Mining the Gobi: The Battle for Mongolia's Resources

Aug. 10, 2013— -- The construction of a huge mine in the middle of the Gobi Desert was supposed to catapult Mongolia toward rapid economic growth. But an ongoing conflict over profits from the gold and copper mined there threatens to capsize the young democracy.

Mongolia is over four times the size of Germany, with nearly 3 million inhabitants and a GDP of $10 billion (€7.5 billion) in 2012.

British-Australian mining corporation Rio Tinto employs 71,000 people in more than 40 countries and is worth about $60 billion.

These two unequal partners -- a poor, potentially rich nation and the second largest mining corporation in the world -- have joined together to mine one of the globe's largest deposits of copper and gold. But will they be capable of distributing this wealth fairly?

The mine in question lies an hour's flight south of the Mongolian capital Ulan Bator, near the border with China. There is enough copper in the ground here to build the Statue of Liberty more than 800,000 times over. Once the planned mine goes into full operation, it could increase the country's GDP by a third. It could, at least in theory, bring prosperity to this country where many people still live in simple yurts and huts.

But in practice, the transaction between this global corporation and this country that is poor but rich in raw materials looks quite different. In fact, the project serves as a prime example of what is happening in a growing number of newly industrialized and developing countries.

Here we have a weak country that needs the help of a business that is economically far more advanced to tap its own natural resources. One side has raw materials everyone wants; the other has the necessary technical expertise, as well as a great deal of money and smart lawyers. How can the inexperienced country benefit from this relationship without being taken advantage of? And how can the government of this frail democracy explain to its people that in the coming boom years, a few people will get rich very quickly, while most stay poor?

Custodians of the Mine

The conflict surrounding the Oyu Tolgoi mine, which is named for the turquoise-colored copper ore found in the Gobi Desert, began about four years ago. In order to acquire a 34 percent share in the mine's construction, the Mongolian government had to take out a loan. This loan came from Rio Tinto, the company that operates the mine. When news of that deal emerged, people in Mongolia started asking who will ultimately get more out of the mine, Mongolia or Rio Tinto.

Geophysicist Samand Sanjdorj is the mine's vice president, making the 67-year-old the highest ranking Mongolian on site. His office is in an air-conditioned glass building that rises out of the Gobi Desert like a blue spaceship. Every few weeks, a company jet flies him and his colleagues back and forth between the capital and the mine. Asked whose side he is on -- his country's or his company's -- Sanjdorj takes a long time to answer. Finally, he says, "I'm Mongolian first, but this mine is my baby."

One of the men in the capital responsible for the copper mine is Chuluuntseren Otgochuluu, the 35-year-old head of the Mining Ministry's planning department. His office is on the fifth floor of an aging Soviet building with no elevator and creaking floorboards.

'The People Haven't Benefited'

It isn't far from Otgochuluu's downtown office to the bleak hills north of the city center, where 800,000 rural refugees have settled -- nearly a third of Mongolia's population. They live in gers, a Mongolian style of yurt, and have no running water, no sewage systems and only sporadic electricity. Even in winter temperatures of minus 30 degrees Celsius (minus 22 degrees Fahrenheit), they go outside to reach their outhouses. And they fuel their heating stoves with anything that burns, including carpeting, tires and plastic waste. The air in Ulan Bator in winter is even more polluted than in China.

"So far, the people haven't benefitted from the mine," Otgochuluu says. "Our deal with Rio Tinto hasn't been a fair one. Rio Tinto is doing great work in the desert here, but if they want to cheat us when it comes to money, then we can't be friends."

This is how things have gone all along. The government accuses Rio Tinto of breaking agreements and rejects the company's future plans for financing the mine.

How this dispute ends will have a decisive impact on Mongolia. The country, whose economy has been growing faster than almost any other, is almost entirely dependent on the export of raw materials. Mongolia has things everyone wants -- coal, copper, gold, uranium, rare earth minerals -- and that potential wealth is reflected in the high-ranking visitors it draws. Donald Rumsfeld has been to Ulan Bator, as have Angela Merkel and several Japanese prime ministers. Beijing especially is making an effort to reach out to its northern neighbor.

