B.Solongoo: Mongolia must make the 1st draft of  the new Oyu Tolgoi agreement

B.Solongoo: Mongolia must make the 1st draft of the new Oyu Tolgoi agreement

  • By Dulguun   -   Apr 21,2021
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Deputy Head of the Cabinet Secretariat B.Solongoo gave the following interview about the ongoing negotiation for the Oyu Tolgoi project with Rio Tinto, which holds a 66 percent stake in the project through its majority-owned Turquoise Hill Resources.

B.Solongoo is a member of the government taskforce tasked with the negotiation with Rio Tinto.

The Mongolian taskforce has launched its face-to-face talks with Rio Tinto. The sides must have conveyed their interests to each other at the first meeting. What was the Mongolian side’s position in the initial meeting?

A taskforce was assigned to enforce Resolution No. 92, approved by Parliament in 2019, to protect the interests of Mongolia in the Oyu Tolgoi project. The taskforce has been holding online meetings with Rio Tinto’s representatives since April 2020. Back then, the taskforce was led by then-Head of Cabinet Secretariat L.Oyun-Erdene. Resolution No. 92 is very broad. The taskforce prepared quite a bit to implement the resolution. The sides couldn’t meet in person last year due to the pandemic.

The Rio Tinto delegation led by Copper Executive Director B.Bold arrived in Mongolia and we held the first face-to-face meeting on April 12, after they completed the 14-day quarantine. The taskforce comprises of nine members, all of whom expressed their positions at the meeting.

A temporary committee has been set up to monitor the implementation of the resolution. The committee’s Head Ts.Davaasuren briefed the negotiating parties on guidelines the committee issued. Rio Tinto made its position clear -- it is ready to listen to the government’s proposals and make the project as mutually beneficial as possible. Lawmakers included in the taskforce asked made certain inquiries related to the Oyu Tolgoi project. Rio Tinto is to answer them at the next meeting.

The Rio Tinto delegation led by Copper Executive Director B.Bold arrived in Mongolia and we held the first face-to-face meeting on April 12, after they completed the 14-day quarantine. The taskforce comprises of nine members, all of whom expressed their positions at the meeting.

A temporary committee has been set up to monitor the implementation of the resolution. The committee’s Head Ts.Davaasuren briefed the negotiating parties on guidelines the committee issued. Rio Tinto made its position clear -- it is ready to listen to the government’s proposals and make the project as mutually beneficial as possible. Lawmakers included in the taskforce asked made certain inquiries related to the Oyu Tolgoi project. Rio Tinto is to answer them at the next meeting.

Are you saying that the sides have only exchanged information at the moment?

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). Both sides need to agree on issues such as tax disputes arising from investment agreements. Resolution No. 92 called for the implementation of the Oyu Tolgoi investment and shareholders’ agreements to be improved within the framework of the current legislation in Mongolia. So we will definitely raise the issue of revising these two agreements. We don’t believe that the problem can be solved by just revoking the Dubai agreement. We will continue our dialogue with the investor to address this project in a comprehensive and fundamental manner. Negotiations will not be easy – it will likely take a long time.

There’s a saying, “yaarval daarna” (you’ll get cold if you rush). The foundation to a successful negotiation is making sure to prepare well. We’ve been working continuously to prepare. For a successful negotiation, it is necessary to make very principled, reasonable and feasible proposals. We have made relevant suggestions.

People are expecting the negotiation to be over before the presidential election but you just said that it would take a while. In the past, the sides couldn’t reach an agreement and established the Dubai agreement after two years. Will the negotiation take this much time?

The underground development has reached an important stage. Around 90 percent of the total mine development is complete. We must decide to begin mining in the underground ore body this June. This stage must proceed or the project will lose its value. The investor side is also hoping to start underground mining. They’re pushing for the project to move forward quickly, be mobilized immediately and take advantage of rising copper prices.

On the other hand, Rio Tinto is also interested in getting the project up and running fast. It is committed to reaching an understanding with the government and starts working on the project. Nevertheless, the government must be very thorough in its negotiations. In November 2020, we proposed an analysis of the project’s cost blowout and delay and decided to seek an independent expert opinion. Now, an external expert has been appointed, with the initial report expected to be out by end-June.

