments to resume. Needing a source for its large high tech industry, Japan formed a “strategic partnership” with the Mongolian government to explore and map the country’s reserves.

Ties between the two countries continue to grow, as Toshiba has recently inked a deal with the Mongolian company MNFCC LLC to conduct a feasibility study on Mongolia’s rare earth supply infrastructure.

Beyond these preliminary deals, Mongolian companies that lack the technology to harness the country’s rare earth potential will look to form partnerships with foreign investors.

Significant opportunities exist in the exploration, extraction and processing of these minerals. Unlike in China, foreign companies in Mongolia are not prohibited from mining rare earths or rare-earth smelting and separation projects.

Proximity to demandAmong its neighbours, Mongolia can count some of the strongest and most mineral-hun-gry nations in the world. China, Japan, Russia, and South Korea together account for 47% of coal consumption and 80% of global rare earth demand.

Mongolia is also unique among its neigh-bours in having healthy diplomatic relation-ships with all four countries. When key infrastructure is in place, Mongolia may be able to undercut more distant mineral suppliers.

The majority of Chinese coal imports come from Australia and Indonesia, not Mongolia. But this is likely to change, argues Wal King, chief executive officer of the mining company Leighton Holdings Ltd. According to Leighton, the opening of Tavan Tolgoi and other expansion projects should allow Mongolia to deliver coal to China for under $100/tonne, less than half of the $220/tonne for Australian coal.

Source: Mineral Resources Authority of Mongolia

Exploration and mining licences distribution 2009Exploration license Mining license Total

QuantityArea

hectares /mill/

QuantityArea

hectares /mill/

QuantityArea

hectares /mill/

Domestic companies

2572 22.89 746 0.24 3318 23.13

Foreign companies

1087 16.08 339 0.22 1426 16.30

Total 3659 38.97 1085 0.46 4744 39.46

0

KM

400

UvsBayan-Ölgiy

Hövsgöl

Arhangay

Bulgan

Selenge

Töv

DundgoviDorngovi

Dornod

Hentiy

UlaanbaatarSübaatar

Bayanhongor

Ömnögovi

ÖvörHangayHovd

Govi-Altay

Dzavhan

Mongolia

Russia

Kazakhstan

China

Mongolia and its provinces

January 2011 industrial minerals 3

Mongolia

The story is similar for Japan’s would-be rare earth sources. Besides Mongolia, Japan is exploring rare earth prospects in Vietnam, Australia, and India. But if Mongolia has sufficient access to the Japanese market, the other countries will be at a disadvantage if supplying the same elements, because of shipping costs.

The Mongolian government realises that China and Japan will be the primary consumers of their minerals, so they are set on improving transport links between the countries.

Plans are underway to link Tavan Tolgoi and the southern Gobi Desert region to the Chinese railway system through the Gashuun Sukhait border crossing. For export to Japan, the Mongolian government is considering a northern connection with the Trans-Siberian railroad to the port of Vladivostok. It remains to be seen which project the government and investors will sponsor first.

Regulatory reformThe Mongolian government recognises the importance of a thriving mining sector and

regulates accordingly. However, the recent history of mining regulations has been one of considerable back-and-forth, with the pendulum swinging between the promotion of foreign investment and the protection of native Mongolian interests.

The fall of the former Soviet Union and consequent loss of economic aid delivered a shock to the Mongolian economy. Having lost its primary source of trade and government aid, Mongolia recognised the need to attract new economic partners.

The 1997 Minerals Law reduced investment taxes, strengthened land tenure rights, and increased transparency. In 2002, the govern-ment again ramped up efforts to attract FDI, further lowering royalty payments on all minerals to 2.5%.

From 1996 to 2006, foreign direct investment in Mongolia grew 2,200% to an annual total of $344m. The early 2000s mineral boom was highlighted by the discovery of the world’s largest untapped copper and gold deposit at Oyu Tolgoi in the south Gobi Desert.

