One of the top priorities in Mongolia in 2012 will be resolving the issue of development and production at Tavan Tolgoi (TT), the world’s largest undeveloped coal deposit, which holds an estimated 6.4bn tonnes of coking and thermal coal.

It appeared that an agreement to develop the site was reached in July 2011 by a consortium of Mongolian, Chinese, Russian and US interests. However, since then that deal has fallen apart and the government has resolved to try again.

TT is one of two large-scale mineral deposits in the Gobi Desert, in the southern part of the country close to the Chinese border. The other, Oyu Tolgoi (OT), holds copper and gold and is forecast to begin commercial production in 2013. Much of the output of both mines is expected to end up in China, where it will help fuel the development of the country’s massive northern cities. Before that takes place, however, the two deposits must become mines.

Mongolia has only two neighbours, Russia and China. Throughout its modern history the country has been shaped by the need to maintain friendly relationships with both of these world powers. Consequently, geopolitics is expected to play a larger role in the development of TT than in most mining deals elsewhere. With this in mind, it is possible that ramping up production at the mine from the initial stage reached in 2011 could take until 2013, according to market research from China’s Huatai Securities.

VAST RESOURCES: The deposits at TT were first discovered in the 1950s by Soviet geologists, and drilling continued into the 1970s. After Mongolia began to transition to a capitalist economy in 1990, private sector exploration began. BHP Billiton acquired a licence to explore TT soon thereafter, but relinquished it to a precursor of the Mongolia Mining Corporation, a locally owned firm. In 2008 the licence to explore the area was transferred to Erdenes MGL, a state-owned firm established a year earlier to handle the government’s stake in the country’s largest mines, which it considers strategic deposits. By then it was clear what a massive resource Mongolia had on its hands. As of 2010 the government had settled on a rough plan for development. The state planned to divide the deposit into two blocks, with Erdenes responsible for one and the other to be offered to private sector mining companies. Production began on Erdenes’s eastern half in 2011, with the first ore sold to Chinese interests.

With initial production already started, capital will be required to get to the expected production of 15m tonnes per year. According to B. Enebish, the CEO of Erdenes TT, the company will own the core mine licences for the TT deposits. “We have around 26, 000-29,000 ha that are ready to be mined and exported,” Enebish told OBG (see interview). “We have already started our mining work, and our production and volume are growing very quickly.”

Most investors are waiting for the company to sell shares in an initial public offering (IPO). According to Erdenes, the shares will be offered on the Mongolian Stock Exchange (MSE), but also simultaneously on the London Stock Exchange, as the local exchange is not large enough to provide the capital to fund ramping up production.

The plan to offer the IPO on the London Stock Exchange reflects the perception that Mongolia is too small to be able to capitalise such a project alone. The joint listing also ties in with the MSE-London Stock Exchange Group management contract. While initially there were also plans to float the company’s shares on the Hong Kong Stock Exchange, this has now been dropped, due to the government’s plan to give citizens shares ahead of listing, which contravenes the Hong Kong market’s regulations (see Capital Markets chapter).

ON AND OFF: For the other half of the mine, the main concern for investors is which firms will win the right to develop it. A number of companies submitted bids in January 2011, with the list of interested firms including Mongolian, Chinese, Russian, Swiss, Brazilian, Indian, US, Japanese and Korean bidders. In July 2011, after negotiations with finalists, winners were announced. Shenhua Energy of China was awarded a 40% stake in TT’s western deposit, and a Russian-Mongolian consortium 36%. US company Peabody Energy, the world’s largest private sector coal company, was to take a 24% interest.

The arrangement was widely criticised. Each of the parties involved was expecting a greater stake. Japanese and Korean interests – many of which are very active in Mongolia – were angry at being shut out, and local opposition focused on the question of what percentage of the profits would stay in Mongolia. In September 2011, citing security concerns because the deposit is large enough to be considered of strategic importance to the country, the deal was cancelled, and Mongolian officials went to work restructuring it. It is widely expected that the same players will be involved, but that Japanese and Korean firms will also be in the mix. In October 2011 local newspapers reported that the government planned to announce a new deal before parliamentary elections in June 2012.

RESOURCES: Sorting this out will mean delaying the development of TT West, in addition to pushing back the construction of a new railroad network, which was expected to be a catalyst for overall economic growth. Part of the July agreement was a Russian promise to build the railroad, and to offer a 50% discount on shipping in order to compensate for the far-higher costs of transport to Russian ports in comparison with the short journey south to China. In the north-west the rail line would pass by several potential mining sites that have not yet been developed before heading south-east to TT and OT. It would then proceed north-east toward Choibalsan, to link up with a spur of the Trans-Siberian Railway, which could potentially take the minerals mined in Mongolia to ports on Russia’s Pacific coast.

These links are a crucial part of Mongolia’s vision for its mining sector. Without access to those ports, the only existing route to customers is through China. Although the deposits are located only approximately 250 km from the Chinese border, Mongolian officials are determined to have more than one option for exporting, to maintain leverage with buyers. Without the new rail line, the government fears an overreliance on China, which would likely result in lowball prices from Chinese buyers.

Mongolia’s long-term plan for its railroad network includes a rail link to China, after the Russia option is established. Currently, however, with the deal on hold, the railroad question remains unsolved. The newly created Development Bank of Mongolia plans to raise capital to carry out the railroad plan, but has not yet gone further than an expression of intent.

EASTERN HALF: In terms of the eastern side of TT, the big question is the IPO. Approximately 29% of Erdenes’s value would be offered in shares, according to a report by Resource Capital, a Mongolia-focused investment bank. The IPO plan is ambitious. The company will also offer the shares on the exchange in London. Mongolian law mandates that the public must get 10% of any IPO. In Erdenes’s case, this has already taken place – all citizens born before the end of March 2011 were issued 536 shares of the firm, according to G. Saruul, the chief regulatory officer of the MSE. Mongolians can enlist a stockbroking firm to redeem the shares from a central clearinghouse at any time.

G. Temuulen, Erdenes’s deputy director, told OBG that the IPO was expected to be carried out after March 2012, which is when government authorities are expected to provide feedback to the company on its specific plans. Once issues such as Erdenes’s IPO and the development arrangement for the other half of TT are settled, the next set of issues will include logistics and services. Erdenes has been charged with conducting feasibility studies for an on-site power plant, for example. Questions of water access and tariffs may eventually become an issue, as there are not many water resources in the south.