With ageing facilities, constraints that discourage efficiency and growing demand, Mongolia’s energy sector faces a number of challenges. Geography makes it reliant on one supplier for refined fuels, with a tenuous supply and a high purchase price. Several projects in the works now have the potential to reverse this trend, if they are successful. Efforts are focusing on boosting and diversifying supply for both electricity and fuels, as well as establishing a positive track record for Mongolia as a viable place for private investment in large-scale energy projects. The pending mining boom in Mongolia may catapult the country’s tiny economy into one of the world’s most important ones. This type of growth, if it materialises, brings along a range of by-products that pose challenges. Inflation, for example, has already hit the economy hard, in part due to a pronounced scarcity of resources, labour, materials, goods and services.
POWER DEMANDS: Electricity is near the top of the list of crucial inputs in short supply, and is deeply intertwined with what is considered the country’s biggest social and environmental problem: pollution. The winter air in Ulaanbaatar among the world’s worst, thanks to large amounts of coal burned for heat by people who lack access to the centralised heating system. Plans for massive new housing developments, if realised, will mean a great leap in demand. Meanwhile, Mongolia is working with a decrepit set of power plants and grids, and a legal environment and tariff regime that has made investment in maintenance difficult for capital-starved plant operators. As a result, the coal-powered generation facilities are inefficient, as are the power grids. In its fuels sector, Mongolia is starved for options. Rates paid for diesel, petrol, jet fuel and other basics are high by international standards and the country had been reliant on a single supplier – Rosneft, the state-owned Russian producer – until recently, as initial diversification efforts followed a large fuel crisis that was widely perceived to be political in nature.
GOOD POTENTIAL: The good news is that Mongolia does not lack for domestic sources of energy. Coal is plentiful and supply is available to meet the needs of electricity production (see analysis). Renewable energy sources are also plentiful. The country’s first wind farm is due to begin feeding into the central grid in early 2013, and potential for wind power is strong. Solar power is already leveraged on a small scale. Increasing numbers of nomads power TVs, lamps and basic appliances in their felt tents by way of single solar panels, thanks to a programme designed by the Mongolian government and financed in part by a number of international development organisations.
For the future, Mongolia could also meet its growing energy needs by using hydrocarbons and nuclear energy. Oil production is low, but could grow thanks to increasing interest in exploration, particularly in the eastern third of the country, an area with geological similarities to petroleum-bearing areas in northern China. The government has also announced plans to finish construction of its first oil refinery by 2015.
INFRASTRUCTURE: The constraint is infrastructure, and in late 2012 hopes were high that the Mongolian government was succeeding in a trial-and-error effort to remove the obstacles to building more. An important marker of progress in 2013 will be a deal with an international consortium to build Ulaanbaatar’s fifth power-and-heat plant, on a public-private partnership ( PPP) basis. In Ulaanbaatar and other main cities, steam produced as a by-product of electricity generation is captured and spread through a network of pipes to heat buildings, and so electricity plants are generally referred to as combined heat and power (CHP) plants. A successful conclusion to negotiations and the commencement of construction could make Mongolia a proven and bankable destination for PPPs, which the state has been trying to achieve through improving the legal regime and by building and expanding capacity for tendering on a large scale. Another key piece of infrastructure that would boost the economy would be an oil refinery. The idea to build such a facility has come out of recent struggles experienced by the country in regards to ensuring a secure and cost-effective supply source for fuel, and several proposals are in early stages of evaluation.
For the long term, there is plenty of opportunity for sector growth, even beyond domestic needs. If the infrastructure gets built, Mongolia has the potential to generate far more electricity than it can use, and China, its southern neighbour, is one of the most electricity-thirsty countries in the world. As of now Mongolia imports some power from China, and while there are no specific plans to change this dynamic, the future may see Mongolia help China cope with its own massive demand story, fundamentally different because it is meeting the needs of 1bn people vis-à-vis Mongolia’s demand factors based on only 3m. Compound annual growth in electricity demand in China was at about 9.7% from 2007 to 2011, which is roughly in line with GDP growth there. The country plans to spend $390bn on grid construction alone by 2015, according to the plans of the Chinese Electricity Council. It is easy to imagine a future in which Mongolia uses its existing connection to that growing grid, and perhaps creates several more, to help meet Chinese demand.
