Terrence Edwards in Ulaanbaatar -
Investors in Mongolia are hoping the giant Oyu Tolgoi copper mine can cure the sick economy, as optimistic projections for so-called “Doctor Copper” coincide with the landmark deal over an expansion project for the mine.
The deal over commissioning five underground mine shafts at Oyu Tolgoi, agreed on May 18 after years of wrangling between its two owner Rio Tinto and the Mongolian government, is expected to result in production arriving at a sweet spot for the red metal. Mongolia may have to depend more on copper in the coming years as the outlooks are quite poor for its other largest export commodities, iron and coal. Thus, extending the life of the mine by up to three decades is of huge importance and at peak production Oyu Tolgoi is alone expected to generate a third of Mongolia's GDP.
Oyu Tolgoi ranks among the world's largest copper deposits. However, last year it only produced a sixth as much concentrate as the world's largest, the Escondida mine in Chile, in which Rio Tinto also has a stake (Rio Tinto owns 66% of Oyu Tolgoi indirectly through majority-owned Turquoise Hill Resources; the Mongolian government owns the remaining 34%). Developing the underground complex is crucial because it contains 80% of the mineral wealth, geologists say.
Rio was under huge pressure from investors to lock down a deal with the Mongolian government in the hope that the expansion would align with a window when the price of copper is expected to rally due to a deficit of the metal on world markets. Nicknamed Doctor Copper for its ability to act as a gauge for the health of the global economy, the metal is closely correlated with global economic growth because it's so widely used in construction for its highly conductive properties for heat and electricity. “A project of this scale is bound to be affected by the commodity cycle over its lifetime,” says Neil Ashdown, an analyst for IHS Economics & Country Risk.
Analysts are predicting a global deficit starting at or around 2019. The underground mining complex in Mongolia will take between five and seven years to complete, according to Rio, which could see commercial production begin in 2020 if construction begins as soon as this year.
Global disruptions and delays to the development of other new copper projects are central to this prediction of a deficit. Miners are depleting deposits more quickly than originally expected because they have learned to accelerate production. There's also the time needed to bring new mines on stream, which can span decades. “So even if we were to discover a whole host of deposits over Latin America or Mongolia, the chance any of these actually contributing to the supply-demand balance over the time horizon that anyone is really interested in is vanishingly small,” Paul Gait, lead copper analyst for Bernstein Investment Research and Management, told an audience at the Natural Resources Forum in London in February.
But it was even before analysts picked up on this expected trend in copper that Rio was keen to develop copper projects. The global miner has looked to the red metal as it has sought to diversify its portfolio away from a heavy concentration in iron ore, which made up about 47% of revenue last year.
Similarly, Mongolia has become progressively more reliant on copper as its coal and iron ore sales continue to flop. Copper concentrate exports shot up 26% in April compared with a year ago, thanks to a ramp-up in production at Oyu Tolgoi. Coking coal and iron ore, meanwhile, fell 29% and 35%, respectively.
Long-term trends for coking coal and iron ore are uncertain because of growing oversupply. In addition to the slowdown in China sapping demand, concerns about the pollution pumped into the air from coal burning has pushed Beijing toward imposing restrictions on coal consumption and higher taxes on imports in 2014.
Both coal and copper prices have fallen some way this year, but increased exports from Oyu Tolgoi has resulted in net gains for copper exports. That's easier said than done for coal because of the vastly larger volumes of deliveries and the transportation bottlenecks in Mongolia. Ashdown at IHS reckons that of even greater importance than the state of the commodities market “is the quality of road and rail infrastructure to Mongolia’s international customers, as improvements in this regard will make Mongolia mineral exports more competitive.”
There's also always the worry over substitute commodities when there is price growth. Aluminium, for example, is often used as a conductor when copper gets too expensive.
Recognizing these risks, Mongolia introduced a fiscal stability fund in 2011 to act as a buffer for swings in commodity prices. If commodities are booming, the government stashes funds away that it can later tap into when prices fall. Unfortunately, there wasn't much time for saving before the country hit its economic bump in 2012.
The growth of non-mining industries will also factor into the development of a sustainable economy. There, too, Oyu Tolgoi can play a role. If it has learned anything from its economic illness, Mongolia will use the deal to expand the mine as momentum to launch a balanced diet of projects spanning a range of economic sectors.
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