Positive outlook: Improving the competitiveness of coal exports should see long-term payoffs

Though Mongolia’s mining industry is still relatively young and new factors may change the calculus, for now its fortunes are expected to rise and fall with China, which is the primary buyer for the country’s mining output and highly likely to continue in that role.

Given that relationship, Mongolian-economy watchers have been paying close attention to trends there in hopes of forecasting demand for coal exports. For the foreseeable future, Mongolia’s fortune is to be found in coal more than any other mining export – it accounted for around 60% of industrial output as of the second quarter of 2012, according to World Bank data. Indeed, the country has become China’s largest coal supplier, in particular for hard coking coal as an input for manufacturing steel.

SLOWING PRODUCTION: The expectation for major exporters such as Erdenes Tavan Tolgoi (ETT) and Mongolian Mining Corporation (MMC) is for a weak market from the second half of 2012 and into early 2013. Some miners were already slowing or halting production by mid-2012. Producers such as South Gobi Resources and Prophecy Coal, which mine the Ovoot Tolgoi and Ulaan Ovoo coal deposits, respectively, suspended production from the third quarter, citing in part weaker demand. The forecast was also for a subdued 2013, but a brighter long-term future.

FUTURE POTENTIAL: While the outlook in particular for hard coking coal is positive, expanding transportation links could further improve the fundamentals. Once rail lines are built, the competitiveness of Mongolian coal will rise. As of now coal is going by road to China, which is expensive, and the road is already at capacity. By October 2012 ETT had a stockpile of between 500,000 and 600,000 tonnes of coal awaiting transport. According to an ETT presentation at the Mongolia Investment Summit in Hong Kong in October 2012, unwashed coking coal at Tsagaan Khad, on the Mongolian side of the border, had fallen from $70 a tonne in early 2012 to $64 mid-year and $57 by late October. The first half of 2012 showed growth, however. Mongolia’s National Statistical Office reported exports of 10.3m tonnes, up from 7.7m tonnes in the first half of 2011 as capacity increased at new mines. Production in the second half of the year is almost certain to drop, in part thanks to market conditions and due to uncertainty for South Gobi Resources.

The company is majority-owned by Rio Tinto through a controlling stake in Turquoise Hill Resources. Turquoise Hill had struck a $926m deal to sell South Gobi to Aluminium Corporation of China (Chalco), however, the agreement faced political opposition to the extent that the mining regulator, the Mineral Resources Authority of Mongolia, fielded a request to suspend or cancel South Gobi’s mining licence, which was denied. The company’s licences are in good standing, but its future and production plans remained unclear as of late 2012.

SUPPLY & DEMAND: MMC reported a 56% jump in profit for the first half of 2012, to $31m. However, it has also shelved a plan to mine thermal coal and cut its 2013-14 output target by 13%. MMC’s CEO, G. Battsengel, told media the firm would boost coking coal output in the period to between 12m and 13m tonnes, up from 10m tonnes, but dropped a goal of 5m tonnes of thermal coal production. He said that prices for coking coal in China had slumped by 15% over the first half of 2012.

ETT is likely to be insulated from any demand concerns in 2013 because it already has a purchase agreement in place. ETT’s East Tsankhi deposit, part of the six deposits that comprise Tavan Tolgoi (TT), is the only ETT-controlled site from which there is current production. While the plan is to sell shares in ETT in an international initial public offering, the company has funded itself thus far from a coal-purchase agreement with Chalco in which the buyer paid up front and is obliged to take deliveries from the seller until contract is fulfilled. That agreement was for an initial value of $250m, and later extended for another $100m in coal. It stipulated that for the first 1m tonnes the price to be paid was $70 a tonne. After that, it is based on a weighted average of the international seaborne rate for coal and three other Chinese coal prices. The contract calls for ETT to take its output to a delivery point at Tsagaan Khad, 26 km from the Mongolia-China border. Chalco is responsible for transporting it from there. That means Chalco, instead of ETT, must import the coal into China, which costs $7 per tonne. Chalco also handles the 17% value-added tax China applies at the time of import.

As of October 2012, the price derived from the contract’s calculations was $65 per tonne, according to ETT. The company has been criticised for the deal on account of the low price earned – ETT’s new CEO, D. Byanjargal, called the contract “inferior’’ in an interview with local media on November 2, 2012, noting that the company was selling for less than cost at that time, and said that he would seek to renegotiate with Chalco.

HOW IT COMPARES: Mongolian coking coal is not necessarily the highest in quality produced in the wider region – some Chinese and Australian deposits are rated higher for their energy concentration and are thus more valuable. Mongolia’s hard coking coal is generally considered of standard grade, a notch below premium hard coking coal, but more valuable than semi-hard coking coal or semi-soft coking coal. An area in which the country’s coal has an advantage is in the costs of production. Stripping ratios for ETT are very favourable. Typically mined ore is three parts dirt and other non-coal materials to one part coal. That is far better than some of the Australian coals on offer to the Chinese market, where the ratios are 12:1 on average and range from 8:1 to 15:1, according to ETT research. Mining costs overall are also far lower – $25 a tonne at ETT’s East Tsankhi mine against $120 to $150 in Australia, according to ETT. Mongolian coal is also fetching lower prices in part thanks to a lack of leverage because the country is landlocked and had fewer markets to sell to.

COST OF TRANSPORTATION: Where Mongolia’s coal loses competitiveness is in transportation costs. According to research from Citibank, a tonne of thermal coal costs $20 to produce, but $38 to deliver to customers in China’s Inner Mongolia province, for a total cost of $58 a tonne. That compares with a spot price at the time of research of $47 a tonne there, making Mongolian thermal coal non-competitive if quality factors are equal. However, the research shows that if sent by rail, coal produced from MMC’s Ukhaa Khudag mine would be $10 to $18 cheaper per tonne, suddenly making it either close to on par with Chinese coal or cheaper.

Citibank’s research estimated transportation costs for rail to be $0.03 per tonne per km compared to $0.06 or $0.07 per tonne per km by road. In China, rail capacity for coal is expected to double by 2015.

RAIL LINK: MMC recently undertook a project to build a 240-km railroad from the Ukhaa Khudag mine to Gashuun Sukhait, on the border with China. “The railway will not only enhance the efficiency, reliability and safety of our transportation operations, but will also be a sustainable and environmentally friendly coal transportation solution,” Battsengel said.

However, the plan, which was expected to cost around $700m, has been put on hold. According to an MMC announcement in November 2012, the government decided to consolidate a number of rail projects, which has created questions about ownership and management. MMC’s subsidiary Energy Resources has already invested greatly in the project and has agreed to continue cooperating on the project, however, as of early 2013 it was unclear when construction would resume and what final agreement would be reached. Should the Mongolian government negotiate a consortium to develop more of TT, the expectation is for a major railroad expansion that would aid the mining sector.

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The Report: Mongolia 2013

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