Due to the pandemic, the appointment of an independent expert was delayed due to a change in the executive management of Turquoise Hill Resources. This has postponed the report. Some decisions will become clear after the audit’s conclusion. We’re waiting for the results.

Rio Tinto estimated the total cost of the underground expansion to reach 5.3 billion USD in 2015, with production to begin in January 2021. However, this period was postponed for 22 months to October 2022. Capital expenditures im- mediately rose by 30 percent or 1.4 billion USD. Rio Tinto explained the delays and increased costs were due to geotechnical conditions or rock formations. However, many conflicting re- ports 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 about 20 days ago. The 160-page document of the revised claim raised a very serious issue. There is a possibility that Rio Tinto has 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. Therefore, we need to study this issue well. After an independent expert has given an opinion on a problematic issue, we’ll be able to discuss certain issues with Rio Tinto. Therefore, the issue will not be resolved in haste before the election. We are in no rush. Rio Tinto is the one in a hurry. They are interested in getting the project to advance as soon as possible and get the underground mining investment cost overrun accepted.

The boards of Rio Tinto and Turquoise Hill have approved a 1.4 billion USD surge in underground mining investment cost. Oyu Tolgoi LLC’s board has not yet approved it. Rio Tinto believes that the problem will be resolved only if Oyu Tolgoi’s board acknowledges the investment cost blowout. We are of the opinion that we will consider the issue after examining the reasons for the additional costs and the conclusion of an independent expert.

Which company is conducting the independent audit?

We can’t disclose detailed information about the auditor before the conclusion of the analysis. We have started to work with the world’s leading experts in the field of underground mining. Oyu Tolgoi has established a special committee, with two members representing Mongolia and two members representing Turquoise Hill. Rep- representatives of Rio Tinto are not included. As it is managing the project, there may have a conflict of interest. Rio Tinto is required to provide the independent experts with the information they need to conduct research immediately and to cooperate with their operation.

The independent expert’s report is scheduled to be released in late-June. This will make it clear whether there is a cost blowout, and whether it was caused by troublesome geotechnical conditions, or if this was meant to mislead investors. The negotiation will go smoothly if the cost blowout was necessary, but if misleading, how will negotiations proceed?

In any case, the talks will continue. Mobilizing the underground mine will benefit Mongolia and investors. Stopping the project is fruitless for everybody. The government has not said it will stop the project. It wishes to gain as much understanding between the sides as possible and ensure the project is beneficial to Mongolia. We can do this. The most important thing is that the government and Parliament remain on the same page. We will succeed in the negotiations if we have the same stance. On the other hand, Oyu Tolgoi is one of the largest deposits in the world. By beginning production at the underground mine, (Rio Tinto) will become the third or fourth-largest company worldwide in terms of (copper) production.

It is clear that the project will bring certain yields to our economy. But the yield needs to go to the Mongolian people. It would be unfortunate if Mongolia puts into operation a world-class mine but is unable to get dividends and royalty from it. We are working to make this project profitable for Mongolia. It may take time. However, we believe that it is possible to discuss and resolve the issue without delaying the commissioning- ing of the underground mine. To raise benefits to Mongolia, we’re faced with the question: Why were unprofitable contracts signed? I don’t know what the situation, the budget, and the economy were like at that time. However, this time we will prepare very well and provide Rio Tinto with the documents that reflect our requirements. We are of the opinion that the first draft of the agreement to increase the profitability of Oyu Tolgoi should be submitted by the Mongolian side.

The government has repeatedly expressed its position to rescind the Dubai agreement. Can you explain this in detail? Why must the investment and shareholders’ agreements be revised?

The reason why we are trying to cancel the Dubai agreement or plan is the court’s ruling that the process was flawed when the agreement was first established. Back then, the government didn’t issue a resolution on the plan or present the issue to Parliament. It wasn’t even discussed at a Cabinet meeting. Former Prime Minister Ch.Saikhanbileg had immediately issued an order authorizing the approval of the deal. How- ever, the Administrative Court of First Instance ruled in November 2019 that this process “violates the basic principle in which the government should make decisions in the chamber”.

