China to Learn Multilateral Negotiations in Mongolian Venture

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Op-Ed Commentary: Chris Devonshire-Ellis

Jul. 28 – The Chinese state-owned mining company Shenhua has won the lead bid as part of a joint Chinese, Mongolian, Russian, and U.S. consortium to develop the western Tsankhi block of the Tavan Tolgoi coal mining field in Mongolia. Shenhua has been granted the leading 40 percent share, leaving a Russian-Mongolian concern with 36 percent and U.S.-based Peabody Energy with 24 percent.

The deal is typical in its political structuring, with the Mongolian government, as expected, opting in part to satisfy China’s huge appetite for energy resources. The open pit Tavan Tolgoi, one of the world’s largest untapped mines, has proven coal reserves of 6.4 billion tons, including 1.2 billion tons in the Tsankhi block alone. But the government also wants to use the mine project to strengthen its longtime political and cultural links with Russia, while including Peabody can be seen as a nod to America’s role as a geopolitical balancer in Asia, especially for Mongolia’s relations with China and Russia.

Shenhua has long shown its interest in Mongolian coal investment. In 2009, the company started building an Inner Mongolia railroad line from the coal-belt city Baotou to Ganqimaodu at the Mongolian border – just 180 kilometers from Tavan Tolgoi. Shenhua’s current annual production capacity is about 400 million tons of coal. The company currently has about RMB70 billion in cash available for acquisitions.

However, details of the three-way split at Tavan Tolgoi have yet to be finalized, and none of the three operators have given public explanations as to how they may proceed or even work together. That is likely to prove interesting for Shenhua, even with their larger stake.

Russian companies chosen by the Mongolian government have until now shown only scant interest in developing Tavan Tolgoi. Indeed, the Russians may eventually cash out by transferring their mining rights as soon as the contract is signed. For Mongolia, the government plans to use some of the money raised through the bidding process on social projects. The rest would go toward eastern Tavan Tolgoi mines being developed by Mongolia’s state-owned Erdenes, which is due for an initial public offering, perhaps on the Hong Kong or London Stock Exchange, in the first quarter of 2012.

Moreover, disagreements between the three winning bidders may arise over issues such as feasibility studies, spending levels and public stock. The Russian side lacks capital, while the Chinese and American concerns may differ over the project’s rate of return. A Huatai Securities research report said the three-way talks and the sheer size of the project may hold back a production startup until late 2013.

Another possible sticking point is transportation. Mongolia currently operates a single trunk railroad between the border with Russia and Erenhot, Inner Mongolia, that’s unable to meet current demand for freight trains and would be hard pressed to handle more coal trains.

However, railroad plans for the Tavan Tolgoi mine have yet to be determined. One option is to build a railroad south to Shenhua’s railhead in China. Another option is to build an east-west line linking Tavan Tolgoi to the existing north-south line between Russia and China. The Chinese government favors the first option, but for national security reasons Mongolian officials are unwilling to open a new rail line at the China-Mongolia border, according to a source with information on the topic.

The second option – which reportedly Russia prefers – would lead to the first upgrade for the Mongolian line to Erenhot since it opened about 60 years ago. Another challenge is that Mongolia has Russian-style, broad-gauge railroad tracks, while China’s are standard gauge. The Russian-backed option may have an additional advantage in that its Ministry of Railways and the Mongolia Ministry of Roads, Transport and Tourism each hold 50 percent of the Mongolian railroad operator, Ulaanbaatar Railway.

Either way, Shenhua, and the Chinese government, are going to be learning a great deal about multilateral cooperation between Russia and the United States while doing business in old Cold War territory. With China becoming partially dependent upon Mongolian reserves, they may have to be more flexible in the next decade over operating in multilateral joint ventures than they have shown in recent territorial disputes.

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