Economic assessment of the impact ofMongolia’s foreign investment environment and the proposed new mineral law Dr Brian Fisher Presentation to the Business Council of Mongolia, 18 March, Kempinski Hotel, Ulaanbaatar
Economic assessment of the impact of Mongolia’sproposed new mineral law Purpose and contents of the analysis Purpose of the analysis: The analysis seeks to estimate the total impact (direct and indirect) of proposed new mineral law implementation on the Mongolian economy (domestic and external sectors, households and government) Contents: • Role of the mining sector in the Mongolian economy 1 • Proposed new mineral law 2 • Methodology and assumptions used in the analysis 3 • Implications of the proposed new mineral law on the economy (model insights) 4 • Conclusions 5
The contribution ofmining to theMongolian economy
The mining sector became Mongolia’s export engine ofgrowth after the GFC Mining sector impact on GDP and exports Nominal GDP Exports 16 6 MNT t Mining sector Non-mining sector Mining Exports Other exports US$ b 14 5 12 4 10 8 3 6 2 4 1 2 0 0 2009 2010 2011 2012 2009 2010 2011 2012 On average, the mining sector contributed around a quarter of national GDP over the past four years. After OT and TT reach full capacity, the mining sector will make further significant contributions to the domestic economy. The GDP share has not fully reflected the importance of the mining sector in recent years. From 2011, the mining sector has contributed more than 90% of total exports. Coal, copper and gold make up about 80% of mineral exports.
The growing demand for mining commodities and afavourable business environment in the past haveattracted foreign direct investment into Mongolia Mining sector impact on investment Foreign direct investment Major foreign investment in the mining sector 5.0 4 US$ b Mining FDI Non-mining FDI US$ b MMCs IPO and Bond OT CAPEX 4.5 MAK loan from EBRD 3 4.0 3.5 3 3.0 2 2.5 2 2.0 1.5 1 1.0 1 0.5 0.0 0 2009 2010 2011 2012 2010 2011 2012 Of the total FDI inflow, US$8.6 billion or approximately 81 per cent has been injected into the mining sector in Mongolia in the past four years. Of this percentage, OT alone has invested US$6.2 billion of CAPEX in its first phase. In 2012 the Mongolian Mining Corporation (MMC), which owns one of the largest coking coal mines, Ukhaa Khudag, planned for its capital expenditure on infrastructure to rise by approximately US$1.3 billion.
Income from the growing mining sector is a vital sourceof finance for the Mongolian government Mining sector impact on government revenue Key taxes that apply to mining in Mongolia Budget revenue (MNT trillion) 6 Income Tax Revenue from sources other than mining (10%-25%) Export Revenue from mining (including prepayment) Duties VAT 5 (none) Import Withholdin 4 Duties g Tax (5%) (20%*) Mining Tax 3 System Tax Holiday Depreciation (none) (Mainly 10 years) 2 Progressive Royalties 1 Royalty (5%) 37% Loss Carry (0%-15%) Forward 31% 23% 35% 27% (4-8 years) 25% 0 *Subject to double taxation treaties 2007 2008 2009 2010 2011 2012 The government’s reliance on mining sector income has grown higher in recent years via both tax and non-tax income collection. In the past four years the government earned MNT 4.2 trillion in tax income and MNT 0.75 trillion of prepayment from the mining sector. Not only is direct tax income from the mining sector important, tax income from mining service companies is also growing significantly. For example, a total of MNT 283.9 billion has been paid to local suppliers from Oyu Tolgoi LLC in the past three years.
If the business environment is favourable a number ofmining companies are expected to commissionoperations in the near future Strategic Resource Classification Number of projects 40 9 NEW PROJECTS 35 30 25 20 15 10 5 0 2000 2008 2010 2011 2012 2013 2014 2015 copper coal gold iron ore In the coming three years mining companies may implement nine new projects if business conditions are favourable. Coal projects are likely to constitute the majority of new projects. It is estimated that the total investment in these new mining projects could be US$6.3 billion by 2015.
