Terrence Edwards in Ulaanbaatar -

Mongolia is brokering its second-largest investment with a foreign consortium to help develop the troubled state-owned Tavan Tolgoi coalmine – a deal likely to set the tone for foreign investment under the new government headed by Prime Minister Chimed Saikhanbileg.

A deal that would put a group of investors that includes China Shenhua Energy in charge of Mongolia's largest coking coal deposit is expected to conclude before Mongolia's Lunar New Year celebrations begin on February 18. The strategic partnership with state-owned mining company Erdenes Tavan Tolgoi will put in motion the prime minister's plan to use this high-profile mining project as a means of restoring foreign investor confidence and boosting economic growth. “Getting significant export shipments of coal from the huge Tavan Tolgoi coal deposit will have a meaningful impact on GDP,” argues Jim Dwyer, executive director to the Business Council of Mongolia.

China Shenhua Energy and Japan's Sumitomo Corporation have teamed up with a mining unit owned by the Ulaanbaatar-based firm Mongolian Mining Corporation to come up with $4bn in investment to develop the mine in partnership with the state. That kind of foreign direct investment (FDI) is sorely needed after it fell 71% in the year to November 2014 compared with the same period the previous year.

Dwyer says the investment into Tavan Tolgoi could have a similar impact on Mongolia's $12bn economy as the initial $6.5bn investment between 2009 and 2013 into the country's other giant mine, Rio Tinto's Oyu Tolgoi copper-gold mine. The investment into Oyu Tolgoi had a multiplier effect, he says, that created about $3 for every dollar spent on the project. “It's hard to quantify, but it could be two to three times the amount of investment,” says Dwyer. “The $4bn could boost up to $8bn-12bn over two or three years as things move onward.”

Competitive coals

Located in the southern Gobi desert, about 200 kilometres from the Chinese border, the mine holds some 1.8bn tonnes of high-quality coal – with a wider resource amount put at around 7.8bn tonnes.

Despite the introduction of import duties on coal imports, China is still in need of higher grades of coal that pollute less – essential as the world's second largest economy struggles with choking air quality in cities such as Beijing. “A high-quality resource has premium hard coking [coal], which means volatiles of low ash and low sulphur,” says David Paull, managing director of Aspire Mining, which is currently developing Mongolia's second-largest coal resource, Ovoot, in north-west Mongolia. “It certainly reduces emissions.”

Paull said China is taxing all coal imports at a minimum 3%; lower-grade thermal coal, which is typically used to feed power plants, can be taxed up to 6%. He adds that Mongolian coal exports are “very competitive” against other nations' coal exports to China, such as those from Australia or Indonesia.

A troubled mine

Despite theses advantages, Tavan Tolgoi remains a troubled project. Poor management and a softer coal market have hit the company developing the coalmine, the state-owned Erdenes Tavan Tolgoi, hard.

The 1.8bn-tonne of high-quality coal reserves are divided into the East Tsankhi and West Tsankhi mine sites. Coal mining from the eastern block hasn't been profitable because it has only been used to pay back an upfront purchase and loan from Aluminum Corporation of China - better know as Chalco – totalling $350bn. Work became nearly impossible after the Mongolian government in 2011 forced it to borrow $310mn, according to the Ulaanbaatar-based Economic Research Institute, in order to finance monthly allowances of about $15 that were distributed to every Mongolian citizen. Politicians introduced the programme, which no longer runs, to ease voters' apprehensions that most would never benefit from the country’s mining industry. The financial strain from that largesse eventually resulted in suspended coal deliveries for much of 2013 after the firm fell behind on payments to transport companies. More recently, Australian contractor MacMahon Holdings halted mining at the East Tsankhi last August after months passed without payment worth $22mn.

The West Tsankhi part has been even less of a success. Mining was only launched last year, three years after Mongolia scrapped a strategic investment plan with a different group of investors that also included China Shenhua Energy. That plan was similar to the one being negotiated today, except it only granted control of the West Tsankhi mine. The deal never panned out because of outcry from Japan and South Korea over their exclusion from the strategic partnership. The unrealised deal also put on hold an expected three-city share offering in Hong Kong, London and Ulaanbaatar that Mongolian Investment Banking Group (MIBG) estimates would have been worth about $3bn at the time.

Mongolia is asking that the new consortium investors commit to at least $4bn in investment into the whole deposit. It also requires that Mongolian Mining own 51% of the deal because it is a Mongolian entity, although its shares are traded in Hong Kong. They'll also have to come up with a solution for the remaining debt to Chalco. “There's some question as to who's going to provide the financing,” says Dwyer, whose Business Council includes Erdenes Tavan Tolgoi as a member. “Can all of it coming from the 49% owners? The Mongolian party in the investment, they don't have the cash.”

Although the government hasn't made any statement regarding a possible IPO, MIBG reckons one might appear at the Hong Kong bourse. “Looking forward, participation by Energy Resources, a subsidiary of Mongolia Mining Corp., could lay the groundwork for a future Hong Kong listing,” says MIBG in a December email note to investors.

Further on the horizon are complementary projects, such as construction of a coal washing plant and power plant. The coal-fired power plant would be used to generate energy for itself and other mines nearby in the Mongolian Gobi desert. There's also a need for rail infrastructure to deliver the coal more cheaply and efficiently that Tavan Tolgoi already has a role in. “They've really got to build,” says Dwyer.

Indeed, and they'll need foreign investors to build anything.