One hundred percent of the materials from Oyu Tolgoi are exported to China. This July, four years after the mine's construction began, the first flat-bed trucks set out from Oyu Tolgoi to China, each bearing 36 tons (36,000 kilos) of a brown, cement-like powder, from which copper and gold would be extracted on the other side of the border. It was a historic day, whose date had been postponed several times. Geophysicist Sanjdorj had begun to fear he wouldn't get to experience it before his retirement.

Mapping the OreSanjdorj steers his Land Cruiser to the top of the highest slag heap and points out Oyu Tolgoi's open-cast mine, as well as the headframe and ventilation shaft for the underground mine, and a crusher the size of an ocean liner, for grinding the copper ore into dust. The first time he stood on the spot, looking for copper, was over 20 years ago. "The Russians didn't leave us much," he says. "But their geological maps were good. We knew where we needed to look."

In the mid-1990s, shortly after the release of those Russian maps, Australian mining giant BHP obtained the first mining license for Oyu Tolgoi and spent several years digging for copper deposits. Sanjdorj and his colleagues worked there in 40 degree Celsius heat in the summers and minus 40 degree Celsius cold in the winters. If they had dug just 30 meters (100 feet) deeper, they would have reached the richest layers of ore back then. But they didn't, and in 2000 the Australian company lost interest for good, selling its license to Canadian mining company Ivanhoe for about $40 million. The price of copper at that point was $1,700 per ton, a quarter of its value today.

Ivanhoe's founder, American mining tycoon Robert Friedland, had made a great deal of money through a project mining nickel in Canada and a copper mine in Burma. He continued the drilling at Oyu Tolgoi and soon reached his goal, when geologists found a kilometers-long, banana-shaped copper deposit that extended as far as 2,000 meters into the earth and had a very high copper content. Now Friedland just needed people with the skills and means to excavate that banana.

'Cash Flow Engine'

By 2005, the price of copper had exceeded the $3,500 mark and Friedland attended an investors' conference in Florida, where he gave a speech that international mining company managers still rave about -- and at the same time made him the most hated man in Mongolia.

"Our lands" -- as Friedland referred to the claim he had purchased -- "are the largest land position in the mining industry." The method he planned to employ there, he said, was so easy that "kids with joysticks can be running these things from the surface." Then he offered an analogy: "So you're in the T-shirt business, you're making T-shirts for 5 bucks and selling them for 100 dollars."

"And the nice thing about the Gobi," he added, "there's no railroad tracks in the way, there are no people in the way, there are no houses in the way. There's no NGOs." Oyu Tolgoi, he said, is a "cash flow engine," every investor's dream.

After that speech, says Davaasambuu Dalrain, who at the time was Mongolia's ambassador in London, "It wasn't easy to trust Friedland." But Friedland wasn't the only one in need of a company capable of turning the discovery of Oyu Tolgoi into a functioning mine. The Mongolian government was in the same boat. "So we both turned to Rio Tinto," the former diplomat explains.

Where Were the Profits?

In 2006, Rio Tinto bought shares in Friedland's company. By early 2012, when the corporation took over the majority, miners had dug more than 1,000 meters into the earth, and thousands of workers had conjured a small city out of the Gobi Desert, with an airport, a track for vehicles and power lines connecting the mine to China. The price of copper at this point was over $8,000. So much investment was pouring into the country that for a time its economy was growing at a rate of more than 17 percent.

But when Mongolia held parliamentary elections in June 2012, the victorious Democratic Party, until then only the junior party in a coalition government, found itself gazing into yawningly empty government coffers. How could that be? Why hadn't the country earned its share during the boom?

"The main problem is the loan," says Mining Ministry planning head Otgochuluu. Rio Tinto, he says, has exceeded the mine's originally estimated construction costs of $5 billion by hundreds of millions of dollars. He believes Rio Tinto managers' salaries are too high and that the company deducts consulting and materials costs that don't make sense.

Because the Mongolian government committed to bearing 34 percent of all the mine's costs, as costs rise so do the country's debts with Rio Tinto. "It will take us decades to pay back the loan," Otgochuluu explains. "We expected to see the first dividends on the mine in 2019. But it turns out it will be 20 or 30 years before we receive a share of the profits."