Then again, there are tax disputes over the plan. Changing taxes is a matter for Parliament to decide. If the sides wanted to negotiate tax-related issues, they should have sought Parliament approval first. The calculation of royalties included in the Dubai agreement is controversial. In fact, the investment agreement quotes the entire provision of the Minerals Law. However, the Dubai agreement seems to have been resolved at the investor’s discretion. This is not considered to be a contractual issue. We did not consider it legally possible to amend the plan, which was problematic from the beginning. The issue I mentioned about the calculation of royalties included in the plan is part of the tax dispute.

The General Taxation Department of Mongo- lia issued a tax act as it viewed that Article 6 of the plan on how to calculate and pay royalties for the use of mineral resources is invalid. We must cancel this agreement with erroneous content and establishment a process to move forward. Rio Tinto didn’t want to cancel the plan and instead wanted to make changes to it at first. However, they have agreed to replace it with a new one.

The reason we’re so focused on the plan is that the financial estimates and feasibility have completely changed from the ones that were made at the time the plan was signed. Operating and recurrent capital costs have increased by 1.4 billion USD as mentioned before. As a result, the benefits promised to Mongolia at the time have greatly diminished. Rio Tinto announced its de- tailed financial estimates for the underground mine in December 2020. According to these estimates, Mongolia will be left with a debt of 22 billion MNT by 2051. We cannot accept such financial estimates. Certain measures must be taken and demands must be made. Investors are being asked to review these financial estimates and increase the returns to Mongolia.

In addition, we’re going to review the share- holders’ and investment agreements. Prime Minister L.Oyun-Erdene, who chaired the taskforce, demanded in November 2020 to review the im- implementation of all agreements signed between Mongolia and Rio Tinto in connection with the Oyu Tolgoi project. Through the assessment, he wanted to resolve all the issues that were leading to misunderstandings and disputes once and for all so that the project can continue successfully. Rio Tinto agreed to this. But no action has been taken. It’s one thing to say, it’s another thing to take action. It seems we need to press on.

I understand that the sides are planning to get permission from international financial institutions that loaned 4.4 billion USD for the underground mine development to amend the Oyu Tolgoi investment and shareholders’ agreements. What is the government doing in this regard?

Loans were received from about 15 financial institutions, including the International Finance Corporation and the European Bank for Reconstruction and Development. This financing document does not specify the Dubai agreement as the chief project document. Instead, it specifies the investment and shareholder agreements as such. If these two agreements are to be amended, Oyu Tolgoi will need to obtain permission from its creditors. We will first cancel out the plan, which doesn’t require permission from creditors and resume our negotiation by discussing changes to the investment and shareholders’ agreements. The government is dealing with the banks. In general, all stakeholders of the project have been contacted. The government is giving them clear information and relaying its position on the matter. Resolving issues through consensus is mutually beneficial.

It appears that Mongolia has gathered quite a lot of knowledge and information about the Oyu Tolgoi project and its relevant agreements, and is now set on correcting the errors. Is the Mongolian side ready to negotiate with Rio Tinto?

We have a clear vision and options for the negotiations. We can’t reveal it to the public as we shouldn’t reveal all our cards. We must have a plan and strategy for whichever steps we are to take and how to make specific proposals and demands. I have been a business consultant for over a decade and as a qualified lawyer, I believe that in order to take advantage of any negotiations, you must submit the first draft of the contract. Since investors have come to Mongolia and are talking about how to use natural resources, we must submit the first draft of the agreement. That way, we can turn the conversation to our advantage. During the talks, our working group is pre- paring to submit the first draft of the agreement. The previous agreements of the project were all developed by a consulting company, a hired lawyer or Rio Tinto. Thus, Rio Tinto was given an advantage. Blaming someone for it doesn’t really matter. But I think we have to be well-prepared. People might be wanting the negotiations to be done and over fast. They may feel that our work is not clear. The government is working to make the project more profitable for Mongolia without compromising Oyu Tolgoi’s current operations.

Some people fear that the Mongolian side might lack experience and skills, and allow a poor agreement to be signed, leading to another dispute.

We must approach the talks in a professional and principled manner. We are getting professional consulting on the matter. We will get legal, financial and technical consulting services from professionals. We believe that the government should study the issues to a certain extent at a professional level and, most importantly, make sound and feasible proposals. A reasonable and principled approach to negotiations will bring results. I don’t think we lack experience in this area. Our working group has three sub-groups – legal, financial, and technical teams – to provide professional and methodological support to the taskforce. These sub-working groups include professionals from relevant ministries and government agencies.

