On October 6 Mongolia’s government signed an agreement with Canada’s Ivanhoe Mines Ltd and London-based Rio Tinto mining companies to develop what will be the world’s largest copper mine. The agreement follows six years of torturous negotiations between Ulaanbaatar and the foreign consortiums, but the imminent establishment of the US$ 4 billion Oyuu Tolgoi ("Turquoise Hill") mining site is expected to yield a billion pounds of copper and 330,000 ounces of gold every year for at least the next four decades, with peak output of more than 725,000 tons of copper annually projected to occur within six years after start-up.

BACKGROUND: While Mongolia’s economy was traditionally based on herding and agriculture, the country also has some of Asia’s richest deposits of minerals and neighboring China’s rising demand for minerals has underpinned its current mining boom. Mongolia’s vast minerals reserves include copper, coal, gold, molybdenum, fluorspar, uranium, tin, and tungsten deposits, but Ulaanbaatar has lacked the fiscal resources and technological expertise to develop them.

Further complicating the picture, Ulsyn Ikh Khural (State Great Hural, or Parliament) members were concerned about foreign deals being overly exploitative. Accordingly, amendments to Mongolia's 1997 Mineral Law became a political football as various Ulsyn Ikh Khural members attempted to prove their nationalist commitment by proposing differing permissible levels of foreign investment. In a nod to nationalist sentiment, in May 2006 the Mineral Law was amended to include a windfall tax, which raised tariffs to 68 percent on gold when its world market price exceeded US$500 an ounce, and copper when it surpassed US$2,600 per ton. Ivanhoe Mines and Rio Tinto baulked at proceeding with Oyuu Tolgoi under what they regarded as overly onerous terms, especially as their estimates, based on an initial 45-year mine life projected Oyuu Tolgoi project capital costs at US$7.3 billion over the life of the project, make it the largest single development project and largest foreign investment undertaking in the history of Mongolia.

The country’s mineralogical resources even became an element during last year’s June electoral campaign for 76 seats in the Ulsyn Ikh Khural, with the Ardchilsan Nam (Democratic Party, or DP) promising each Mongolian a one-million togrog (US$ 884) “share of treasure” of the country’s forthcoming mineralogical revenues. The ruling Mongol Ardyn Khuv'sgalt Nam (Mongolian People's Revolutionary Party, MPRP) subsequently upped the ante, promising that each Mongolian would receive from the “country's profit” a 1.5 million togrogs (US$ 1,296) grant.

The new coalition government, headed by MPRP Chairman and Prime Minister Sanjaagiin Bayar, was determined to finalize a Mining Law that would allow Oyuu Tolgoi to proceed.

The Ulsyn Ikh Khural voted on July 16 to authorize the government to conclude a long-term, definitive Oyuu Tolgoi Investment Agreement with Ivanhoe Mines and Rio Tinto. In response, Bayar’s government requested convening a special session of the Ulsyn Ikh Khural to debate proposed government changes to four laws inhibiting a definitive Oyuu Tolgoi contract, particularly annulment of the 3-year old 68 percent windfall profit tax, to take effect from January 1, 2011. The Ulsyn Ikh Khural approved the changes on August 25, clearing the way towards concluding the Oyuu Tolgoi Investment Agreement. Of the other changes, the Mongolian Government downsized its equity interest in the project to 34 percent.

IMPLICATIONS: Geologists estimate that that the Oyuu Tolgoi mine, which is expected to begin production in 2014, contains about 36 million tons of copper and 45.2 million ounces of gold. Oyuu Tolgoi’s impact on the Mongolian economy will be massive, more than any other single project of the country’s Communist or post-Communist history, as it is estimated that the mine will eventually generate US$30-50 billion in revenues. Rio Tinto CEO Tom Albanese said, “This is an incredibly important milestone in bringing on-stream one of the finest undeveloped copper-gold projects in the world. The Investment Agreement is also a landmark for the future development of Mongolia's resources industry.”

According to the Center for Spatial Economics' report, entitled "The Economic and Fiscal Impacts of the Oyuu Tolgoi Project on Mongolia," the average annual percentage increase in the country’s real GDP over the life of the project could reach almost 35 percent, with unforeseen consequences for the Mongolian economy’s ability to absorb such a massive influx of cash.

It also remains to be seen whether the Oyuu Tolgoi agreement is a one-off, or will be used as a template for other foreign mining project investments. Aspects of the agreement continue to roil the Ulsyn Ikh Khural, as some parliamentarians are pressing for the government to come up with a different approach to compensate for the loss of revenues currently being generated by the windfall profits tax, which will now expire in 2011. Minister of Minerals and Energy Dashdorj Zorigt said the government intends to study the possibility of gradually increasing the royalty tax if necessary and will submit the proposal to the Ulsyn Ikh Khural. Other companies as well as neighboring Russia and China will be keenly observing implementation of the Oyuu Tolgoi Investment Agreement and doubtless will be pressing Ulaanbaatar for similar terms if they feel their own agreements fall short.

CONCLUSIONS: The Oyuu Tolgoi Investment Agreement represents a watershed in Mongolia’s post-Communist economic development. The country’s substantive economic problems diminished the government’s latitude to negotiate more favorable terms, as in the end it was forced to accept a minority share in the project. Nevertheless, 34 percent of a multi-billion dollar project will have a significant impact on a nation of 3 million.

Two issues remain unclear. The first, already mentioned, will be foreign business and governmental pressure over the terms of the Oyuu Tolgoi Investment Agreement. The second consideration is how the revenue generated by Oyuu Tolgoi will be used. Mongolians have a dim view of corruption in their country; according to Transparency international’s Global Corruption Barometer 2009, 47 percent of those surveyed rated their government’s fight against corruption as “ineffective.” In a country where the CIA estimates that more that 36 percent of the population lives below the poverty line with an annual per capita income of US$2,900, many destitute Mongols are going to be awaiting their “share of treasure” of the “country's profit.” If however, a significant portion of the Oyuu Tolgoi revenue somehow winds up in Swiss offshore accounts, then Prime Minister Bayar’s government could face civic unrest that made the July 2007 demonstrations in Ulaanbaatar look placid.