Resetting the course for Oyu Tolgoi
The multi-billion dollar Oyu Tolgoi project is yet again a subject of dispute. Through negotiations with Rio Tinto, the project's majority stakeholder through Turquoise Hill Resources, the government hopes to secure more benefits from the largest investment project in the country. As it stands right now, both sides seem to concur that the agreements forming the backbone of the project need to be “improved”.
Deputy Chief of the Cabinet Secretariat B.Solongoo, who has been serving as the spokeswoman of the government taskforce charged with implementing Parliamentary Resolution No. 92 to ensure benefits from the project to Mongolia, has underscored that Mongolia wants to get the Oyu Tolgoi deal right this time around.
The taskforce stressed that the dispute has not escalated to the point that the government wants the project stopped, as some have surmised.
“I don’t think the issue will reach a point where the Oyu Tolgoi project will be stopped,” B.Solongoo assured.
B.Solongoo said talks with Rio Tinto about outstanding issues at the project are just beginning. After communicating with Rio Tinto since April 2020, the taskforce held its first face-toface meeting with the Rio Tinto delegation led by Copper Executive Director B.Bold on April 12.
“The negotiation has just started. We view that it will be very broad. Besides rescinding the Underground Mine Development and Financing Plan (Dubai agreement), we must relook at the investment (2009 Oyu Tolgoi Investment Agreement) and shareholders’ agreements (2011 Amended and Restated Shareholders’ Agreement).”
In March, the Secretariat of the National Security Council recommended the government to replace the 2015 Oyu Tolgoi Underground Mine Development and Financing Plan, known as “Dubai agreement”, with a completely new deal. It said the agreement should have gone through before Parliament before the prime minister of the time, Ch.Saikhanbileg, signed it.
The National Security Council’s Secretariat made the following recommendations:
1. Amend the provisions of the shareholder agreement to ensure it is beneficial to Mongolia.
2. Amend the investment agreement based on amendments to the shareholder agreement.
3. Cancel the entire Dubai agreement, and include the relevant regulations in the investment agreement in a mutually agreed form.
4. Renew and approve Oyu Tolgoi LLC’s charter in accordance with the amendments to the abovementioned agreements.
B.Solongoo said revoking the Dubai agreement alone will not resolve the issues at hand, and that negotiations will likely prolonged.
The Dubai deal has been criticized as giving disproportional advantage to the foreign investors of the project in the past. But Rio Tinto points out that it was signed at the request of the government in 2015, during a Dubai road show to promote Mongolia internationally as an attractive investment destination.
THE TASKFORCE
Mongolia has lacked experienced negotiating with foreign investors before, as Oyu Tolgoi was the first major mining project in Mongolia. The Cabinet Secretariat deputy chief said the government will hire international professional consultants to ensure that the taskforce has the brains to deliver a good outcome from the talks with Rio Tinto.
“We will get legal, financial and technical consulting services from professionals,” she said. “Mongolian civil servants have become more knowledgeable about international agreements over the past decade. The government is ready to provide the necessary funds to hire the world’s largest consulting companies.”
The public is still skeptical of the government taskforce’s capability and ethical integrity when it comes to deals involving a lot of money. Some politicians who used Oyu Tolgoi as their platform in the past have made their way into the taskforce.
The taskforce has nine lawmakers, and is headed by Justice Minister Kh.Nyambaatar. A parliamentary temporary committee led by lawmaker Ts.Davaasuren was set up to monitor the implementation of Resolution No. 92 by the taskforce.
With so many political agendas within the taskforce, and the outsourcing of the important tasks at hand – review of financial, legal and technical reports, documents and performance – confidence in a good outcome for Mongolia from the talks are not assured.
COST BLOWOUT
Rio Tinto in December 2020 confirmed a 1.5 billion USD cost overrun at the Oyu Tolgoi underground copper mine, taking the total cost of the underground project to 6.75 billion USD. Sustainable production from the underground operations will be delayed by 22 months compared to the initial plan of January 2021.
B.Solongoo said the government sought an analysis of the project’s cost blowout and delay at the underground development at Oyu Tolgoi in November 2020 through an independent expert. The initial report is expected to be out by end-June.
“Rio Tinto explained the delays and increased costs were due to geotechnical conditions or rock formations. However, many conflicting reports were made last year. In particular, people who worked on the Oyu Tolgoi project claimed it was not due to geological conditions, but because of Rio Tinto’s project management and procurement errors. Turquoise Hill’s minor shareholders sued the company in New York,” the taskforce representative said, before adding, “There is a possibility that Rio Tinto concealed the reason for the cost blowout. If this is true, the company may have misled not only its investors, but also the Mongolian government.”