Empty Mines, Bad Experiences

Rio Tinto vehemently denies having broken any contracts. The costs, the company says, are only $786 million higher than agreed upon with the government in a 2009 feasibility study. "By any measure, this is effective cost management for a project of this size," says a representative for Rio Tinto. Besides, he adds, the government has received "over $1.1 billion in taxes, fees and pre-payments so far," with the corporation paying more taxes in Mongolia than in many other countries where it operates mines.

Otgochuluu smiles bitterly. "We've had bad experiences," he says. A Canadian company that set up a gold mine north of Ulan Bator in 2004 insisted on being exempt from taxation for seven years, on the grounds that geological conditions in the area were supposedly very complicated. "Four years later," Otgochuluu says, "the mine was depleted." As for Rio Tinto, he estimates the company will earn around $1 billion with its sales of copper concentrate from Oyu Tolgoi this year and $2 billion next year. The corporation declines to comment on these figures.

"We will end up with $70 million this year and perhaps $200 million next year in licensing fees," Otgochuluu says. "But that's not enough. We need at least $700 million to fund our budget."

Public Distrust Grows

That the government can't get its budget under control and fails to distribute the country's resources fairly can hardly be blamed on Rio Tinto's managers. It is more likely due to incompetent, corrupt government employees such as the former head of Mongolia's Mineral Resources Authority, who was sentenced to several years in prison, or the country's ambassador to Germany, who was for a time under investigation by public prosecutors in Berlin for suspected money laundering.

Still, the language used by foreign mining company managers who like to regard the country as a "cash flow engine," as well as the non-transparent deals they conduct, are increasingly turning the Mongolian people against them.

Sanjaasuren Oyun, Mongolia's minister of the environment and tourism, says she doesn't like the term "resource nationalism," but believes her country unavoidably had a great deal to learn on its way to becoming a raw materials giant, and needs to take a much more self-confident stance.

"Twenty years ago, we thought mining was a business like any other -- you sell your natural resources and collect the fees," Oyun says. In 1997, the 49-year-old explains, the government opened up nearly half the country for mining licensing. That's a geographical area nearly equivalent to the entirety of Turkey. "We fell into the same trap as many others before us -- dig now and clean up later."

The Downside of Dependence

As the protests grew louder, the country's cabinet froze all licenses that had already been issued. Last year, when a foreign company wanted to sell a coal mine to a Chinese corporation, Mongolia's new government temporarily halted all foreign strategic investment in the country.

Environment Minister Oyun describes herself as a staunch economic liberal, but believes that in the case of poor but resource-rich countries such as Mongolia, liberalism needs some limits. "It isn't good to make yourself dependent, whether on a large neighboring country, on a company or on natural resource price cycles."

In late July of this year, the price of copper was around $7,000. Under the shimmering sun of the Gobi Desert, Rio Tinto's drilling machines had surrounded half of Oyu Tolgoi's banana-shaped deposit with a dense network of tunnels and shafts. Another seven years and a further $5 billion would make this the world's most modern copper mine, extracting ore from every shaft and making its owners rich.

The Tug-of-War Continues

At least, that's what the company's stockholders thought until last week, when the British-Australian corporation suddenly halted work, saying the Mongolian government had announced that not only the cabinet, but the parliament as well, needed to approve funding for the mine. "In view of the current uncertainty … all funding and work on the underground development will be delayed until these matters are concluded and a new timetable has been agreed," the company stated.

That didn't just sound like a threat, it was a threat. Shortly after the company's announcement, raw materials analyst Tony Robson warned that, "Mongolia's reputation for mining investment has been destroyed."

Later last week, the government tried to calm mining investors' worries: "Parliament has already made the decision and signed their agreement," Prime Minister Altankhuyag Norov said at a press briefing. Not even the cabinet would have to be involved. "All issues can be discussed and decided at the board of directors level," he explained.

The tug-of-war between the poor, rich country and the corporation will go on.

Translated from the German by Ella Ornstein