SIZE & SCOPE: Mongolia’s installed electricity capacity is 897 MW, according to the Ministry of Mining. Of that total, 88% is derived from seven coal-fired thermal plants producing both electricity and heat, according to a study by the Institute of Energy Economics Japan (IEEJ). There are 600 plants that use diesel-fuelled generators, generally with a capacity between 60 KW and 1 MW, which produce 8% of the total. Renewables installations account for the balance of 4%. In addition, imports are a key part of the mix, with most of western Mongolia deriving its electricity from Russian imports, and the central area – the country’s most populated region – purchasing from Russia as well during peak hours.
To a lesser degree energy imports also come from China, in particular to power the Oyu Tolgoi copper and gold mine until a permanent electricity solution is found. As of late 2012 a transmission line had been completed and an import agreement was under negotiation by authorities on both sides. In total the country imported 138 MW of electricity in 2011, up from 135 MW in 2010, according the IEEJ study figures.
Forecasting is ongoing to produce the most accurate figures possible, but demand is expected to roughly double by 2015, going from just under 800 MW in 2011 to more than 1500 MW in 2015, according to ministry figures. Most of the rise will come from mining operations in the southern part of the country.
GENERATORS: Of the seven coal-fired plants in Mongolia, four were built to service Ulaanbaatar and are located in or near the city. CHP1 has outlived its usefulness, and CHP2 is nearing that same point as well. CHP3 has a capacity of 130 MW, while CHP4 is the workhorse of the group, providing approximately 70% of the country’s electricity. It has 480 MW of capacity, and a revitalisation programme is due to add another 100 MW. The work is being done with financing from KfW Entwicklungsbank, the German development bank. KfW conducted a study on the plant in 2011 and is financing a number of efficiency measures, such as cleaning pipes and refurbishing equipment. This work will allow for an additional turbine that will boost capacity to 580 MW, according to the bank.
NEW SUPPLY: The proposed CHP5, a hot topic in Ulaanbaatar in late 2012, would be the first new generation capacity in 30 years, and is planned to have the potential to generate some 450 MW. Negotiations between Mongolia and a consortium of local and foreign investors are structured in a PPP deal, which would be the first such arrangement in Mongolia, and perhaps help to boost investor confidence to participate in more PPPs in the country (see analysis).
All of Mongolia’s 21 aimags (provinces) and 318 soums(towns or villages) have access to electricity from a centralised source. At the soum level, 15 are supplied by local renewable or hybrid systems. In lieu of a national grid Mongolia’s electricity supply is sent through a number of regional systems. The Central Energy System (CES) accounts for more than three quarters of the entire system, and is the only one in which more than one major power plant feeds into the grid. It powers key cities along the north-south Trans-Siberian rail line, such as Ulaanbaatar, Darkhan and Erdenet. The Western Energy System (WES) and Eastern Energy System (EES) are the two other major systems. WES is entirely reliant on imported electricity from Russia, and the EES is powered by one coal-fired plant in the eastern city of Choibalsan, with an on-paper capacity of 36 MW, but a realistic ability to produce an amount closer to 29.5 MW.
Two smaller systems also run off a single power plant: a southern system providing electricity to the South Gobi aimag with a plant in that aimag’s capital of Dalanzagdad, and the Altai-Uliastai Energy System, which serves the Altai and Uliastai aimags. A fifth regional system for the southern part of the country was in the early stages of development in late 2012.
Remote soums too difficult to connect to the regional grids are typically powered by stand-alone systems of less than 1 MW, in some cases powered by renewable energy. Several of these have been built by the World Bank on a non-commercial basis. The development bank also helped finance a programme called the National 100,000 Solar Ger Electrification Programme, which is expected in 2012 to complete its goal of providing 100,000 solar kits to nomadic families.
SECTOR ORGANISATION: Electricity in Mongolia is governed by the Energy Law of 2001, which unbundled the integrated public authority into 18 state-owned companies: five generation companies own the plants. The National Electricity Transmission Grid Company (known as the Central Regional Electricity Transmission Company until April 2012) oversees transmission. It has been operating a single-buyer model since 2002. Distribution is handled by regional bodies. There are also two heat-distribution companies; one each for Ulaanbaatar and Darkhan. The law mandates that the transmission company must be publicly owned due to national security concerns, but all other assets are envisioned to be sold to private interests in the future. However, at the end of 2012 no specific privatisation plans were under way. Privately owned assets in the current system include several small-scale distribution companies outside Ulaanbaatar.
