Tumultuous Outlook Guarded By Cautious Optimism
BMI View: Underpinned by surging nationalist sentiment, the implementation of a new law that caps foreign investment into sectors of strategic importance will have a material impact on the future growth prospects of Mongolian mining industry. While rising tensions between the newly elected government and foreign mining firms will restrict investment activity in the near term, we maintain our view that the more investor-friendly Democratic Party-led coalition government will remain open to foreign investment given the paramount importance of the mining sector to the country's overall economy.
In line with our expectations, an influx of foreign capital into Mongolia's mining space has enabled the country to experience blistering economic growth over the past few years. According to the World Bank, Mongolia was the world's fastest growing economy in 2011, with real GDP growth coming in at 17.5%. While an abundance of mineral reserves has fuelled a gold rush of investors into the country's mining sector, the introduction of a new law seeking to cap foreign investment into sectors of strategic importance poses a significant threat to the future growth prospects of Mongolian mining industry. Although rising tensions between the newly elected DP-led coalition government and foreign mining firms will continue to restrict investment activity in the near term, we hold on to our conviction that the former will remain open to foreign investment over the long run. Indeed, the mining sector is of paramount importance to Mongolia's overall economy, contributing more than 20% to the country's GDP.
|Mongolia - Mining Industry Value & Growth|
Although we currently do not envision a return to the record 17.5% real growth seen last year, we note that robust mining activity and still-high industrial metals prices will provide a strong tail wind for Mongolia's US$8.6bn economy this year. Overall, we expect the country's mining industry value to increase from US$1.9bn in 2011, to reach US$4.9bn by 2016, marking a stellar growth rate of 21.8% per annum.
Stellar Growth Potential
Mongolia sits atop a treasure trove of copper, coal and gold reserves and is home to an estimated 6,000 deposits of 80 different minerals, including one of the largest copper and gold mines in the world - the Oyu Tolgoi project. The Oyu Tolgoi mine, slated to start operation in early 2013, has an expected production capacity of 425ktpa (thousand tonnes per annum) of copper and 460ktpa of gold. The mine is currently owned by Oyu Tolgoi LLC, 66% owned by Rio Tinto's Turquoise Hill Resources Ltd and Mongolia, the rest.
Apart from the Oyu Tolgoi mine, we expect the eventual opening of the 6.5bnt (billion tonnes) Tavan Tolgoi coal mine to be among the main drivers powering Mongolia's mining and economic growth over the long term. The East Tsankhi deposit of the Taval Tolgoi mine will continue to be developed and operated by state-owned Erdenes MGL. As for the West Tsankhi deposit (which contains approximately 1.2bnt of the total 6.5bnt in Tavan Tolgoi reserves), the government announced in July 2011 that China Shenhua Energy, Peabody Energy and a Russian-Mongolian consortium will be given 40%, 24% and 36% share respectively of the West Tsankhi deposit. As the new investment law will not affect existing agreements with foreign mining firms, we expect production from copper and gold mine Oyu Tolgoi, and exploration mining of vast coal deposits at Tavan Tolgoi in the near future will act as a major boon to the country's economy.
|A Land Of Opportunities|
|Mongolia - Coal & Metals Mines|
Surging Nationalist Sentiment
Recent developments in Mongolia have sparked off a wave of concerns over growing resource nationalism and greatly increased the level of uncertainty surrounding the government's stance towards the mining industry. Our view for the opposition parties to grow more prominent in Mongolian politics has played out following the election defeat of the ruling Mongolian People's Party (MPP) on June 28. Shortly after the formation of the opposition Democratic Party (DP) coalition, it has been reported that the 'Justice Coalition' will seek to retain 100% ownership of the Tavan Tolgoin coal mine for the government, while also seeking to renegotiate the terms of the 2009 agreement with international mining firm Ivanhoe Mines, which is now owned by Rio Tinto. We highlight that rumours of such attempts have previously stirred up investor concerns over the future of Mongolia's investment climate, and latest political developments seem to point towards a more tumultuous outlook for mining investment.
|New Law A Blessing Or A Curse?|
|Mongolia - Scenarios for GDP: 2011 prices, MNTbn (LHS) & Real Growth, % chg (RHS)|
Investors Adopting A Wait-And-See Approach
Investors have been keeping a nervous eye on Mongolia recently as the implementation of a new law on foreign investment that came into effect in May looks set to adversely affect the future growth prospects of the mining industry. For one, the new law seeks to cap foreign stakes in firms operating in sectors of strategic importance, including minerals, communications, banking and finance, at 49%. The Mongolian government will now have to approve any acquisition by a foreign company of a stake above 33% of a strategic sector entity, or where the stake would provide the foreign investor executive decision-making rights. Given the fact that the new law has yet to specify the exact procedure for the submission of the request for approval, we believe the new law will have a chilling effect on new investment due to ongoing ambiguity and uncertainty for investors.
The China Syndrome
In line with a trend that we have witnessed in countries around the world, the Mongolian government has been adopting an increasingly interventionist stance towards the mining sector of late. In an attempt to boost state revenue from the country's growing mineral wealth, the government had earlier stalled a bid by the Aluminium Corporation of China's ( Chalco) for coal mining group SouthGobi Resources. If successful, the US$926mn bid would give Chalco, a Chinese state-owned entity, up to 60% of SouthGobi's shares and cede control of one of Mongolia's most profitable coal mines to China.
The enormous influence of China on Mongolia has been a highly politically sensitive and contentious issue. The Chinese insatiable appetite for natural resources is a key driver powering the surging mining trade that has led to the stellar economic growth performance of Mongolia in recent years. We believe the Mongolian government has little choice but to continue and endorse a strategic partnership with neighbouring China, which consumes over 90% of all Mongolian exports, the majority of which are coal and copper. The Mongolian economy is likely to remain highly dependent on Chinese demand over the coming years, and could face a growing interest from China for both its mineral resources as well as mining-related infrastructure assets. We would expect this to inflame the already sceptical nature of public opinion towards mining exploration in Mongolia, and could see the government, in turn, introduce more restrictive regulation on foreign ownership rights.
|An Uneasy Relationship|
|Mongolia - Exports To China (US$mn)|
Still Room For Optimism
Despite the near-term headwinds that we have mentioned, we maintain our view that the DP-led coalition government will remain open to foreign businesses and mining companies operating in the country. To highlight, the newly-elected government has been adopting on a series of reforms aimed at addressing the anxiety of the international business community, while reaffirming its commitment to foreign investment. In an attempt to quell foreign investors' fears about protectionism, the government has lately turned down a proposal that would see Mongolia gaining access to a larger share of the US$6bn Oyu Tolgoi project. Moreover, we do not expect the Mongolian government will embark on further measures that will jeopardise growth in the country's mining sector, especially when exports to China have been falling in recent months. According to estimates by Bloomberg, Mongolia experienced a more than 39% y-o-y drop in exports to China in August. Our below consensus view on the Chinese economy, which will lead to a further softening in China's demand for imports, further reinforces our expectation for the Mongolian government to adopt a more moderate stance towards foreign investment.