Much of the attention in the mining sector in late 2012 had been on Oyu Tolgoi, where production of copper and gold was imminent but the focus was instead on the controversy over how the government and its partners would split the revenue. Meanwhile, developments at Tavan Tolgoi (TT), the other flagship mining project in Mongolia, were ongoing at a slower pace.

TT is important for several reasons. In addition to being a huge coal deposit with the potential to have a profound impact on the economy, the railroad-building programme expected to go along with it to get the coal to market will also remove obstacles for other mines and industries across the country. As of late 2012, the authorities were promising an end to TT negotiations with the consortium formed to develop a part of it by the end of the year. TT is a site with six major coal deposits in the south-central part of the country. Erdenes Tavan Tolgoi (ETT), an arm of Erdenes MGL, the state-owned mining company, controls five of the six. Mongolian Mining Corporation, a privately owned miner, is currently extracting coal from the sixth, Ukhaa Khudag and another company, Tavan Tolgoi JSC, is mining a small enclave of East Tsanki territory thanks to a licence granted in the 1950s.

EAST & WEST: ETT is focused on two of the deposits: East Tsankhi, from which extraction began in 2011, and West Tsankhi, for which negotiations are ongoing. ETT can handle extraction from West Tsankhi itself – like most of TT that has been explored so far, extraction is a simple and inexpensive open-pit process. For East Tsankhi, ETT has enlisted Perth-based Macmahon Holdings in an alliance contract that runs for five years and can be extended to seven if performance targets are met. The contract allows for ETT to supply the workers, meaning there is a degree of knowledge transfer from McMahon to ETT’s workforce. ETT began extraction from East Tsankhi in 2011 and since then has pulled 2.2m tonnes of coal from its open pit. The goal for 2012 is a total of 3m tonnes, an amount that will increase to 20m tonnes by 2017.

Despite production and a $350m advance payment from Aluminium Corporation of China for coal in the process of being delivered, ETT is short on cash. As of October 2012 it lacked enough operating capital to fulfil that supply contract. That is due to the fact that $250m of the $350m raised so far has been transferred off ETT’s balance sheet and spent by the government, in a cash pay-out to citizens ahead of the 2012 parliamentary election. In early January 2013 ETT told Parliament that it needed $200m to fulfil its current obligation. For now, the coal being produced is being trucked to the agreed-upon delivery point, as there is no rail link. Energy Resources, which falls under the same corporate umbrella as Mongolian Mining Corporation, had agreed to build a rail connection that would serve the Ukhaa Khudag mine, but as of early 2013 the future of the project was uncertain as the government had decided to take over the project. While ER has agreed to cooperate, the future and timeline for the rail link was unclear. That leaves Mongolia with only one viable customer for the coal: China. If and when work on building more rail links commences, it will open up additional export options. Capital to develop West Tsankhi and export its coal, therefore, is an issue.

THE BIG PICTURE: That makes TT’s full potential impossible to consider without the context of Mongolia’s wider economic and foreign-policy goals. Choosing international partners to help develop West Tsankhi is a process that has considerable political, economic, geographic and other strategic factors. Specifically, the country has a “third neighbour” policy that aims to reduce its reliance on Russia and China, which sit on its borders. If an international consortium is indeed formed to develop West Tsankhi, its members will almost certainly come from those two countries and also the US, South Korea and Japan. Negotiations in late 2012 involved Russia, China, South Korea, Japan and Peabody Coal, a US-based private firm.

BUILDING RAIL LINKS: Further development of TT will be dictated by how rail links are to be built. The state wants access to a port from which it can export to Japan, South Korea and beyond. The options are ports in Russia and China. TT’s growth will be constrained until that rail link exists and until ETT can find more capital. Both problems are addressed in Mongolia’s wider strategy of forming an international consortium to develop West Tsankhi. A deal was announced in the summer of 2011 that involved the Mongolian and Russian governments; Shenhua Group, a Chinese state-owned energy and mining company, and Peabody. However, it was never a formal, legal agreement, and it collapsed weeks later, in part because of domestic government objections and because South Korean and Japanese partners complained about being left out.

The mostly government-to-government negotiations beyond that point were halted for most of the first half of 2012, in large part because Mongolia’s government put major decisions on pause ahead of the June 2012 parliamentary election. The negotiations of late 2012 are expected to yield a partnership that includes South Korean and Japanese interests, as a reflection of those countries’ economic relationships with Mongolia, their potential as buyers, and their third-neighbour roles.

INITIAL ROUTE: However, the possibilities for infrastructure building have also increased. The 2011 version of the deal envisioned a rail link that would send ETT’s coal on a more than 5000-km journey to Pacific Ocean ports either at Vladivostok or north at Vanino. Vanino’s port is closed for about three months a year due to ice, and Vladivostok’s lacks capacity. Furthermore, according to ETT, it is owned by Russian coal companies and the cost per tonne of shipped coal would be $25 for ETT – a price that would make its product uncompetitive. The Russian State Railway was, however, offering to ship ETT coal at half the normal rate.

OTHER OPTIONS: Mongolia hired McKinsey to study railway options, and the consultancy recommended adding links to China to attract more private sector interest. Another option has since emerged as an end point – a port at Dandong, China. Located on the Yellow Sea and near the border with North Korea, it is about 20% of the distance of the Russian ports, and therefore far cheaper for transportation costs. Enlisting Shenhua as a major partner could potentially provide ETT with a champion in China to help ensure port access, should political opposition to using Chinese rail capacity for Mongolian coal arise.

Mongolia’s government is already in talks with authorities at Dandong to build processing facilities, said O. Chuluunbat, the deputy minister of economic development. The country’s goal is to sell some of TT’s coal to Chinese interests and to ship the rest through ports. Opting for a rail route through China instead of Russia may not moot the point of Russian participation, or its investment into Mongolia’s railroad system. Building a second line along the one existing north-south line in Mongolia, which is part of the Trans-Siberian Railway, is another possibility. Double-tracking this line would provide capacity to open up a new export route for Russian resources producers to the Chinese market .

FINANCING: With a proven method for getting its coal to market, ETT envisions that an international initial public offering (IPO) would be a success, solving the firm’s capital problem. ETT has long planned an ambitious equity strategy in which it is listed on exchanges in Ulaanbaatar, Hong Kong and London. The government has already awarded 20% of the company’s shares to citizens. When market conditions are right, a further 29% will be sold in overseas IPOs, leaving the mining sector holding company, Erdenes MGL, with a controlling stake of 51% of ETT. That is not likely until late in 2013.