Mongolia's mining sector awaits key rules for implementation of legal reform

A perfect storm of falling commodity prices and policy changes since May 2012 has taken its toll on mining investment, heightening fiscal pressure on the state to rebuild investor confidence. Having repealed the restrictive Strategic Entities Foreign Investment Law (SEFIL) with the new Investment Law of October 2013, which grants equal treatment to local and foreign investors, an investor-friendly State Policy on Mining was issued in mid-January 2014. The government hopes new policies and laws will jumpstart investment, though this will also depend on implementation, the resolution of disputes with investors and commodity prices.

New Approach

The change in government rhetoric following the culmination of the 18-month electoral cycle in the June 2013 presidential election was swift. By October parliament had enacted a new Investment Law that rescinded the most egregious elements of the vague yet restrictive SEFIL, swiftly passed in May 2012 to block attempts by Aluminium Corporation of China (Chalco) to buy out SouthGobi Resources. Rather than SEFIL’s requirement to secure parliamentary approval for majority acquisitions above 49% or over MNT100bn ($60m) in strategic sectors, including mining, the Investment Law grants the new Invest Mongolia Agency – which reports directly to the prime minister – full authority for approving acquisitions by foreign state-owned agencies (where a state holds over 50%) of over 33% of a Mongolian asset. The law also provides tax stabilisation certificates, which freeze all relevant taxes for between five and 22.5 years. Five of the six projects applying for this benefit as of September 2014 were mining related (see Trade & Investment chapter).

Fresh from hosting the National Council of Private Sector Support in December 2013, the presidency backed a 12-year State Policy on Mining to 2025 in January 2014. The policy frames the state’s role as one of support and encouragement for the private sector, with its role limited to regulation and supervision. The policy also calls for a more sustainable and transparent industry, paving the way for parliamentary approval of the Transparent Government Law in spring 2014 and the Extractive Industries Transparency Initiative Law in the autumn, as well as state support for value-added processing. In parallel to the State Policy, parliament cut the gold royalty and passed separate legislation on common-occurrence minerals, removing them from the Minerals Law, reducing their royalties to 2.5% and awarding acreage on a first-come-first-served basis.

Amended Minerals Law

The pace of reform accelerated in July 2014, when the non-binding terms of the State Policy were enshrined in the long-awaited amendment to the Minerals Law. Although an entirely new draft law had been proposed segmenting foreign and local investors in December 2012, it met stiff opposition from business. The July 2014 amended law introduces 13 significant provisions altering exploration terms and governance in the sector.

The creation of a National Geological Office of technical experts will establish an independent policy council to help prepare feasibility studies and exploration reports, while a new National Minerals Council under the Minerals Resources Authority of Mongolia (MRAM) will evaluate the studies and issue policy recommendations under the State Policy’s terms.

“One of the most encouraging reforms under the amended Minerals Law was the creation of a tripartite Minerals Council bringing together government, civil society and the private sector to make recommendations for legal changes,” N. Algaa, the Mongolian National Mining Association’s president, told OBG. “Although there is no guarantee, this could create far more stability in the legal framework.”

Building on the Mining Cadastre launched online in 2013 with World Bank support, the law calls for an integrated national database to pool geological studies and resource reports. While requiring right of first consideration for local service providers, the law relaxes foreign staffing caps to 10% of subcontractors’ labour. It also strengthens government oversight of environmental aspects of mining contracts in particular. For instance, miners must now have one full-time employee for environmental matters and must notify MRAM of any coal-bed methane discovery.

Government Take

The amended law does not significantly alter the structure of royalties and taxes, with standard royalties and special surtaxes. Royalties are set at 5% for all minerals except gold, which was set at 2.5%, and a new surtax replaced the windfall tax for 23 minerals in January 2011. This was set on a sliding scale of 0-5% depending on the price and level of processing, except for copper, which was set higher at 30%. State-owned Erdenet pays 5% basic and 13% excess royalties, while Oyu Tolgoi pays only the basic 5% as its investment agreement insulates it from new taxes.

Calculations of royalties for coal have compounded troubles: the General Department for Taxation (GDT) calculates the 5% export tax based on a reference price using a basket that includes the more costly Australian coal. A reference price of $73 per tonne in September 2014 yielded an effective 20% export tax on state-owned Erdenes Tavan Tolgoi’s (ETT) production, sold at around $34 per tonne to Chalco. In contrast, the 25% corporate income tax is calculated on contract value. While royalty calculations were changed to use contract price in April 2014, the GDT ruled in July that royalties would remain based on reference price with spreads on contract prices refunded quarterly.

Strategic Deposits

While the new law preserves the idea of strategic deposits, it introduces crucial flexibility in its application. The prior clause allowing state-owned Erdenes to take stakes of 34-50%, depending on the source of investment, in an initial list of 15 strategic projects (all uranium, at no cost under the 2009 Nuclear Law) created uncertainty over the valuation methods employed. “There are two different interpretations of how the government could exercise its 34% stake in strategic deposits, valued either as the amount invested or the market value,” N. Tselmuun, vice-president of Mongolyn Alt Corporation (MAK), told OBG. The measures of such deposits – potentially contributing more than 5% of GDP or with the potential to impact economic and social development and national security – were also left vague.