For a fact, Mongolian civil servants have become more knowledgeable about international agreements over the past decade. The Oyu Tol- goi investment agreement was the first major mining project Mongolia made. It was the first example of how a negotiation should go with an investor. We may have lacked experience back then, but now we don’t. Blaming lack of experience now would be irresponsible. We will seek the advice and conclusions of all necessary experts and continue the dialogue in a professional and principled manner. The government is ready to provide the necessary funds to hire the world’s largest consulting companies. It is more important for us to be united than to belittle ourselves. People may be wary of thinking that we might worsen the situation in our attempt to remedy it, but I hope they will be patient. It may not work at the speed some people expect but I’m sure we will get real results.

The government said that it is consulting with the US firm Akin Gump Strauss Hauer & Feld LLP and German firm Fichtner on geotechnical and water-related matters. Have you selected a financial advisor?

A tender was announced. The results should be out later this month. A good financial advisor is important in our negotiations as it will help make the most feasible options. For example, there are rumors among the public that it would be better to give up 34 percent of Oyu Tolgoi’s shares and receive the project’s benefits in the form of a special royalty or a production sharing agreement.

Resolution No. 92 orders the study into this condition.

Yes. Selling 34 percent may be worthless and unprofitable at a time when the underground mine is not yet complete. If global copper prices continue to steadily rise and favorable conditions remain, it will not be profitable for us to sell our stakes. So we need to approach this issue carefully and research it well. We can’t rush into a decision. With a 34 percent stake in Oyu Tolgoi LLC, we can appoint our people to its own board of directors and receive information. Owning a 34 percent stake is not at all bad. The most important thing is to create conditions for profitability.

We are exploring opportunities to bring forward the time of receiving dividends from the 34 percent stake. In general, we’re focusing on comprehensively increasing the overall yield rather than the project’s tax contribution and dividend. The project’s implementation is dissatisfactory right now. It is imperative to select a financial advisor and seek advice on how to improve the effectiveness and increase the return on the project.

The return on the project is declining as investment costs escalate and the launch of the underground mine is delayed. Mongolia has a basic agreement to receive 53 percent of the total project return. Has this agreement and our rate of return suffered due to the cost blowout?

Investment costs of the underground mine have risen significantly and the project is delaying, causing a negative impact on (Oyu Tolgoi LLC)’s operations. Additional funding is necessary. There is a need to defer repayment of the project’s loan financing because of the delay to underground mining, which was set to begin in January 2021 and boost the company’s revenue several folds. Now we need to figure out how to raise investment. Due to these factors, the project’s total return ratio of 53 percent to Mongolia and 47 percent to the investors has been lost, based on calculations. In any case, Mongolia must get 53 percent of the total yield and calculations are being done to ensure this.

Oyu Tolgoi earned 1.1 billion USD in sales last year. In the last three to four years, sales have exceeded 1 billion USD, of which 70 million to 80 million USD is paid to Mongolia as royalty. Rio Tinto receives around 80 million USD a year in project financing guarantees. It also receives around 180 million USD in management fees. Rio Tinto and its affiliates receive approximately 260 million annually from the project. This clearly shows how the cash flow is distributed. The benefit to Rio Tinto is higher than the royalties paid to Mongolia. We need to address this. Moreover, Oyu Tolgoi’s credit burden is very high. It has a total debt of 11 billion USD. It pays 1.8 million USD a day in loan interests. That’s about 650 million USD a year. The fact that it gives more than half of its total sales revenue to pay interest indicates that the company’s financing and investment structure is problematic. We have to talk about this with Rio Tinto.

Rio Tinto will probably want the Mongolian side to compare the money it receives with the total tax collected from the Oyu Tolgoi project. There were talks about reducing shareholder interest rates and management fees to improve return on the project. Have you made such a proposal to the investor?

Rio Tinto had said that it is possible to reduce loan interest rates and management fees, but nothing was done about it. Again, it’s one thing to say and another thing to get it done. 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. Management fees were charged as a percentage of operating costs. Then, how is their operational performance? If they’re operating well, why aren’t they able to put the underground mine into operation on time? I would like to ask them whether they’re able to do their job right and whether they are incentivized to do so. Hence, the government has demanded that management fees be linked to performance. This will give us the conditions and incentives to make them work well. In this case, Oyu Tolgoi will pay performance-based management fees, not 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 de- ducted. The goal of a mining company is to operate efficiently and extract the ore body at the lowest cost. We need to monitor whether they are able to do what they are supposed to do.

