VZCZCXRO0515
RR RUEHCN RUEHGH RUEHVC
DE RUEHUM #0527/01 3430618
ZNR UUUUU ZZH
R 080618Z DEC 08
FM AMEMBASSY ULAANBAATAR
TO RUEHC/SECSTATE WASHDC 2588
RUEHOO/CHINA POSTS COLLECTIVE
RUEHUL/AMEMBASSY SEOUL 3596
RUEHKO/AMEMBASSY TOKYO 3260
RUEHMO/AMEMBASSY MOSCOW 2458
RUEHVK/AMCONSUL VLADIVOSTOK 0344
RUEHOT/AMEMBASSY OTTAWA 0723
RUEHBY/AMEMBASSY CANBERRA 0339
RUEHTA/AMEMBASSY ASTANA 0088
RUEHDBU/AMEMBASSY DUSHANBE 0015
RUEHEK/AMEMBASSY BISHKEK 0153
RUEHAH/AMEMBASSY ASHGABAT 0111
RUEHNT/AMEMBASSY TASHKENT 0006
RHEHAAA/NATIONAL SECURITY COUNCIL WASHINGTON DC
RUEHLMC/MILLENNIUM CHALLENGE CORP WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEKJCS/SECDEF WASHINGTON DC

UNCLAS SECTION 01 OF 05 ULAANBAATAR 000527 
 
SENSITIVE 
SIPDIS 
 
STATE PASS USTR, USTDA, OPIC, AND EXIMBANK 
STATE FOR EAP/CM AND EEB/CBA 
USAID FOR ANE FOR D. WINSTON 
USDOC FOR ZHEN-GONG CROSS 
 
E.O. 12958: N/A 
TAGS: EINV PREL PGOV ETRD EMIN ENRG MG
SUBJECT: REFLECTIONS ON A SLAG HEAP: WINNERS AND LOSERS CONTEMPLATE 
MONGOLIA'S CURRENT MINING POLICIES 
 
ULAANBAATA 00000527  001.2 OF 005 
 
 
Sensitive but Unclassified - Not for Internet Distribution. Contains 
proprietary and confidential business information 
 
REF: A) ULAANBAATAR 521; B) ULAANBAATAR 474; C) ULAANBAATAR 382; D) 
ULAANBAATAR 068; 
E) 2007 ULAANBAATAR 652; F) 2006 ULAANBAATAR 870 
 
¶1. (SBU) SUMMARY.  Failure to establish a fair and stable regulatory 
environment for the mining sector, coupled with the global economic 
crisis and commodities market crash, have come back to haunt 
development of Mongolia's minerals sector.  Small exploration firms, 
already hammered by dropping commodity prices and tight capital, 
hesitate to invest more into Mongolia with a government that 
maintains the right to expropriate their deposits and ignore their 
legal rights.  Absent significant short-term changes, these firms 
may depart Mongolia for regions with better business climates. 
Large multi-national mining companies, on the other hand, are 
prepared to use their deep pockets to protect their investments, 
waiting for sense to prevail among the GOM leadership.  For its 
part, the GOM seems to realize finally that the legal and regulatory 
problems may be chasing away or delaying mining investment -- and 
so, have begun sincere reforms.  Unfortunately, these reforms may be 
too little and too late to keep most mining companies in Mongolia. 
END SUMMARY. 
 
THE LANDSCAPE HAS CHANGED 
------------------------- 
 
¶2. (SBU) As discussed in ref A, the global financial crisis has 
shocked the Government of Mongolia (GOM) into the realization that 
it needs to act immediately on mining.  Many private mining 
companies, service providers, and other observers, however, find 
that this change of heart has come too little too late.  Few, if 
any, private companies active in Mongolia's mining sector praise the 
GOM's recent approaches to legislating and regulating mining. 
Across the board there is bitter criticism, bordering on contempt, 
from players large and small about Mongolia's approach to crafting 
and executing mining policy, and words such as "chaotic," 
"capricious," and "amateurish" are not uncommon.  (NOTE: For 
reporting on Mongolia's legal and regulatory frameworks over the 
last three years consult refs A, C, D, and F.  END NOTE.) 
 