The Mineral law is the main regulation affecting the miningsector but there are many other laws that have an impact onmining Legislation relevant to mining projects General Law on Law on Land Environment Subsoil Protection Law on Public Admin Land Law Explosives Law Mining Law on Nuclear Health and Protected Mineral Law Energy Law Equipment Areas Certification Competition Corporate Labour Law Law Law Foreign Law on Law on Land Investment Taxation Fees Law Foreign Long Named Water Law Labour Force Environment Laws^ Law* ^Sending Labor Force Abroad and Receiving Labor Force and Specialists from Abroad *Law to Prohibit Mineral Exploration and Mining Operations at the Headwaters of Rivers, Protected Zones of Water Reservoirs and Forested Areas
Foreign investment environment needs to be stable in order to continue to attract foreign capital• The attractiveness of a country to foreign direct investors is dependent on the domestic investment environment, the stability of the policy regimes in place and the effective tax rates imposed compared with alternative investment destinations.• An uncertain environment where tax rates and other policies are unpredictable and where there is pressure to re-negotiate established investment agreements will be less attractive to investors than locations where policies are stable and predictable and where investment agreements, once established, are honoured in full.
Impact of proposed new mineral law on explorationcompanies is very negative Relevant law article to the mining projects Types of mining companies Summary of law implication • Higher ownership requirement (up to 75% vs up to 50%) • Impractical requirement for local involvement (at 60% Big mining projects: OT, procurement, mandatory cooperation agreement with the community in prospecting and exploration) TT, EMC • Prohibition of high grading (required to extract entire ore without regard to the commercial value) • Reduced financial incentive for investment (stabilization Medium and small agreement is only available to strategic deposits, upfront closure cost payment tying up the capital investment) projects • Reduced security of tenure (if the stabilization agreement ceases to comply with the interest of Mongolia, reopens the agreement and the equity is transferred to Mongolia free of charge) • Prohibitive minimum exploration expenditure requirements Exploration companies (US$100k) • Lack of transparency in the licensing process (Where a tender is rejected or blocked, it locks up potentially prospective ground for up to 4 years)
Despite potential future mining growth implementation ofthe proposed mineral law and any failure to honourexisting investment agreements would restrict investment Likely implication of the draft mineral law on mining companies Impact Implication 1 • Decreased FDI (no investment on Large mining • Higher ownership requirement underground at OT and West Tsankhi projects (OT, TT, • Impractical requirement for local at TT) EMC) involvement • More bureaucracy • Costly operation 2 • Sharp decrease in FDI in domestic • Prohibition on high grading companies listed abroad (no growth in Medium and • Reduced financial incentive for investment production) small projects • Reduced security of tenure • No additional investment in domestic companies (no growth in production) • New projects will not be launched 3 Exploration • Prohibitive minimum exploration expenditure • No additional exploration companies requirements • Potential expropriation of a number • Lack of transparency in the license process of existing small to medium size companies
Methodology andassumptions used in theeconomic assessment ofthe new mineral law
MINCGEMv2: A dynamic general equilibrium model with detailed sectoral, national and government accounts Methodology of the economic analysis of proposed new mineral law Database: GTAP8 database Methodology: Dynamic CGE Highest Impact:2020 XXX: 2025 (MINCGEMv2) (Computable General Key features Equilibrium) 1 GTAP v8 database with a base 1 Dynamic multi-region, multi- CGE models ensure that the most year of 2007 and covers 129 sector CGE model developed by BAEconomics important economic identities countries/regions across the and constraints (extremely world and 57 commodity groups 2 Capable of simulating economic important for simulating long- term scenarios): scenarios over a long time 2 The MINCGEMv2 expands the horizon. Each time step is one • GDP measured by the GTAP commodity groups to 71 year expenditure approach and the and was aggregated into 10 income approach; economies (Mongolia, China, 3 Demand for commodities in the • Supply of capital, labour and Russia, India and others*) and 20 model is determined by the natural resources; commodities social accounting matrices of the • Market clearance of individual Mining (thermal coal, met coal, modeling regions, the prevailing markets; copper, gold, oil, gas, coke, economic conditions and policy CGE models are structured on • The relationship between the petroleum and other minerals) settings the basics of supply and demand. current account and the Agriculture (crops, livestock, Each sector of the economy is capital account; 4 linked by supply structured on CGE models are and use of • The relationship between fishing and forestry) factors and intermediatedemand. the basics of supply and inputs. government expenditure and Manufacture (Processed Food, Each sector of the economy is taxes; Copper refining and linked by supply and use of are respected during each manufacturing, other CGE models account for the factors and intermediate inputs. manufacturing) simulation time step. industrial flow-on effects 5 CGE models account for the CGE models contain detailed Electricity triggered by shocks in other parts of the flow-on and the industrial economy effects industry cost structure and Transport bilateral trade information in their economic feedback effectsother triggered by shocks in that databases such that substitution Construction are of the economy and the parts neglected in many between commodities and Public Administration, Defense, government policy analyses that economic feedback effects competition between economies Health and Education are neglected in many can be modelled explicitly Other services government policy analyses CGE models have several features making them the most appropriate tool for policy and scenario analysis*see detail in appendix
RunDynam software: for recursive dynamic models
Two scenarios were developed under the MINCGEM frameworkto assess the macroeconomic implications of the new mininglaw and instability in the investment environment Assumptions in the alternative scenarios New mineral law and Existing mineral policy uncertainty law scenario scenario 1 • All the existing mining projects will be • The current mining projects will be Mining operated including the projects of operated* but new exploration projects will production exploration companies be severely affected 2 • Commodity prices are based on • Commodity prices are based on Mining consensus prices and discounted to consensus prices and discounted to prices Mongolian border price Mongolian border price • Additional FDI investment in the mining sector • Determined endogenously by an 3 • Thermal coal - US$1.4 billion alternative sectoral growth pathway Mining FDI (exploration • Metallurgical coal - US$1.2 billion with lower FDI investment in the & expansion) • Copper - US$8.7 billion mining sector 4 • Endogenously determined with the inclusions of • Determined endogenously by an additional infrastructure projects alternative sectoral growth pathway Infrastructure • Coal washing plant: with lower FDI investment in and lower projects • ETT and MMC demand for infrastructure projects • Power plant: • Tavan Tolgoi and Chandgana * - Oyu tolgoi will only operate open-pit mining ** - Tavan tolgoi will only operate East Tsankhii
Production from the mining sector is projected to be severely affected under the new mineral law and policy uncertainty Assumptions : Mining production volume (coal and copper as main commodities) New mineral law and policy Existing mineral law scenario uncertainty scenario Coal* Coal* 200 200 Mt Mt 150 150 100 100 50 50 0 0 2005 2010 2015 2020 2025 2030 2005 2010 2015 2020 2025 2030 Paid Copper Paid Copper 1.2 1.2 Mt Mt 1.0 1.0 0.8 0.8 0.6 0.6 0.4 0.4 0.2 0.2*included HCC, 0.0 0.0SSCC, thermalcoal and washed 2005 2010 2015 2020 2025 2030 2005 2010 2015 2020 2025 2030coking coal, Bef0re 2011 Mongolia’s thermal coal was mainly used in domestic consumption (power and heating). Thermal coal exports began at the end of 2012 (November).
Price assumptions are based on latest consensusprices from economists around the world Assumptions : consensus prices (2013 real prices) Thermal coal Coking coal 120 80 US$/t US$/t 70 100 60 80 50 40 60 30 40 20 20 10 0 0 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 Copper Gold 400 1,800 USc/lb US$/oz 1,600 350 300 1,400 1,200 250 1,000 200 800 150 600 100 400 50 200 0 0 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030 Coal price is discounted to Mongolian border price in the model
Although the mining sector is the main contributor to export revenue, import purchases by this sector are high due to the lack of domestic companies that produce final goods such as fuel, electricity and other machinery and equipment External Sectors Mining sector impact on external sector Exports (US$ billion) Imports (US$ billion) 6 8 Copper Met coal Auto vehicles and their spare parts Gold Crude oil Machinery and equipments China 7 Diesel and petroluem Other mining Non mining exports 5 downturn Other imports impact*** 6 4 Coal growth** 5 3 4 GFC* 3 2 2 1 1 0 0 2007 2008 2009 2010 2011 2012 2007 2008 2009 2010 2011 2012 The mining sector contributes the dominant share of total exports. About 80 per cent of mineral exports is made up of coal, copper and gold. Mining related imports (mostly trucks, mining equipment, electricity, fuel) have increased significantly in the past few years as the number of new mining projects grew quickly.*Copper price declined by 70% after reaching a peak in July 2008 at the height of the global commodity boom**New big coal mining projects and coal price structural change in 2011 (Before structural change (2010) Border average price is US$50/t , After it US$100/t)***Coal border price declined by 15%, Copper border price declined by 13% relative to 2011
