Terrence Edwards in Ulaanbaatar -

It is not the best of times for Mongolia's two largest mines. Both are falling well short of their moneymaking potential and, ever mindful of this, the government is in talks with its partners in each project to open a new chapter in the Mongolian investment story.

Expectations were high for the Oyu Tolgoi copper mine and Tavan Tolgoi coking coal mine; both projects ride on their enormous reserves of 2.7m tonnes of recoverable copper and 1.84bn tonnes of coal, which are in big demand in next-door China. "Mongolia is an extended China resource play," says Howard Lambert, chief representative of ING Bank in Mongolia. "If you believe in China's demand for commodities, Mongolia should be on your radar as a producer of low-cost minerals."

However, the gloss has come off the projects after a series of disputes between the government and the projects' partners, as well as slowing growth in China. The International Monetary Fund (IMF) warned in its World Economic Outlook report in October that a slowing Chinese economy has caused it to cut Mongolia's projected GDP growth for 2015 from 7.6% to 5.8% and for 2016 from 9.6% to 3.6%. "China's economy is expected to rebalance away from a mostly investment-based growth model toward a more consumption-based growth model," Geert Almekinders, who led a recent IMF mission to Mongolia, said on October 7. "Both these factors are bound to have major spillovers globally and especially in the region. Spillover risks will particularly affect the more vulnerable emerging market economies. In light of this, Mongolia needs to change course to avoid becoming highly exposed to these external shocks and risks of crisis."

The problem for Mongolia is that too much hope has been invested in these two mines. For example, the investment agreement signed in 2009 governing Oyu Tolgoi, which is destined to be one of the world's largest producing copper mines, set the stage for the investment boom in Mongolia and it acts as an investment bellwether for the economy as a whole.

However, the Mongolian government has found itself continually at loggerheads with Rio Tinto, which is leading operations at Oyu Tolgoi with a 66% stake in the project through its subsidiary Turquoise Hill Resources. The development of an underground mine there, where the company says 80% of the mine's value lies, is on hold after a government official notified Rio that parliamentary approval was necessary for a $4bn project financing package. Rio says the financing package is the only option to move forward, but the government is hesitant to permit the financing package until it has a better understanding of costs related to the project.

Then there's the problem at the state-owned coal miner Erdenes Tavan Tolgoi, or Erdenes TT as locals call it, since it signed an off-take agreement with Aluminum Corporation of China (Chalco) that left it with $350m in debt to be repaid in coal exports. Erdenes TT now regrets signing the contract because it set below-market prices for coal in an already depressed market. The Mongolian government has since attempted to cancel the contract by paying a cash penalty and even suggested it would try to secure a better deal from another Chinese state-owned miner, Shenhua. That didn't pan out, however, and Mongolia has since been stuck with the original deal.

Public pay-off

An attempt to deliver immediate benefits from the mining boom to a population where some 30% still live in poverty has also created problems for both projects. Oyu Tolgoi and Tavan Tolgoi were required to contribute $250m and $350m respectively to the Human Development Fund (HDF), whose ambitious goal is to bring Mongolia's human development status to the same level as that of the developed countries by 2020. Although the programme was sold as a way to turn mining profits into societal benefits, in practice redistributing those loans to the country's 2.9m citizens in cash has been more effective in driving up inflation, which until March had been in double digits for the previous two years, hitting 14% in December 2012. Erdenes TT was financially crippled by the HDF obligation, while Rio expected its debt to the fund to be treated as a pre-paid tax credit for 2012, but the government refused to allow it, creating another bone of contention.

Despite the stumbling blocks, Lambert at ING, which was the first foreign bank to open a representative office here in 2008 and has seen at first hand the ups and downs at both projects, says the problems with the two mines need to be put into context. "In terms of mineral production, Mongolia has come a long way in a relatively short period of time," he argues. "OT [Oyu Tolgoi] is producing from phase one, which is a milestone achievement. [Erdenes] TT is also producing and has been for some time - the question now is in relation to the timing of the buildout of the necessary infrastructure, power, wash plant and rail."

One optimistic sign is politicians' apparent mellowing over the issue of ownership at Oyu Tolgoi, which given its importance has always put it at the centre of a bitter debate over resource nationalism. A number of populist-leaning politicians criticised the 2009 investment agreement because it leaves Mongolia with a minority share of 34%. But now even the mining minister, a long-time critic of the original agreement, has softened his stance. "It is true, I used to criticize the Oyu Tolgoi agreement," said Mining Minister Davaajav Gankhuyag at a September 26 press conference. "Now the government of Mongolia is not against the OT agreement... The OT agreement was made already, so we'll fulfil the agreement and everything shall be handled according to the agreement."

The two sides are back at the negotiating table. Government officials met with Rio management in London in late September and another meeting is widely expected to be held in Ulaanbaatar soon. Since then, Mongolian officials have spoken more amicably about Oyu Tolgoi and the need to find consensus with the Anglo-Australian mining group. Prime Minister Norov Altankhuayg is also set to visit China on October 22, where many expect him to discuss outstanding issues with China about Erdenes Tavan Tolgoi's agreement with Chalco. He may also try and work out a customs issue that has prevented some 38,000 tonnes of copper concentrate that travelled over the border to China from reaching Chinese smelters.

An end to the mines' problems, and a new beginning for Mongolian investment, could be in sight.