Mounting costs have had negative impact on Oyu Tolgoi’s profitability. B.Solongoo says the project’s total return ratio of 53 percent to Mongolia and 47 percent to the investors has been "lost." She said Mongolia must get 53 percent of the total yield, according to the deal made in 2009.
“We are critical of the fact that management fees are calculated as a direct percentage of costs. Management fees cover 3 percent of the total investment cost of the Oyu Tolgoi project and 6 percent of operating and recurrent investment costs.”
The government has demanded that management fees be linked to performance, rather than calculated as a percentage of costs.
“The project’s investment has overrun twice and the production has delayed by 22 months. Since they’re not working effectively, their management fees should be deducted. The goal is to operate efficiently and extract the ore body at the lowest cost,” asserted B.Solongoo.
Despite Rio Tinto profiting from rising costs, through management fees, the company maintains that it doesn’t gain from rising costs.
The company’s website even has a section where it debunks “myths” about Oyu Tolgoi, which said, “Increases in project costs impacts all shareholders. The more the project costs, the more time it takes for all shareholders to see a return on their investment by repaying the capital outlay and deriving a dividend.”
Multiple cost blowouts have had severe effect on the relations between the government and Oyu Tolgoi’s foreign investors. It causes reduced returns for both sides. The extent of changes the government will demand in the project's agreements will depend on the independent analysis of the cost blowout, which is expected in late-June.
The independent group assigned to review cost overruns and schedule delays at the project, which was formed by Oyu Tolgoi shareholders Erdenes Oyu Tolgoi and Turquoise Hill Resources, reported on April 28 that Rio Tinto refuses to hand over several key documents relating to technical expert reports and project management documents. Erdenes Oyu Tolgoi said Rio Tinto is hindering the review and breaching its obligations as a project manager to provide data to Oyu Tolgoi’s shareholders when requested.
The independent review will determine the path forward for the talks, and attempts to obstruct it, real or perceived, will only serve to aggravate the conflict.
TAX ISSUES
Oyu Tolgoi was slapped with tax acts twice to date. The company received a tax act for approximately 228 million USD from the Mongolian Tax Authority for taxes due from 2016 to 2018. The previous tax act was for 155 million USD, for the period between 2013 and 2015.
On February 20, 2020, Turquoise Hill announced that Oyu Tolgoi LLC initiated formal international arbitration proceeding in accordance with the dispute resolution provisions in Oyu Tolgoi agreements with the government. Turquoise Hill said it believes Oyu Tolgoi LLC has paid all taxes and charges required.
Despite the arbitration filing, Oyu Tolgoi seems to have yielded to the government with regard to the latest tax act. Before Mongolia entered lockdown on April 10, the government issued 300,000 MNT one-time grant to each citizen of Mongolia to provide assistance during the COVID-19 pandemic. The government said the grant was funded through the money collected from the Oyu Tolgoi tax act.
Rio Tinto claims that Oyu Tolgoi has paid the government of Mongolia more than 2.7 billion USD (7.5 trillion MNT) in taxes, fees, and other payments since 2010.
B.Solongoo counters that Rio Tinto includes taxes and fees paid by its subcontractors in its reports, and that Oyu Tolgoi will pay corporate income tax to the Mongolian government only four times during its over 40 years of operation in the country.
“Value-added tax isn’t paid by Oyu Tolgoi. It is paid by the companies that supply goods and services to Oyu Tolgoi. Rio Tinto reports annually that they pay VAT. The Ministry of Finance does not agree with the amount of tax it claims to have paid to Mongolia in its report. Rio Tinto tends to increase the taxes paid in its report.”
“This company is operating at a loss. Therefore, no corporate income tax is paid. The current conditions of the investment agreement allows Oyu
Tolgoi to avoid paying corporate income tax for 11 years even if it gains profit,” she said.
According the Cabinet Secretariat deputy chief, in the last three to four years, annual sales have exceeded 1 billion USD, from which, the company pays 70 million to 80 million USD to Mongolia in royalty.
On the other hand, Rio Tinto receives around 80 million USD a year in project financing guarantees and around more 180 million USD in management fees. Rio Tinto and its affiliates receive approximately 260 million USD annually from the project. This means Rio Tinto gains more from Oyu Tolgoi than Mongolia gets through royalties.