¶3. (SBU) Taking stock of a complex set of political and economic 
factors, firms are making decisions about continued engagement with 
Mongolia's mining sector.  Individual company responses vary, 
depending in large part on a firm's size (i.e., ability to weather 
the storm), investment in-country to date, and their 
mineral-of-interest.  Often with market capitalizations of less than 
USD 50 million, junior exploration companies have been walloped by 
collapsing commodity prices, strangled capital, and the dizzying 
policy gyrations of the GOM.  The giant miners with deeper USD 
multi-billion pockets can play more of a waiting game, but will 
certainly proceed more slowly than if deals had been struck even six 
months ago.  Finally, the coal mining sector brings up a whole 
different set of issues, since, unlike other "strategic deposits," 
the GOM holds clear ownership of the mammoth Tavan Tolgoi deposit, 
meaning that mine will develop much differently than other key 
deposits.  The balance of this cable will discuss these three areas 
in more detail. 
 
JUNIORS REACHING THE BREAKING POINT 
----------------------------------- 
 
¶4. (SBU) The situation is not the same for all junior firms.  The 
standing 2006 Minerals Law allows companies to discover, delineate, 
and then sell off their Mongolian mining prospect to a major mining 
company, and many firms have done so successfully in Mongolia.  The 
problem arises when a deposit emerges as -- or is suddenly labeled 
 
ULAANBAATA 00000527  002.2 OF 005 
 
 
-- "strategic."  The 2006 Minerals Law defines a "mineral deposit of 
strategic importance" as a "concentration where it is possible to 
maintain production that has a potential impact on national 
security, economic and social development of the country."  It 
further defines a "strategic investment" as a "strategically 
important deposit" in which the Government of Mongolia has the right 
to obtain up to a 50 percent share of any mine. In addition, the law 
sets no limit on when a deposit can be claimed as strategic; and so, 
in theory, the GOM could label and grab a deposit at any point in 
its life cycle. 
 
¶5. (SBU) This effectively means that a junior company can engage in 
expensive, time consuming exploration, discover a deposit of 
substantial economic value, then see that deposit suddenly labeled 
"strategic."  Even if this never happens, the threat of 
expropriation looms over the exploration firm.  This reality has 
made junior exploration companies very conservative in their public 
statements of results in order to stay under the GOM radar.  In 
addition, observers say that having a Mongolian prospect in your 
exploration portfolio can be poison for share values.  Junior firms 
active in Mongolia are reporting that stock values decline 80 to 90 
percent generally, no matter the commodity in play -- even gold. 
Consequently, companies (especially those staying in Mongolia) tell 
us that they are restructuring these investments so that they do not 
have to be reflected on publicly reported balance sheets.  In short, 
the GOM has reduced transparency, raised the perception of risk, and 
sent skittish investors running for cover.  Their fear has cut off 
the speculative investment that is the life blood of exploration, 
forcing junior firms to decide between drawing down irreplaceable 
cash reserves to continue in Mongolia or to close down for good 
 
¶6. (SBU) Juniors also accuse regional and local authorities of 
"creeping expropriation."  For example, provincial authorities can 
claim specific areas as being of special historical, cultural, or 
social importance to the people of the province and ban activities 
on that land for five years.  In Bayankhongor and other provinces, 
such special-use takings have proliferated without any 
justifications for such takings.  Both junior and major firms have 
privately told us that representatives from regional and local 
authorities often use this power to their own advantage, labeling a 
mining area as special-use, then approaching the company that holds 
the mining rights, offering to remove the classification in return 
for cash, a piece of the mine, development funds/projects for the 
locality, or some other payback.  Although the 2006 Minerals Law 
allows for compensation for possessing land taken for special uses, 
no one owning such designated land has reported receiving 
compensation from cash-strapped local governments. 
 
¶7. (SBU) According to the World Bank, exploration expenditures from 
all junior companies were down 50 percent in 2007, with most firms 
shifting exploration to other nations.  Observers assert that this 
decline has serious implications for Mongolia's development.  The 
most immediate impact will be on employment of Mongolians in the 
mining sector.  The Oyu Tolgoi (OT) project, operated jointly by Rio 
Tinto (RT) and Ivanhoe, recently laid off 300 workers, and rumors 
continue to circulate that other firms are close to cutbacks. 
Representatives of junior firms hesitate to provide specifics for 
fear of upsetting their workers and shareholders, but many are 
contemplating serious cutbacks in employment and equipment 
purchases, possibly in the very near-term.  Mining equipment and 
service suppliers also report a small but perceptual drop 
(approximately 5 percent) beyond what they expect during the winter 
lull. 
 
