Taking action: Better connections are in the works

As roads are being built and related infrastructure is quickly being put into place, Mongolia’s connectivity and logistics are greatly improving. Real investment in transportation has been made in recent years, especially in 2013, and more is expected. In the coming years internal and international travel and cargo delivery are likely to become faster, cheaper, easier and more efficient. Nevertheless, progress has been mixed in terms of air, rail and urban transport. A new airport is being built, but airlines are facing commercial headwinds. Advances in rail are in need of funding and face geopolitical questions that remain so far unanswered. Traffic in Ulaanbaatar is also getting worse despite the best of efforts.

Road Networks

Road building is one area where significant work has been successfully undertaken and completed, and on many fronts simultaneously. In terms of urban roads, the government committed $200m from the Chinggis Bond to the reconstruction of 33 intersections in Ulaanbaatar. By October 2013 a dozen of those intersection projects had been finished.

Meanwhile, a 17.6-km road and 120-metre bridge are being built to connect the Yarmag Bridge via the north side of Bogd Khan mountain to Bayanzurkh Tovchoo. The hope is that the MNT22.5bn ($13.5m) project will help alleviate congestion in downtown as it will allow people travelling between the eastern and western provinces to avoid the city centre. The plan has been to build 45 new roads in Ulaanbaatar, totalling 75.5 km, in 2013 and into 2014.

But the big story in roads has been the efforts to link rural areas to urban Mongolia. In 2013 the government said it would connect six provinces (Bayankhongor, Dornod, Dornogovi, Dundgovi, Umnugovi and Khuvsgul) to the capital by the end of the year by building a total of 1340 km of improved roads. This project is part of the government’s 2012-16 Action Plan, which sets the goal of connecting all 21 provinces to Ulaanbaatar. Zavkhan, Govi-Altai and Sukhbaatar are scheduled for 2014, and Uvs, Khovd and Bayan-Olgii for 2015. Good progress had been made by the end of the 2013. In late August Bayankhongor was linked to Ulaanbaatar, while Mandalgovi and Dundgovi were connected to Ulaanbaatar by November 2013.

Better Connections

The Action Plan, which was developed by the new government in 2012, calls for a long list of relevant improvements: the renovation of all tarmac roads in the capital, the construction of flyovers and overpasses, the construction of a 990-km expressway from Altanbulag at the Russian border to Ulaanbaatar and on to Zamyn-Uud at the border with China, and the establishment of a 749-km road in the western part of the country from the Yarant border gate with China to Ulaanbaishint on the border with Russia. By the end of 2013 good progress had been made on linking the northern border with the southern border. In September 2013 the Choir to Sainshand road was completed. The 176.4-km section was funded by the US government via the Millennium Challenge Account Mongolia. A 116.25-km section running from Sainshand to Zamyn-Uud and funded by the Asian Development Bank (ADB) was completed in November 2013.

G. Tengis, the CEO of road construction firm Monroad, said, “The most significant challenge that the sector is facing is the availability of skilled labour. There is new technology coming into the companies, like GPS control system equipment, for instance, which can save time and cost, and also eliminates the need to look for experienced operators.”

Before this flurry of road building, the country was not well connected. A paved road went from the capital to the Russian border, and from that road another extended to Bulgan (via Erdenet). A track went west from Ulaanbaatar to Tsetserleg and Arvaikheer and another went east as far as Ondorkhaan. A paved road also extended south as far as Choir. Smaller, isolated, sections were also open in other parts of the country. A paved road extended from Khandgait on the Russian border to Ulaangom and another in the south ran from Yarant to Bulgan, Khovd.

The recent activity is a top priority for the government largely because better communications are seen as a way of keeping prices down, as transportation costs can add to inflationary pressures.

“The reason why the government wants to improve connectivity is to lower costs,” said an official at the Development Bank of Mongolia.

