Oliver Belfitt-Nash in Ulaanbaatar -

Residents wake everyday to thick smog and the whiff of open coal fire smoke that clings to clothes. On warm days power cuts are still common enough to be the bane of computer users but uncommon enough to cause them to act to prevent losing all their work next time it happens. Welcome to Ulaanbaatar, Mongolia's capital.

Economists stare in awe at Mongolia's natural resources and the predicted economic growth rates they will back, but you'll have a hard time persuading a shivering family whose heating has been cut off on a -40° Celsius night that Mongolia is an economic wunderkind.

The country's infrastructure can barely support the population as it is, and with a development sprint about to start, the locals are beginning to worry about the effects from all this growth. Roads must be built, services improved, jobs created and corruption quashed, but nothing is possible without more electricity.

Keep the coal

Mongolia has lots of coal - an estimated 22.3bn tonnes of proven reserves, which ranks it 10th in the world. Investors have begun to pour cash into the sector and get coal out across the border to China. The Mongolian Mining Corporation (MMC) listed last year in Hong Kong and now has a market capitalisation of $5bn, almost equivalent in value to the entire Mongolian economy. The International Monetary Fund (IMF) predicts Mongolia's GDP growth will hit 28% in 2013, the highest in the world. But without more power, that growth will hit a bottleneck in the very near future.

The problem is that Mongolia's 2.7m people rely on seven old soviet-era combined heating plants (CHPs) dotted over a vast 1.5m-kilometre land mass. The central grid supports the majority of this with five coal-fired plants. In addition to that, 4.4% of Mongolia's total energy comes down a line from Russia, bringing total installed capacity to a mere 774 megawatts (MW). During peak demand in winter, the current capacity barely keeps the lights on. And in 2010, demand hit a shocking 96% of generating capacity.

The heating system is in even worse shape, with some eastern districts of the capital already unable to cope with demand. When temperatures fall below -25°C and stay there for several months during winter, the lack of heating becomes a real life-threatening crisis.

Stunted by the old soviet pricing system, the state-run mines and power plants are operating at a loss. So Mongolia's Energy Regulation Authority (ERA) was founded in 2001 to solve the problem. "A new CHP plant is needed urgently, but the companies cannot improve and expand when increasing tariffs is politically forbidden," says Mujaan Ganchimeg, head of the Tariff and Pricing Department. "However, we now have the authority to allow prices to rise gradually, and will achieve cost-effective power suppliers by 2013."

The new agreement, structured by the ERA, has recently been approved by parliament. It includes a drive to encourage private investment, build a new power plant and finally amend the Energy Law. It is the first big step towards upgrading this decayed system free from political manipulation. "We have a yearly 36bn tugrik ($28.8m) subsidy to carry this through. Through PR, journalism and reports, people must understand what's at stake for the future."

The wind in the steppes

Newcom, one of Mongolia's largest investment groups, has other ideas. "Coal is simply not sustainable," argues Bayanjargal Byambasaikhan, Newcom's managing director.

His company focuses on long-term infrastructure projects and is the only Mongolian giant without a mining subsidiary. Its latest project is an ambitious 50-MW wind farm project to connect directly to the central grid, due to come online in 2012. It will be the first commissioned power project of any kind since 1984 when the last soviet power plant was finished. With help from the European bank for Reconstruction and Development (EBRD) and FMO (Netherlands Development Finance Company), $80m will be spent to harness the open steppes' abundant wind energy. "Coal may export energy, but we would import pollution - we can't have that, take a look outside," says Byambasaikhan.

Indeed, Ulaanbaatar hosts an average particulate matter concentration level 14 times higher than the World Health Organisation's recommended level, resulting in extremely high instances of bronchitis and cardiovascular disease. Some 70% of this pollution comes from people burning open fires in the poor ghetto areas to keep warm in winter. These migrants have moved from the countryside to be part of the economic boom in the cities, but now find themselves stuck in abysmal conditions. "We either re-house these families or just hope for wind," says Byambasaikhan.

As a viable alternative, Byambasaikhan makes a good case. It costs $1.5m per MW of wind energy versus $1.4m per MW of coal-fired CHP power. Wind-generated power can be exported to China and this will be completely sustainable for the future. With the government's 2005 Clean Energy Program, wind energy could be sold to the central energy system at a higher price than coal power to encourage projects like these. "Our dream is to eventually create a 10-gigawatt farm in the South Gobi region," he says, sweeping his hand across a map covered in red to indicate high levels of wind energy.

But the wind project will be too little, too late given the ballistic economic growth projections for the next few years. Mongolia needs energy now. "The new power plant should have been completed three years ago, not just beginning," says Byambasaikhan. "We are now at a stage where the only way to increase capacity fast enough is to improve efficiency. Close windows, turn off lights, save energy. Short term, there are really no other options. The shortage will hit any day now."