¶8. (SBU) Some junior companies are doing more than downsizing; in 
fact, they may close completely and move to better climes.  Industry 
observers and players explain that while they would no doubt suffer 
the same tough economic conditions in other mining destinations, 
 
ULAANBAATA 00000527  003.2 OF 005 
 
 
they would prefer to suffer in a country whose government is 
predictable and consistent.  One local attorney serving many junior 
companies lamented, "The companies see the Mongolian government as 
just too risky. I never would have imagined that clients would see 
Africa a safer bet than Mongolia, going to Lusaka of all places!" 
(NOTE: The same attorney observed that if the mining business 
continued to slide, she would have to discharge eight of her eleven 
Mongolian employees.  END NOTE.) 
 
THE GIANTS PLAY A WAITING GAME 
------------------------------ 
 
¶9. (SBU) Among the major multi-national mining companies, the impact 
of current GOM activities varies with the project in prospect. 
Expressing "disgust" with a regulatory and legal environment that 
seems to change daily, giant BHP Billiton seems set to suspend all 
exploration and perhaps close its Mongolian offices permanently. 
For RT and Ivanhoe, however, prospects seem to have improved.  The 
GOM and the State Great Hural(SGH), or parliament, want to secure a 
deal ASAP so that development can proceed, and on December 4 
unambiguously confirmed this desire through a formal decree of the 
SGH that authorizes the GOM to negotiate investment agreements on 
both Oyu Tolgoi and Tavan Tolgoi. (NOTE: Although the decree 
designates February 1, 2009, as the day the GOM must send agreements 
to the SGH for approval -- probably too ambitious a deadline for two 
such complex, multi-billion dollar projects -- both Rio Tinto and 
Peabody have told us they are satisfied that the Mongolians have 
formally committed to a negotiation process at long last.  END 
NOTE.)  OT is the most advanced of all the projects.  Its ownership 
status is clear and the private companies have significant assets in 
place to move development forward quickly (see ref A).  Motivating 
factors for the GOM include replacing declining revenues from the 
Erdenet copper mine (see ref B) with royalty advances, tax revenues 
from jobs, fees, redeeming campaign promises, and forward-looking 
development schemes. 
 
¶10. (SBU) Ivanhoe and RT have quietly suggested to the GOM that it 
should move as expeditiously as possible.  However, Ivanhoe, a 
junior explorer with controlling interests in OT, is desperate to 
get the deal done immediately.  Tapped out and unable to entice cash 
into the current environment, Ivanhoe has all but mothballed its 
operations, discharging 300 of its 600 employees (and that down from 
1,500 in December 2006) and halting all development at the OT site. 
These recent layoffs include high-paid expatriate technical experts, 
lower-paid Mongolian skilled labor, and unskilled Mongolian labors 
as cooks, housekeepers, and drivers. 
 
¶11. (SBU) RT also wants a deal but is in no particular hurry to 
conclude one.  Depressed markets for base-metals, tight capital, 
debt accumulated from previous mergers (primarily RT's acquisition 
of Canada's Alcan), and cost of fending off BHP Billiton's failed 
hostile takeover attempt have all exacted a toll on RT's cash flow. 
While RT remains committed to the OT project in the mid-term, the 
firm is content to wait for capital and commodity markets to recover 
a bit before launching an estimated USD seven billion project.  More 
positively for Mongolia, RT tells us that the failure of BHP's 
takeover is significant for OT's future, because the failure 
definitively settles the question of project ownership.  If BHP had 
succeeded or the takeover attempt lingered without resolution, the 
OT project would have likely languished for several years as BHP 
would have no doubt delayed acting on OT as it dealt with the 
consequences of the merger. 
 
PEABODY AND TAVAN TOLGOI 
------------------------ 
 
¶12. (SBU) Peabody Energy remains interested in the Tavan Tolgoi (TT) 
coal mine and other coal prospects.  They remain in regular contact 
 
ULAANBAATA 00000527  004.2 OF 005 
 
 
with us and are quietly increasing their activity in the Mongolian 
market.  But the problem is that Peabody will not enter Mongolia in 
force until the GOM clarifies just how it sees TT evolving.  That 
evolution also must be commercially viable for Peabody.  Regarding 
that resolution, no clear answer exists.  We consistently encourage 
both the GOM and Peabody to talk with each other more actively, 
because it seems to us, based on what the GOM and some MPs are 
saying that Mongolians are looking for ideas on how to proceed at TT 
and would welcome some discrete concepts at this point. 
 