On Track

Considerable progress has been made in the rail sector, at least in terms of planning and preparation. In 2008 the Mongolian Railway State Owned Shareholding Company (MTZ) was formed, and two years later parliament ratified the State Policy on Railway Transportation, which calls for the building of a national rail network. In 2011 an advisory team was formed to undertake a feasibility study on the railway. The group included Liberty Partners, a local private equity firm; Pillsbury Winthrop Shaw Pittman, the international law firm; BNP Paribas; and McKinsey & Company. In October 2012 the Mongolian parliament passed Resolution 121 of 2012 authorising the construction of phase I and phase II of the country’s new railway project. The government also passed Resolution 28 of 2012 approving a build-operate-transfer arrangement for the development of phase I and phase II.

These two phases, of the three planned, will run a total of around 1800 km. Phase I extends from Tavan Tolgoi to Sainshand and then km from Sainshand to Khuut. There it splits, a northern line going to Choibalsan. Phase II includes four sections totalling 800 km, but the key section is the line from the mines at Ukhaa Khudag to the border at Gashuun Sukhait, as well as lines between Khuut and Bichig and Khuut and Numrug. Phase III will run west with multiple spur lines to China and Russia. The project has a technical adviser, Nippon Koei, and the monitoring consultant is Deutsche Bahn International. In early 2013 Samsung C&T was chosen to build the line to the Chinese border.

The main interest of the government is to get the coal from Tavan Tolgoi and other mines in the south Gobi to the Chinese border, the closest international market. That being the case, it would have made the most sense to have sought a partner for and raise funding for phase II first. But according to sources close to the transaction, the advisers suggested selling both phase I and phase II as a combined package to the international investment community, although phase I will take priority in terms of actual construction.

The decision to pursue two lines also has political and economic dimensions. While the route south directly to the border is the shorter of the two, the route east comes with some advantages. In the case of the former, coal is sold into inner Mongolia. This is China’s coal-producing region, so it is a buyer’s market and prices reflect that fact. Phase I, the eastern line, takes coal to a part of China that is industrial, cold and in need of fuel – more a seller’s market. In addition, the eastern line connects to an existing line that runs from Choibalsan to Ereentsav on the Russian border. Via this route Mongolia could sell to alternative markets, Russia and countries accessible by Russian ports ( Vladivostok or Vostochny), if sales become difficult in China or if prices become unattractive there. “Two-thirds of the value is disappearing to Chinese infrastructure companies and traders,” said A. Zorig, head of the project department at the MTZ. “It’s good to have options.

Gauging Progress

MTZ was set up because the country wants a Mongolian-controlled railway company that will give it access to major markets. But financing will take considerable international support. The plan is to have a strategic investor take 49% of a special-purpose vehicle (SPV) that will remain under the purview of foreign equity investors and MTZ, which is 100% state owned. MTZ will in turn finance 40% of the SPV, which itself will be approximately 60% backed by debt investors. Control would remain in the hands of the government, but the majority of the estimated $5bn in financing would come from overseas.

As of early 2014 it was not clear who would be chosen as the investor, though executives involved in the project said it might be a company that would have an interest in the project beyond simply the dividends it would generate (such as a port or a contractor).

Mongolia Mining Corporation will potentially have a stake in the new company as well. The government agreed to pay it a total of MNT84bn ($50.4m) in compensation for the work the company had carried out on a 2012 concession for a rail running from Tavan Tolgoi to the Chinese border. That concession was cancelled as the government decided to put all its new rail assets under one national company, and it has been suggested that compensation will be paid in the form of equity in the project. In 2013 a request for a proposal was issued, and 20 companies applied to be a strategic investor. From those, just a handful remained in the running by early 2014.

Russian Involvment

Managing and investing in the existing rail system has been a challenge, as it is 50% owned by Russian Railways, and the relationship is complicated. The shareholding in the Ulaanbaatar Railway (UBTZ), which runs from the Russian border to the Chinese border, dates back to a 1949 Soviet-Mongolian pact. According to Sergey Radchenko, an academic specialising in Sino-Soviet relations, the line was largely ignored by Russia until 2007, when the US government, through the Millennium Challenge Account, offered $185m to improve the existing line. Russia responded by denying access to the railway’s accounts to US auditors and then offering to finance the upgrade of the UBTZ. The back and forth to a large extent inspired the Mongolians to create MTZ.