Despite the promise of economic growth, factions of parliament became uncomfortable with increasing foreign dominance in the mining sector, fearing that Mongolia was not keeping a big enough slice of the pie.

A 2006 revision of the Minerals Law was significantly more protectionist. The new regulation doubled royalty rates, imposed a Windfall Profits Tax of up to 68% on copper and gold, and reserved the right for the government to claim ownership of “strategi-cally important” deposits.

This new concept allowed the government to take up to a 50% equity stake in deposits discovered with government assistance or 34% for privately explored deposits. The definition of a “strategically important” deposit is largely up for interpretation by the Mongolian parliament, but in practicality it includes world class deposits of copper and coal as well as all deposits of uranium and rare earths.

Importantly, the government has commit-ted itself to compensating firms for the expropriated equity share at market value.

Backlash to the new legislation was sharp, and investor sentiment took a turn for the worse. As the 2008 global financial crisis spread, both demand and prices for Mongo-lian commodities plummeted.

Foreign direct investment fell by a third and total exports by one fifth. Mining-related revenue, which at one time represented 40% of the government budget, also fell sharply.

Amid the global downturn, Mongolian legislators realised that their economic recovery largely rests on the return of foreign investors. In 2009, the Windfall Profits Tax was repealed and replaced by a sliding scale of

royalties effective at the beginning of 2011. After five years of negotiations regarding

Oyu Tolgoi, Ivanhoe Mines finally reached an investment agreement with the government, an important step in framing a new minerals law.

Not all changes have been positive. The government revoked a 10% VAT exemption on pre-production mining equipment, though so far the law has rarely been enforced.

In mid-November, the Ministry of Natural Resources suspended 1,700 licenses for mines that violate a 2009 law restricting mining in forested areas. Although only 10% of the country is covered by forests, and no significant coal or mineral mines were affected, this action may be a precursor to more environment-based restrictions on the sector.

Mongolia’s current mining regulatory framework is still a work in progress. While the Mineral Law allows 100% foreign ownership of businesses, only individual Mongolian citizens can own the real estate under mineral deposits to be exploited.

The current tax code is an improvement on its predecessor with its flattened rate schedule and more opportunities for deductions for capital investments.

In a country experiencing such rapid change, foreign companies must employ local sources of knowledge to ensure they are well informed of planned regulatory changes before they become law to ensure the viability and long-term stability of their projects.

OutlookRecent regulation has raised questions about the government’s commitment to foreign investment in the mining sector, but other challenges remain. In the short-term, the profitability of industrial minerals projects will depend largely on China’s economic and diplomatic policies.

Rare earth developments, although promising, are in the early stages of explora-tion and may take up to a decade for significant production to begin. Even with insatiable demand and proven supply, massive infrastructure projects are needed to link the landlocked country with its trading partners.

These concerns, although valid, cannot obscure Mongolia’s mineral potential. The IMF predicts the economy to grow 8.5% in 2010 and per capita GDP to quadruple by 2018.

More than driving industrial development, the mining sector has the opportunity to lift thousands of people out of poverty over the next decade. The future remains bright in the Land of the Blue Sky…Mongolia rocks!

Contributor: Alexander Czarnecki, Research Analyst, Tractus Asia Ltd, Vietnam.

Mongolian industrial minerals production 2008 (tonnes)

Mineral Production

Cement, hydraulic 270,000

Fluorspar, acidspar 116,200

Fluorspar, submetallurgical & other

219,300

Gypsum 26,000

Lime 55,000

Salt 103

Crushed stone 207,000

Source: US Geological Survey

Source: Mineral Resources Authority of Mongolia

Natural resources of MongoliaNatural resources Number of deposits

Gold 511

Copper 6

Molybdenum 3

Lead 4

Zinc 4

Tin 12

Tungsten 17

Iron 29

Coal 85

Fluorite 83

Limestone 48

Clay 81

Sand and gravel 84

Sand for construction materials

53