¶13. (SBU) Peabody's reticence has been difficult for the GOM to 
fathom, as most other suitors for TT make lavish gestures, ranging 
from alleged bags of cash to members of parliament to generous 
praise in local and international press.  A senior official from the 
Ministry of Minerals and Energy, skilled in both politics and 
business, recently complained to us that the GOM doubted that 
Peabody was really committed to the TT project because the firm had 
not yet responded to a request from the GOM to reveal how Peabody 
would finance the project.  In response, we asked the official how 
the GOM thought Peabody could offer a financing plan when the GOM 
had yet to set the parameters of the project, noting that Mongolia 
should see Peabody's hesitation as a sign of professionalism and 
good faith rather than as disinterest. (COMMENT: Mongolian 
institutions and individuals simply have little experience reading 
corporate behavior or framing requests that companies can fulfill in 
good faith.  All of this suggests that Mongolia needs the services 
of professionals to act as intermediaries in negotiating with 
international mining companies, as discussed in ref A.  END 
COMMENT.) 
 
¶14. (SBU) The GOM owns 96 percent of TT and wants to move ASAP; 
however, there remains no consensus on what approach to take. 
Everyone with whom we speak mentions a variety of options without 
signaling a favorite.  However, certain aspects of the ideal deal 
seem to bubble to the surface.  First, in the long run (say 20-30 
years), the GOM would like to become the operator and majority owner 
of the property, like state-owned CVRD of Brazil.  In the near term 
the GOM recognizes that it cannot afford to build the sort of TT 
that it wants -- an operation that would produce tens of millions of 
tons of coal annually in relatively short-order -- and so would 
accept private involvement, perhaps by issuing a 20-plus year 
operating license.  In this scenario, the GOM would hold a majority 
stake of at least 51 percent and perhaps sell off 49 percent to the 
private operator and others. 
 
¶15. (SBU) Another loosely affiliated group of Mongolian politicians, 
officials and business people wants the state to develop TT without 
foreign involvement.  They propose starting TT off very small, using 
the currently operating state-owned Little Tavan Tolgoi mine, 
adjacent to TT, as an example (see ref E).  In this case TT would 
start out with a scant few million tons a year, then expand as funds 
became available.  (COMMENT: Given Little TT's poor record on paying 
the state its rightful share of the revenues, corruption, horrible 
environmental reputation, and health and safety violations, skeptics 
note that the latter model seems most popular with politicians whose 
focus appears to be on lining their own pockets.  END COMMENT.) 
 
COMMENT 
------- 
 
¶16. (SBU) Ironically, Mongolia appears to have seen the error of its 
ways and may be willing to change.  But the turnaround may be too 
late to retain the junior firms and to spur Rio Tinto into early 
action on the desperately needed OT project. However the real 
problem is not that OT will not start, because it will, although a 
year or two later, after RT has stabilized.  The real problem is 
that government policy gyrations, which have discouraged or are 
driving junior companies out of Mongolia, make it next to impossible 
 
ULAANBAATA 00000527  005.2 OF 005 
 
 
for Mongolia to expand the mining sector beyond the current high 
profile OT and TT. 
 
¶17. (SBU).  In the long run observers agree that the departure of 
junior firms could cripple mining in Mongolia, for Mongolia's recent 
discoveries of strategic deposits came from privately held firms 
uncovering completely new deposits or revisiting deposits previously 
explored by the GOM but left undeveloped because the GOM lacks the 
hundreds of millions of dollars needed to explore. (NOTE: For 
example, Oyu Tolgoi, the world's largest undeveloped copper-gold 
deposit was unknown to the GOM.  It was not until the Canadian 
junior Ivanhoe spent USD 800 hundred million on exploring the site 
that the true magnitude of the deposit was determined.  END NOTE.) 
OT and TT are world class deposits to be sure, but to keep revenues, 
jobs and infrastructure developments going, a mining nation needs 
explorers constantly running all over Mongolia's valleys, deserts, 
and mountains.  If the GOM persists in pursuing a chaotic legal and 
regulatory regime the only running will be that of explorers and 
investors to competitor countries. 
 
MINTON