In contrast to the UBTZ and other recent transactions, MTZ is being pursued in a highly transparent fashion. International best practices are being used so that quality funding can be procured and so that the rail will be free of renegotiation risk. The process will be open so no one can later claim that the deal was in any way unfair or less than optimal for the country.

The main issue is one of gauge. Russia and Mongolia currently employ a wide gauge: 1520 mm. China’s tracks are 1435 mm. This is where geopolitics and economics collide. It makes the most sense to adhere to the Chinese standard, which is also the international standard, as most of the country’s exports head south. Using the Russian gauge would require changing bogies or transferring loads at the border, a time-consuming process that adds to the cost of shipment.

The Importance Of Logistics

Some believe that all the talk of gauge is misplaced. A. Munkhbold, president of the Mongolian Logistics Association, said that a special Canadian gauge used for massive coal loads should be adopted, as the line simply has to be built to achieve the lowest costs and highest efficiency. Munkhbold added that the government now understands the importance of getting logistics right, and is starting to understand what exactly is involved. It is not just transportation, he noted. Logistics is a matter of coordinating and getting all the various pieces of the network functioning together. According to Munkhbold, logistics in the country is in bad shape. “When we say logistics, people are only discussing transportation, how to get to market,” Munkhbold continued. “We need good transportation, storage and information solutions, and good financing.”

Efforts are being made to improve logistics. Tuushin, a freight forwarding company, is working with the local government on developing an integrated logistics centre in Ulaanbaatar. The city is providing some 53 ha of land around 34 km south-west of the city centre, and the site will be jointly developed by various companies. It will be set up as a public-private partnership and involve considerable project financing from outside sources, such as multilaterals, development banks and private investors. According to Tuushin, the current logistics centres occupying 200 ha in the city are inadequate because they are in the wrong places and contribute to congestion, lack technology and are not set up for a full range of Customs inspection procedures.

The ADB, meanwhile, is supporting a logistics centre on the border with China at Zamyn-Uud. The goal is to develop a facility that can handle rail-to-rail, road-to-rail, and road-to-road transfers of bulk and container cargo, and do so using high technology and in a way that achieves a high degree of interoperability and harmonisation. The ADB project will finance the strengthening of institutional capacity at the centre. The budget for the programme is set at $71.6m, with the bank providing $45m ($40m as a loan and $5m as a grant). Consulting services had been procured by late 2013, and it is expected the facility will be completed in 2015. The ADB sees this as important for the country because the border is one of the major choke points that increases costs and delays imports and exports.

Up In The Air

The air transport segment has been growing rapidly. According to a recent report by the International Civil Aviation Organisation (ICAO), passenger traffic in 2012 reached 1.1m, up from 892,392 in 2011 and 670,783 in 2010. Of that 758,841 were international travellers and 340,024 domestic. It noted that the country had 22 airports, 19 of which are owned by the Civil Aviation Authority of Mongolia. A total of 16 of those airports are considered functional. However, the ICAO notes that domestic traffic in 2012 was lower than it was in 1993 (though international traffic was up sevenfold). Importantly, the country has started building a new international airport (see analysis).

The airlines themselves have enjoyed a certain degree of success. In 2013 MIAT Mongolian Airlines received a three-star rating from Skytrax, up from two stars. The airline rating company notes strengths including staff service, and said it was mainly MIAT’s outdated product and aged home base that held it back from a higher rating. The national carrier also received its first direct delivery of a 767 from Boeing in May 2013. MIAT has orders for two 737s directly from Boeing. The orders were placed in 2011 when Ts. Elbegdorj, president of Mongolia, visited Washington. US Export-Import Bank financing for the 767 order was finalised in December 2013. In addition to the recently purchased 767, the carrier has two 737s and one additional 767, all leased.