“It is unfortunate that Mongolia would not be able to collect profit tax for 11 years even when the underground mine has been put into operation and the company has started to operate profitably. We will work to ensure that taxes are paid in real terms,” says B.Solongoo.
There’s also speculation that Rio Tinto avoids paying taxes to Mongolia by procuring goods and services through offshore companies.
“A closer look at their report reveals that Rio Tinto’s public policy contradicts Oyu Tolgoi’s tax policy. Through a company called Moveli, founded in Luxembourg, (Rio Tinto) provides shareholder loans to Turquoise Hill, which is used to lend to Oyu Tolgoi. The purpose of issuing shareholder loans through companies founded in Luxembourg and the Netherlands is to reduce taxes. We raised this issue when we filed a tax dispute,” B.Solongoo said. “Strategic management services are not taxed on the grounds that they are provided outside of Mongolia. Rio Tinto received at least 500 million USD in strategic management services from Oyu Tolgoi without paying any taxes. This is a service provided in connection with a project implemented in the territory of Mongolia. Therefore, we require an appropriate amount of tax to be paid on payment sourced from Mongolia.”
The Oyu Tolgoi tax issues have largely stemmed from how the tax provisions of an investment agreement is interpreted. The government believes there are disputes over the wording of the English and Mongolian versions of the investment agreement.
“Amendments to the agreement will not only address tax issues. We need to look back at the provisions that are insufficiently implemented and make them beneficial to Mongolia,” said B.Solongoo.
NO DIVIDEND PAYOUT
Rising debt and costs at Oyu Tolgoi have pushed back Mongolia’s share of profit from the mine indefinitely, as Mongolia borrowed its share of investment in the project from other investors.
“As investment costs rise, the date the Mongolian government will reap dividends will be pushed back further. For instance, the investment cost of the current underground development at Oyu Tolgoi has increased by 1.4 billion USD from the initial estimate. The initial estimate was 5.3 billion USD. This means it’s around 30 percent higher than the initial estimate.”
“The operation of Oyu Tolgoi LLC is largely financed through loans. For project finance, 4.4 billion USD was borrowed from international development banks. On top of this, loans from Turquoise Hill Resources shareholders amount to around 7 billion USD. In total, the company has around 11 billion USD worth of outstanding loans. Loan interest payment is increasing, investment costs are rising.”
Despite not seeing benefits from its share in the mine in the foreseeable future, the government believes converting its share in the project now, when it’s value is low, into a form of taxation wouldn’t be the optimal solution. The shares also provide the government a gateway into the company for better oversight and involvement in the project.
For its part, Rio Tinto says the project does not have any risks as the government has made no equity contribution and the loans to the government shareholders are non-recourse, meaning the government has no obligation to make loan payments if project cash flows were to be insufficient to repay the loan amounts in full. The company said the non-government shareholders are carrying all the financial risk through the outlay of loans and contributing equity to the project to make the investment possible in the first place.
CONCLUSION
Mongolia and Rio Tinto are on the same boat with regard to Oyu Tolgoi. They seem to be rowing in different directions, threatening each other with tax acts and arbitration to have their way. But both want the same thing – for the project to profit as much as possible.
The nature of the conflict is not whether the project is still profitable or beneficial given the cost blowouts and mounting debt, but who gets how much. It looks like the independent review restuls due in June will set the tone for the negotiations.
When you look at the bigger picture, this situation is beneficial to Mongolia, now that negotiations have begun and Rio Tinto accepts need to make changes to the project agreemetns. Around 80 percent of the Oyu Tolgoi wealth is still yet to be explored, lying underground, making the project still hugely profitable in the long run. The cost blowout, delays and tax issues all give the government a legitimate starting point to improve on the contracts with foreign investors while most of the mine wealth is still within Mongolian territory. Plus, copper prices are expected to soar with rising demand for electric cars and such around the world in the coming years.
In the past, the odds were always stacked against Mongolia. It was the inexperienced player, it was in a difficult financial position, trying to start renegotiations soon after signing a deal erased the country’s credibility, and it desperately needed a large foreign investor to put it on the map. But now the positions are reversed. Rio Tinto is on the defensive, trying to justify its failures in managing the mine.
When in full swing, Oyu Tolgoi is set to become the fourth largest copper mine in the world. Mongolia still has the opportunity to make the most of this huge opportunity. Even a slight adjustment in Oyu Tolgoi's contacts can have enormous future benefits to Mongolia and leave plenty of room for foreign investors to profit fairly.