SouthGobi makes a slow crawl back from Mongolian purgatory

By bne IntelliNews April 12, 2013

Terrence Edwards in Ulaanbaatar -

Though Mongolia-focused coal miner SouthGobi Resources had time for a short hooray following the relaunch of operations at its Ovoot Tolgoi project, it still has a myriad of issues to contend with if it's to appease both investors and the Mongolian government.

Just three days after announcing the relaunch of operations on March 22, SouthGobi released an inevitable dismal annual report that included a $103m loss for 2012 –inevitable because the company became the epicentre of a fierce fight over resource nationalism in Mongolia and worries there about growing Chinese influence, and had to endure nine months of being unable to mine its coal deposits while the Mongolian government put the company's licenses under a microscope. That loss compared with a $57.7m net profit for the previous year when operations went undisturbed.

"While a certain amount of volatility remains in the coal markets, signs of improvement justify this restart of operations," said the Canadian-listed company in a statement about the return of operations. "The flow of coal and sales will be carefully managed in order to react quickly to any future changes in market conditions."

For many, the company's fate was sealed in January 2012 when Rio Tinto bought a controlling stake in Turquoise Hill Resources (then known as Ivanhoe Mines), the majority owner of SouthGobi. Rio made it clear that it was interested in holding on to only one of Turquoise Hill's Mongolian assets, with its eyes clearly fixed on the prized Oyu Tolgoi copper and gold mine.

The day to cut SouthGobi loose finally came in March 2012 when a deal was struck to sell Turquoise Hill's 57.6% stake in the coal miner to Aluminum Corporation of China (Chalco). Another Chinese entity, the sovereign wealth fund China Investment Corporation, already owned 14% of the SouthGobi.

Turquoise Hill had hoped to use the proceeds from the sale of the SouthGobi stake to directly fund the development of its $6.6bn Oyu Tolgoi copper/gold mine, but instead the proposed deal set alarms bells ringing in political circles already on edge about growing Chinese influence in the country. The result was the politicians dusted off a piece of draft legislation on foreign investment in the country's natural resources that until then had been languishing and rushed its passage through Mongolia's parliament, plunging SouthGobi into financial difficulties and sending shock waves rippling out through the rest of Mongolia's mining sector.

Government officials said the law was meant to create a review process for deals involving foreign investors in the country's resources that involved parliament, but without a mechanism to see the process through, it effectively killed the deal. Chalco announced last October it had given up trying to take control of SouthGobi, as well as the proposed purchase of a 29.9% interest in Mongolian coking coal supplier Winsway Coking Coal Holdings.

Immediately following the March 2012 announcement of Chalco's proposed purchase of the stake, the government also said it would suspend SouthGobi's licenses, although the company insisted its licenses were in good order. But then an official at the Mineral Resources Authority of Mongolia was arrested for an illegal transfer of licenses, including one held by SouthGobi. Extraction halted at the end of June 2012 and SouthGobi had to start burning through its stockpiled reserves to supply customers. SouthGobi saw its share price on the Toronto Stock Exchange fall 74% from a 52-week high hit in April 2012 of $7.32 to as low as $1.84.


According to Philipp Marxen, chief executive of Xacleasing, which provides the trucks and other base equipment necessary for mining operations, the ups and downs experienced by the coal miner were largely indicative of the sentiment felt throughout the industry as a whole. "In discussions with our lessees, which have been sub-contractors of SouthGobi, the importance of this mining firm's success as a bellwether of the foreign-invested mining sector has become obvious," says Marxen. "If the company can start full-scale production and increase coal exports again, this will positively affect the supply chain."

SouthGobi is likely hoping for some backing from the Mongolian government as it tries to put the incident behind it. The investigation that began last year for the alleged illegal license transfer is still ongoing and the president of the mining unit leading the Mongolian operation, Justin Kapla, is prohibited from leaving the country while authorities continue to look into the matter. According to company spokesperson Altanbagana Bayarsaikhan, one other remaining license requirement under question for failing to meet minimum spending was not considered "material to its business".

The company will also need the government to honour its past project approvals as it deals with a legal battle with a local citizens' council in a province called Umnugobi. The council placed some of its licensed territory for exploration under special protection. Although a local court revoked that protection, the council is appealing the decision. "We are working hard to maintain good relationships with all of our stakeholders including the Mongolian government," Ross Tromans, SouthGobi president and CEO, said in an investor call for its 2012 annual financial results.

He added, "I think that generally, we are working at improving those relationships and it's an ongoing process, whether there's been huge change, it's hard to tell but certainly the relationship is cordial and respectful."

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