As for the comparison of the money received by Rio Tinto from the project with the total tax paid by Oyu Tolgoi, I have a few things to say. Tax revenue is important in getting benefits from the project. In addition to royalties, Oyu Tolgoi pays personal income tax for its employees. Most of the taxes they report are import duties and value-added taxes. This company is operating at a loss. Therefore, no corporate income tax is paid. Looking at the current conditions of the investment agreement, it allows Oyu Tolgoi to avoid paying corporate income tax for 11 years even if it gains profit. Under the 2009 investment agreement, the company received a  three-year tax credit. Once the tax credit expires, the loss is transferred to future payments, deducting 100 percent of the loss from the tax payable for eight years and creating the condition for non-payment of the tax. It is unfortunate that Mongolia would not be able to collect profit tax for 11 years even when the underground mine is put into operation and the company has started to operate profitably. We will work to ensure that taxes are paid in real terms.

Value-added tax isn’t paid by Oyu Tolgoi. It is a tax paid by the companies that supply goods and services bought by Oyu Tolgoi. Rio Tinto re- ports annually that it is the tax it paid. 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 re-port. A closer look at their report reveals that Rio Tinto’s public policy contradicts Oyu Tolgoi’s tax policy. Through a company called Moveli, found- ed 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.

Are you saying that an offshore company was used?

Yes. The use of shell companies established in Luxembourg and the Netherlands solely to reduce taxes is inconsistent with the policy Rio Tinto announced worldwide. It must change its practice of transferring money in this way. In its report, Rio Tinto said that the company called Moveli was liquidated in 2020. This indicates that the issues raised by Mongolia’s tax assessment are reaching tangible results. It should be noted that our tax inspections have improved, especially the introduction of price controls is showing positive impact. Rio Tinto receives significant cash flows, including management fees and interest rates, from Oyu Tolgoi through its affiliates. It is important that we monitor price movements. In other words, we need to work against the artificial increase of costs and reduction of the tax base.

The Mongolian government has launched the Organisation for Economic Co-operation and Development’s Base Erosion and Profit Shifting Program, which supports developing countries in ensuring multinational enterprises pay tax fairly and objectively without exploiting gaps and mismatches in tax rules. The program takes measures to tackle tax base erosion and profit shifting. After launching the project, Mongolia is demanding Rio Tinto to pay the required amount of taxes to the country if it is earning income and profits in connection with the Oyu Tolgoi project, which is based in Mongolia.

Oyu Tolgoi has divided the cost of works and services into onshore and offshore. This is one of the issues that is causing the tax dispute. Offshore means payment for work and services that were not provided in the territory of Mongolia and received from a foreign entity. They do not pay taxes after receiving such services. Rio Tinto does the same for management services. 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.

You spoke in detail about the tax dispute. It brings me to speculate that the reason for the changes in the investment and shareholders’ agreements is related to tax issues. In addition to taxes, are there any other issues warranting amendment to these agreements?

A tax dispute arises over how certain provisions of an investment agreement are interpreted. As mentioned earlier, there are tax disputes re- related to the financing of the underground expansion. There are also disputes over the wording of the English and Mongolian versions of the investment agreement. Amendments to the agreement will not only address tax issues. The main goal of the government taskforce is to implement Parliament Resolution No. 92. The resolution states that the implementation of investment and share-holders’ agreements will be improved within the framework of the current legislation of Mongolia. This is a broad concept. We need to make a broad assessment of the implementation of investment and shareholders’  agreements.  Then we need to look back at the issues that are being implemented insufficiently and make them beneficial to Mongolia.

In general, certain changes need to be made considering the issues that may arise in connection with this project in the future. The talks will cover a wide range of issues, including the environment, groundwater use and the social position of employees. Besides the financial benefits, it is important to consider the current state of Oyu Tolgoi’s water use and whether the continued use of groundwater will have a negative impact on the environment. The successful implementation of this project will benefit Mongolia. Therefore, I hope that the negotiating parties will understand each other’s stances and conclude the dialogue after the issues that have been discussed for many years are settled.

Dulguun Bayarsaikhan

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