REGULATION: The Energy Regulatory Commission (ERC) was created in 2001, and until 2011 was known as the Energy Regulatory Authority. It has licensed 83 sector participants, which between them hold 173 licences over 10 categories, according to the agency.
Possible legal changes in the short and medium term include an energy efficiency law, for which a draft law was among candidates for debate in the autumn session of the Great Khuraal. While the broad goals of the government are to improve efficiency and boost capacity, some specific plans are laid out in the Programme for an Integrated Power Energy System (PIPES), which sets priorities including extending power supply to all Mongolians, modernising existing plants, building CHP5 on a PPP basis, as well as developing a hydroelectric plant on the Egiin River with a 220-MW capacity that would feed into the CES.
Later phases of the plan include grid connections between the regional systems and a further focus on renewables. The 2007 National Renewable Energy Law sets a target of deriving 20-25% of power from sustainable sources by 2020.
TARIFFS: Prices for inputs and end-products are regulated by the government, and as a result most of the operators in the system are money-losing entities – the 19 largest licensees in the sector reported losses in 2011, for example, according to the annual report of the ERC. Each individual power plant owner agrees its power-purchase agreement with the government, a process in which the price is subject to negotiation. Mongolia also has a spot market and an auction market in which companies producing power for the CES system can bid on extra demand.
The 19 biggest operators had a total operational loss of some MNT39.2bn ($27.44m) in 2011. To compensate, MNT32.7bn ($22.89m) was redirected from the state budget to support money-losing operations. CHPs also benefit from the government’s fixed rate they are obliged to pay to coal suppliers – typically one of several of the main producing mines at Baganuur, Shivee Ovoo, Ulan Ovoot or Sharyn Gol. Thermal coal is sold by these mines to the CHPs for MNT18,000 ($12.60) a tonne, below the cost of extraction.
Tariffs vary by user, with apartment dwellers paying MNT84 ($0.06) per KWh, mining operations MNT100 ($0.07), and other industries MNT88 ($0.06). Between 2010 and 2011 prices rose by an average of 9.5% due to a plan passed in 2010 for graduated increases through 2014. A steady rise in tariffs begun in 2009, but was halted in 2012, said ERC’s commissioner, N. Myagmarsuren. It was a decision made by the previous government, he told OBG, and he is expecting the rise to resume at some point over the course of 2013.
Without the ability to charge market rate for electricity, operators have been left lacking the capital needed to maintain existing generation facilities and build new ones. “In raising the tariffs we will make the balance sheets of the power plants healthy, encourage investment and force people to use less electricity and heat,’’ Myagmarsuren told OBG.
The system as it is now has several disincentives to efficiency on top of the subsidised price enjoyed by users. As heat is a by-product of power generation, excess electricity is often produced just to meet the demand for heat, for example. In this centralised system, residents do not have thermostats in their homes, meaning all hook-ups get the same amount of heat, whether it is wanted or not. Those who are too hot tend to open a window, creating waste in the system.
The heating system is turned on September 15 and closed on May 15, and in some years temperatures are not cold enough around those dates to justify usage, causing users to compensate by opening more windows and the wasting of more energy.
FUELS MARKET: Being a land-locked country presents several challenges for Mongolia, and its downstream fuels market is a prime example. Mongolia is basically exclusively reliant on Rosneft for fuels, almost all of which are sent by rail on the Trans-Siberian line from a refinery near Irkutsk in Siberia. The market is deregulated, with four major importers and several other minor ones buying directly from Rosneft. The biggest player is Petrovis, with a market share of about 40%. Other main downstream importer-marketers include Sod Mongol, Just Oil and Magnai Trade. Petrovis purchased a former state-owned enterprise, NIC JSC that was privatised in 2004, and has built on that incumbent’s advantage by capturing large contracts such as supply agreements for Rio Tinto’s Oyu Tolgoi mine.
The average price paid for standard petrol in Ulaanbaatar as of December 2012 was MNT1620 ($1.13) a litre, up from MNT1250 ($0.87) in 2011, according to data from the National Statistical Office (NSO). Diesel jumped to MNT1720 ($1.20) from MNT1576 ($1.10). Therefore, the Ministry of Mining and Bank of Mongolia have agreed to measures to sustain the fuel price. The cost of fuels also affects the price of intercity bus tickets and airline fares. Civil Aviation Authority’s senior deputy director-general, P. Munkhjargal, quotes jet fuel costs at $1800 a tonne in Ulaanbaatar. Imported via rail from Russia, it is then shipped by road to other airports, at a cost of approximately $100 a tonne.