Although the mining sector is not a labour intensive sector, impact on average wages is high Households Mining sector impact on households Number of employees (million persons) Monthly average wage (MNT million) 1.0 Agriculture Mining Manufacturing Agriculture Mining Manufacturing 1.4 Construction Trade Transport 0.9 Construction Transport Service* Otherservice 1.2 0.8 0.7 1.0 0.6 0.8 0.5 0.6 0.4 0.3 0.4 0.2 0.2 0.1 0.0 0.0 2007 2008 2009 2010 2011 2012* 2007 2008 2009 2010 2011 2012 Average salary in the public service increased by ~60% compared to 2011 (highest growth in education and health sector). Average salary in the mining sector fell in 2012 due to the China downturn impact on coal prices.**Electricity, whole sale and retail trade, hotels and restaurant, financial and insurance, public administration, education, health , community and personal service and other services
Only mining projects already operating will continue to operate and all exploration projects will be closed given the new mineral law and policy uncertainty’s impact on FDI Assumptions : Mining production value (US$ billion, 2007 prices), by commodity and project type New mineral law and policy1 Existing mineral law scenario uncertainty scenario Mining By commodity type By commodities production 20 Other 20 Other 18 Copper 18 Copper 16 16 Met coal Met coal2 14 14 12 Thermal coal 12 Thermal coal Mining 10 10 prices 8 8 6 6 4 4 2 2 0 0 2005 2010 2015 2020 2025 2030 2005 2010 2015 2020 2025 2030 By project type By project type 20 20 Explorations and other Started other projects 18 18 Not started big projects** 16 16 Started big projects* 14 Started other projects 14 12 Started big projects* 12 10 10 8 8 6 6 4 4 2 2*EMC, OT open pit, TT East Tsankhi 0 0**OT underground, TT West Tsankhi 2005 2010 2015 2020 2025 2030 2005 2010 2015 2020 2025 2030 Mongolia’s thermal coal was used in domestic consumption (power and heating) only before 2012. Exports of this product commenced in November 2012
The world is divided into 10 economies in MINCGEMMongolia v2 1. Mongolia 6. Russia 7. Rest of Europe 2. China 8. North America 3. Japan, Korea and Taiwan 9. South America 4. India 10. Middle East and Africa 5. Rest of Asia and Oceania
Each economy is divided into 20 production sectors inMINCGEM Mongolia v2 1. Thermal Coal 11. Livestock 2. Coking Coal 12. Fishing and Forestry 3. Oil 13. Processed Food 4. Gas 14. Copper refining and manufacturing 5. Copper concentrate 15. Other Manufacturing 6. Gold 16. Electricity 7. Other minerals 17. Transport 8. Coke 18. Construction 19. Public Administration, Defense, Health and 9. Nuclear & petroleum fuel Education 10. Crops 20. Services
Summary description of new mining law implications • HIGHER OWNERSHIP REQUIREMENT_ (1) 75%, 51% or 34% of the shared capital of the company holding a Mining Licence, must be a Mongolian Citizen • IMPRACTICAL REQUIREMENT FOR LOCAL INVOLVEMENT_ (1) 60% local procurement required – unable to be supported by existing market; (2)Community cooperation agreements required for prospecting and exploration tenements • PROHIBITION OF HIGH GRADE MINING _(1) If companies are required to mine the entire reserve without regard to the commercial value of the extracted mineral it will act as a deterrent to investment in the industry. The definition should include an economic/commercial cutoff. • REDUCED FINANCIAL INCENTIVE FOR INVESTMENT_ (1) The new legislation provides for DDAs to be negotiated for strategic deposits only; (2) Upfront payment of closure costs - requires a deposit of a huge sum of the money tying up capital for the life of the project; (3) Royalty structure (separate piece of legislature) • REDUCED SECURITY OF TENURE_ (1)Minerals of strategic importance/percentage of state equity/equity obtained free of charge (An investor may incur significant costs in exploration and appraisal risk that the GOM will take an unspecified interest in the project) • PROHIBITIVE MINIMUM EXPLORATION EXPENDITURE REQUIREMENTS _ (1) prohibitive min expenditure (US$ 100K) for all but the most successful projects. Mongolian and international juniors not likely to be able to meet min spend requirements. • LACK OF TRANSPARENCY IN THE LICENSE PROCESS_ (1) tender process – prone to corruption. Ability to increase royalties; may be tendency to place this above other criteria such as capacity and experience. Where a tender is rejected or blocked, it locks up potentially prospective ground for up to 4 years.