Terrence Edwards in Ulaanbaatar -

When things get too heated, sometimes it's best to take a step back and let cooler heads prevail. Perhaps that's what the world's second-largest miner Rio Tinto is hoping after talks on the future of the prized Oyu Tolgoi copper/gold mine with the Mongolian government were put on hold until after the country's lunar new year celebrations.

The latest heated talks took place in Ulaanbaatar on February 7 and centred on issues relating to the soaring cost of the gold and copper venture, furthering Mongolian participation in its management, and increasing the number of local companies that can benefit from the project, including the use of a Mongolian bank, the government said in a statement.

Rio Tinto is increasingly facing the prospect of losing the right to exploit the deposit to local companies - as has already happened to other unlucky multinationals hoping to profit from Mongolia's cornucopia of natural resources. Fears were heightened by remarks from President Tsakhia Elbegdorj on February 1 that Mongolia should have more control of the mine, which is 34% owned by Mongolia's government, with the other 66% owned by Rio Tinto unit Turquoise Hill Resources.

The upsurge in tensions is primarily down to costs for the project ballooning, which means Mongolia will have to wait for its dividends that are paid out after the private investors recuperate their initial investment. On February 5, Rio Tinto admitted that the first phase of developing Oyu Tolgoi would be 16% higher than originally planned at $6.6bn. According to an e-mailed statement from the government to Bloomberg, the total cost of the Rio Tinto-operated development in southern Mongolia has jumped to $24.4bn, versus the company's earlier estimate for a total cost of $14.6bn.

A lot is at stake. The mine will account for about a third of Mongolia's economy by itself after it becomes fully operational, says Rio Tinto. Naturally, the government is extremely interested in the project and the Mongolian parliament was already pushing for a bigger slice of the Oyu Tolgoi pie at the end of 2011 and again in 2012. "Although it is hard to see how Rio would benefit from overspending on this project, discrediting the [investment agreement] could work in the government's favour in their intention of increasing the state's share of the mine," reckons Vidur Jain, an analyst at Ulaanbaatar-based Monet Capital.

Government intrusions

Projects on an economy-sized scale are always intensely political and prone to cost-related problems. On the one hand, the government wants to grab as much revenue as they can out of what lies in the ground; on the other, foreign investors tend to play down the costs initially in order to win the right to exploit the deposits in the first place.

Shell fell into the same trap with the Sakhalin-2 field in Russia's Far East. The Kremlin was incensed after Shell announced in 2006 that development costs were going to come in at double the original estimate, meaning that the state would have to wait a lot longer for its first payout. The Russian government promptly suspended Shell's license and arranged for state-owned Gazprom to buy a majority stake in the project - about half of Shell's 55% stake and half of Japan Mitsui & Co's - for a paltry $7.5bn. To add injury to insult, Shell also got itself into trouble on environmental grounds by disturbing the important local fishing industry.

The partners developing the giant Kashagan oilfield in Kazakhstan also found themselves facing environmental impact allegations after the operator presided over long delays and cost overruns. Instead of 2005, delays now mean that Kashagan won't see first oil until later this year, while costs have soared from the initially envisaged $57bn to $136bn. A long drawn-out dispute with the Kazakh government was finally resolved in late 2008 when the shareholders in the project - Eni, Shell, Total, Exxon Mobil, ConocoPhillips and Inpex - agreed to give up part of their shares in the project to allow the state-owned KazMunaiGas to raise its stake to 16.81% from 8.33%. Further, a new operating company called the North Caspian Operating Company replaced the previous operator, Eni subsidiary Agip KCO.

Rio Tinto has got into similar trouble by disrupting the centuries-old herding patterns of Mongolia's nomadic population in the Gobi desert. Indeed, the environmental problems could come back to haunt Rio Tinto. Oyu Tolgoi Watch, an NGO dedicated to monitoring the mining activities at Oyu Tolgoi, in cooperation with the Bank Information Center and London Mining Network, sent out a press release last year criticizing the International Financial Corporation (IFC), the World Bank's financing arm, for even considering a loan for the project. It described the environmental and social impacts assessment (ESIA) as "an elaborate and costly hoax" that only concentrated on the construction phase of the mine while ignoring the impacts once commercial production began.

Rio Tinto has also done little to uphold the "social contract" that was part of the package, argue its legion of critics. The company has earmarked only $1.5m to set up vocational training programme and the renovation of four schools. Mongolian MPs have become increasingly vocal about these shortcomings.

Sainkhuu Ganbaatar - Mongolia's second most popular political figure according to the Sant Maral Foundation, a local pollster - remains unconvinced of Rio's sincerity. "They're just making show - it's show business. They pay some wages and give the odd scholarship to some young people or create an official training centre, and make a show for TV," said Ganbaatar in an interview last August.

Speaking on the growing number of unemployed youth in Mongolia, he added: "They spend a lot of money on media, but they don't give any guarantee to get them employed."

Rio Tinto in January forced out its CEO Tom Albanese in January following $14bn in write-downs. With so much riding on Oyu Tolgoi, a disaster at this project could spell disaster for Albanese's successor, Sam Walsh.