Sale of petroleum is governed by the Petroleum Law of 1991, and regulated by the Petroleum Authority of Mongolia (PAM). Both the private sector and government agencies have been keen to reform and expand the downstream market, largely on account of a shortage in the summer of 2011. “Given the rapidly growing economy the demand for petrol has been rising between 15-20% per year. We expect this trend to continue, especially when demand from China starts picking up again,” said D. Gansukh, the general director of Mongolia-based MPI Consultants, an independent firm specialising in the petroleum industry.
Rosneft was supplying less than needed to meet demand in late 2012, shortages that the company attributed to technical improvements and greater demand from European customers, according to local press reports. However economic research from BDS ec noted that the move coincided with a government proposal to increase the tax on imported fuel, and pointed to a history of Russian state-owned energy firms withholding supply to customers as a form of political pressure, such as when Gazprom stopped gas to Ukraine as a negotiating tactic over the price to be paid. In 2008, BDS ec noted, Rosneft offered to ensure long-term fuel-price stability in Mongolia as long as the government donated 100 sites to the company on which it could build filling stations.
HISTORY REPEATS: As of November 2012 the impact of the shortfall in supply was becoming evident. Market research from Ulaanbaatar-based investment bank Mongolian Investment Capital Corporation (MICC) revealed that several downstream distributors were refusing to buy from Rosneft at increased prices, leading to shortages of fuels such as A92 petrol. According to M. Khaliunbat, the CEO of Petrovis, there was a $49 increase per tonne from Rosneft. Filling-station managers gave expectations of petrol prices rising between MNT200 ($0.14) and MNT300 ($0.21) per litre.
Government sources attributed the shortage to a 10-day suspension in production for maintenance purposes. However, a number of media and economic research agencies speculated on the possibility of the increase serving wider Russian political goals.
To give the country additional negotiating leverage, Mongolia’s importers have sought to diversify. They have had some initial successes – fuels are now coming from Kazakhstan, Byelorussia, South Korea and China. However for now, until major new supply sources are found, the market is still 95% supplied by Rosneft, according to figures from PAM.
IN RESERVE: The government has also made increasing domestic storage capacity a priority. Mongolia has a strategic reserve with a capacity of three months of current supply, but experience has left the country realising it will need more capacity and higher reserves within it. In November, when it appeared that shortages would once again affect the market, MICC’s research indicated that the country collectively had 20 days of supply in stock; PAM’s estimate was 44 days. The government is now encouraging major importers to keep a domestic stock of at least 10% of turnover at all times, and may pass a law requiring this or some other storage obligation for importers, said M. Anat, the general manager of sales and operations at Petrovis’s NIC division. Another solution, he said, would be to rehabilitate Soviet-era facilities, at a price of roughly $20m, which would open up 270,000 tonnes of storage capacity. The government has also been discussing shutting the private sector out of the importing business and becoming the sole importer. That would force Petrovis and other current players to use the state as a middleman, buying from the it to supply end users, and likely cause a fall in profit margins, according to Anat.
REFORM POSSIBLE: Such a change could, from the government’s perspective, eliminate price gouging. In November 2012 Petrovis was facing accusations of inflating prices and reducing supply. It was reported in local media that the government’s Authority for Fair Competition and Consumer Protection could fine Petrovis or even suspend or revoke its operating licence. On January 7, 2012, according to local media, a 20-25% jump in petrol prices at filling stations triggered an investigation by the authority that led to MNT17bn ($11.9m) in fines levied against nine operators, including all of the major players. However, several senior members of the authority were later fired and the fine was cancelled, according to a media report in April 2012.
For now, however, it appears that the market will remain deregulated, to an extent. In late October 2012 the government, the Bank of Mongolia (the country’s central bank) and several downstream companies announced there would be an agreement to keep fuel prices sustainable through government loans at concessionary rates to fuel importers. According to details published in the UB Post, 12 retailers were splitting a $120m loan at 4% interest.
FUTURE PLANS: For the long term, Mongolia hopes to avoid another supply crunch by building its first oil refinery, and perhaps one or two more. Several major downstream companies are considering options here, although none are at the stage of hiring consultants or conducting feasibility studies. For now, however, two main options have emerged. One is to build a refinery in Darkhan, north of Ulaanbaatar and the closest city to Russia, thus making it well positioned to import Russian crude with lower transportation costs than other possible sites. There is, for now, no indication of whether Rosneft or another Russian oil producer would be keen to sell crude to Mongolia instead of higher-margin products that include diesel and petrol.