The July 2014 amendments build on past parliamentary decisions such as the April 2014 decision barring the state from exercising its 34% stake in MAK’s Tsagaan Suvarga strategic copper deposit for lack of funds. A little-noticed clause in the amended law grants the government discretionary powers of adding and subtracting from the list of strategic deposits. “The amendments allow the government to both add new deposits to the strategic list but also to remove deposits,” Graeme Hancock, Anglo American’s president and chief representative in Mongolia, told OBG. “This increases flexibility and enables the government to gently step back from the strategic deposit issue on a case-by-case basis as the economy grows.” The government is, therefore, likely to be more nuanced in its participation in large mines, not wishing to delay projects with fiscal constraints. Indeed, the National Security Council ( comprising the president, prime minister and parliamentary speaker), which has veto power on strategic deposits, is opposed to excessive state involvement.

At the Asgat silver deposit, held by Russia’s Mongolrostsvetmet, the government is taking a 50% stake given its funding of exploration works. Although Erdenes is taking a smaller 20% stake in Centerra Gold’s Gatsuurt, the mine’s strategic deposit status now means the 2009 Long Name Law banning exploration within 200m of rivers and forests does not apply. Mongolian coal miner Tsesten Mining and Energy has also won the inclusion of its Tsaidam mine near Ulaanbaatar on the list.

Jump-Starting Exploration

The government plans to generate over $1.5bn in new exploration in the short term by lifting the June 2010 moratorium on new exploration licences and expanding the areas under exploration from roughly 8% in 2014 to 20%, although exploration licences were cut from 400,000 ha to 150,000 ha. The law also extends the maximum tenure of such licences from nine years to 12 years, in three-year extensions, incorporating the previous three-year, post-exploration agreements into the licences. The new terms set an investment floor of $10 per ha for the last three-year extension, alongside a $5 per ha fee, and provide for late fees and licence-revoking after one month of non-payment, albeit with compensation. While miners had pushed for a competitive tendering of all licences, the amendments maintained a first-come-first-served basis for licences where no previous exploration has taken place and introduced bidding only for previously explored acreage.

Large miners were also disappointed. “A disappointing element of the new Minerals Law was the removal of an anti-speculation clause from the draft law that would have prevented the transfer of a licence within the first three years,” Hancock told OBG. “One of the original justifications for the moratorium on the granting of new exploration licences was to reduce speculation: with this issue unresolved, it would appear that little was achieved by the moratorium.” Nonetheless, the revised terms are generally seen as competitive.

Receiving new licence applications from early 2015, MRAM plans create a two-tiered system for areas under exploration based on geological research. “While roughly 70% of Mongolia is effectively off limits for miners and another 10% is currently being explored or mined, we expect to award licences for the remaining 20%,” N. Enkhbayar, head of the economy, finance and investment division at the Ministry of Mining’s department of strategic policy and planning, said. “For areas where general mapping has revealed potential reserves, about 7%, we will proceed to a competitive tender, while for the remaining 13% we will offer predetermined blocks on a first-come-first-served basis.”

Re-Tendering

New investment will partly depend on the government’s treatment of previous holders of the 106 licences that were revoked in 2013 in the former MRAM chairman’s criminal conviction for corruption in a case upheld at the Supreme Court. Although the amended Minerals Law did not specify the method of redress for the licensees, 24 of which had invested a combined $19m in 31 blocks, the parliament ordered the re-tendering in a separate July 2014 act. Under the new procedure, previous owners will either have their licences reissued or receive compensation from the new owners. By January 2015, 23 licences had been re-tendered, including two of Kincora Copper’s licences. Some redress was offered to previous licensees, who received investment credits equivalent to their exploration costs, ranging from MNT20m ($12,000) to MNT400m ($240,000), while a deposit of 30% of the initial tender price is required from new bidders.

Impact

The industry still awaits a dozen key implementing rules to specify the transition for existing licences, establish model mining licences and constitute key bodies like the Geological Office. Other provisions of the amended law, including the establishment of a mineral commodities exchange for domestic trading will take longer to bear fruit. While the new framework is far more conducive to private investment than previous drafts, investors in the sector will continue to seek to insulate themselves from political risk. “If the government continues to establish a monthly benchmark price for exported minerals, the concept of a mineral commodities exchange in Mongolia as provided in the new State Policy is a non-starter,” Algaa said.

Resolution of the dispute with Rio Tinto over the Oyu Tolgoi project will be a significant boost to confidence. Yet the episode – and the cancellation of four double taxation treaties in 2012 – also highlighted the importance of a legally binding investment agreement for any larger project and its associated infrastructure.

Under the new Investment Law, tax stabilisation certificates (TSC) offer a scaled-down means for investors in projects since 2009 to freeze relevant taxes. The Mongolian conglomerate MCS has taken a two-pronged approach thus far, submitting two of the six applications for TSCs – for two coking coal mines – to Invest Mongolia and one investment agreement for the Tavan Tolgoi power plant to the Ministry of Economic Development in 2014, though this ministry was subsumed under the Ministry of Finance in October of that year.