MIAT flies to Hong Kong, Beijing, Seoul, Tokyo and Berlin, via Moscow. The carrier is considering new routes to Singapore, Bangkok, London and Frankfurt, and may also go to Istanbul (in codeshare with Turkish Airlines). MIAT withdrew from domestic service in 2008.

While MIAT runs at a loss, some of its routes are profitable, according to the company and the State Property Committee. MIAT notes in fact that it is profitable overall during the high season – May to October – and adds that some routes that are unprofitable have to be flown due to its responsibilities as the flag carrier. The Berlin service, for instance, must be kept to maintain the country’s links to Europe, but each flight loses $50,000 in the summer and $100,000 in winter. MIAT, however, is getting creative in improving its income statement despite being state-owned. For example, it signed a wet lease with Biman Bangladesh Airlines for two periods over the course of 2013.

New Routes

Hunnu Air inaugurated regular service from Ulaanbaatar to Bangkok in June 2013. It was the first scheduled flight between the two cities – MIAT has arranged charters previously. Hunnu increased the Bangkok service to two flights a week, from one a week, in July. The flight is popular with vacationers seeking sun or medical treatment. In May 2013 Hunnu signed a memorandum of understanding with China Eastern Airlines. The Chinese carrier will provide ground support, maintenance and catering for Hunnu’s Shanghai flights, as well as training. Hunnu will in turn provide ticketing capabilities in Mongolia. The two airlines are considering a codeshare agreement as well, and Hunnu is seeking to become a SkyTeam airline. Hunnu’s inaugural flights took place in early 2012, and the airline has five aircraft: 3 Fokker F50s and 2 Airbus 319s. It serves 11 domestic destinations and six international routes: Bangkok and Paris, as well as the Chinese cities of Hong Kong, Shanghai, Hailar and Manzhouli.

Other Carriers

A number of other airlines are also operating in the country. Eznis was formed by Newcom Group in 2006 and currently flies to six domestic destinations. It also runs charter flights for mining operations to Tavan Tolgoi and Oyu Tolgoi in the south Gobi. The carrier utilises four Saab 340Bs and two Bombardier Q400s. Aero Mongolia, the former domestic subsidiary of MIAT, was purchased by the Monnis Group in 2001 and started operations two years later. The airline runs a fleet of four Fokker F50s. It currently flies four domestic routes and two international routes: Irkutsk, Russia and Hohhot, China.

According to G. Galbadrakh, director of commerce for Aero Mongolia, the company is trying to build a balanced business, one not too reliant on any one source of revenue. Ideally, the mix would be 30% domestic local, 30% international tourists and the rest mining related. In the past, he concedes, the airline was too committed to mining, and suffered as a result. “We want to keep our portfolio diversified, so we are not too dependent on any one sector,” he said.

Other airlines in the country include Blue Sky Aviation, a church-affiliated carrier that flies humanitarian and medical missions throughout the country; Central Mongolian Airways; Sky Horse Aviation (a charter airline with one Czech L-410 UVP); Chinngis Airways (not yet launched, but has discussed a wet lease for long-haul flights to Europe); and Thomas Air, which flies three small aircraft for charter, humanitarian flights and search and rescue. But industry executives say the market is quite crowded and that consolidation could be on the way in the future.

Outlook

 Mongolia’s connections are likely to continue improving over the next few years as more roads are finished and after the new airport is operational.

According to B. Bayar, the CEO of Hunnu Air, “The possibility of turning Ulaanbataar into a regional transportation hub is very real given its strategic location, relatively close to large urban areas in northern Asia. To this end, the new airport will play a very significant role, although we need more investments to make the new airport fully operational, on all levels.”

The main sector challenges will be developing new train lines and dealing with traffic congestion in the capital. The new metro will help, but it will be a number of years before it has an impact on the congestion downtown. In the meantime, stopgap measures are needed to keep commodities and people moving efficiently.