The other talked-of location for a refinery is Sainshand, a city in the south-east that the government would like to build up into an industrial centre. Sainshand is on the Trans-Siberian rail line and has relatively good road connections by local standards, as well as being located fairly close to the mining sites of the Gobi Desert, such as Oyu Tolgoi and Tavan Tolgoi.
A refinery at Sainshand would be poorly positioned for Russian crude imports, but could cut costs for the mining industry and support Mongolia’s long-term goal of developing industries that can use its domestically mined ore to make finished or semi-finished goods, capturing more of the value of the resources within the country’s domestic economy.
Although for now Mongolia’s small domestic crude production is sold in long-term contracts to Chinese interests, future discoveries could be earmarked for a domestic refinery, and one possibility that has been under discussion is to build a pipeline from the northeast, where the country’s petroleum potential is believed to be at its highest, to Sainshand.
UPSTREAM ACTIVITY: Mongolia has developed a small domestic oil production industry, with 15 current production-sharing contracts (PSCs) covering 19 blocks. The government is currently reviewing proposed PSCs on eight blocks, and there are five more presently open for bidding, according to PAM.
Output reached 2.58m barrels of oil for 2011, up from 2.11m in 2010, according to PAM figures. The figures in the 2011 yearbook by the NSO differ slightly, at 2.55m barrels for 2011 and 2.18m for 2012. However, despite the discrepancies in actual amounts, the trend is for large increases in output from this small base: in 2008 1.17m barrels were produced, and in 2009 1.87m, according to the NSO data. PAM’s target for 2012 production is 3.12m barrels. There remains a significant amount of exploration required to see how much oil Mongolia might have, and for now estimates are provided in rather large ranges – as large as between 4bn and 6bn barrels of recoverable resource.
HISTORY: Initial exploration in 1921 found shale, and in 1931 Soviet geologists confirmed the presence of oil underground. The Zuun Bayan oil field was discovered in 1940. Large-scale deposits were never found, however, and by the 1970s oil extraction had ground to a halt and would not be resumed until Mongolia transitioned to a market economy in the early 1990s. Then, the government invited major international explorers to assess the territory, and the presumption based on a BP report is that the eastern part of the country is situated atop a cretaceous basin that extends into China and is in production there. Deposits in the basin are small, with high content of water and little associated gas. Complicating costs come from the climate – for example, during the winter months pipes can freeze and wellheads may seize, requiring anti-coagulants.
Interest in the sector remains, however, and PetroMatad – the upstream division of Petrovis – is working three blocks, of which at least one is expected to produce oil later in the decade, albeit on a small scale.
Foreign investment beyond the Chinese services companies and crude purchasers came in a reverse takeover in July 2012, when Strzelecki Metals, a listed company on the Australian Stock Exchange, purchased the assets of Wolf Petroleum, which has two exploration blocks, in an all-stock deal in which each Wolf share was valued at 25 Strzelecki shares. The company is now the largest petroleum exploration acreage holder in the nation with over 74,400 square km. Drilling is set to begin in 2013.
On the Mongolian parliament’s long-term agenda is a review of upstream terms within the Petroleum Law. Indigenous companies interested in exploration have advocated for a greater share of the take in PSCs, and as of late 2012 it appeared that they may get their wish.
“The previous government proposed reforms and we are still also working on this proposal,’’ G. Ulziiburen, vice-chairman and acting chairman of the Petroleum Authority, told OBG. “Reforms will be oriented to push more exploration, but we will still be working within the current PSC structure.’’ OUTLOOK: Economic growth and the recent fuel-supply crunch underscored the need for major reforms, new sources and more infrastructures in the energy sector. Despite government talk of crowding out private interests, such as the possibility of funnelling all fuel imports through a state agency, the private sector is anticipating further investment opportunities. The state may be the major player in the energy sector, in which the state is the major player, but it is looking for private sector help, according to D. Gankhuyag, a business-development manager for Newcom Group, one of Mongolia’s largest conglomerates.
The government appears intent on making electricity generation a field open to private investment. Should it manage a successful deal to develop CHP5, it will gain credibility as a partner to private interests, which may encourage longer-term economic advancement.
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