The Changing Legal Environment for Mining in Mongolia
By Christian Packard (Legal Para-Professional) & Odmaa Khurelbold (Attorney)
Anderson & Anderson LLP, Ulaanbaatar Office
According to the World Bank’s 2007 Doing Business report,[ Available online at: http://rru.worldbank.org/businessplanet/] Inner Asia is a rather miserable place to run a business. If you drew a line from Hanoi to Moscow, it would not enter any country where doing business was described as “easy” in 2007. The best country to be found on that line would actually be “moderately difficult” Kazakhstan, which ranked substantially more business-friendly than China and far friendlier than Russia or the other former-Soviet “stans” on its southern border. However, if we turn our attention to Mongolia we find that it shares much of the same social, political, and legal legacy of those other countries and yet ranks above all of them, placing comfortably in the top third of the world. Mongolia still has its problems though, and while China advanced eight places in the Doing Business ranking, Mongolia slipped four, putting it in a category of countries falling just as fast as Iraq.
It is no secret that Mongolia’s most prominent business sector today is the mining industry. Therefore, whatever was the cause of Mongolia’s retreat from business-friendliness should be found, or at the very least reflected, in that industry’s surroundings, and there have indeed been some major shifts in the part of Mongolia’s legal environment that deals with the mining industry. Before we go in to more detail about just what those shifts are, it would be instructive to reflect on the major developments in Mongolian mining law in recent history.
The Bumpy Road to a Booming Market
Over the last two decades since the end of communism in far-northern Asia, Mongolia’s legal framework for the regulation of mining has also undergone major changes. A hundred years ago, prior to the Soviet era, there was essentially no resource exploitation to speak of in what was then Qing Dynasty Outer Mongolia. Between that time and the “democratic revolution,” as it is today called, exploration and mining was the exclusive right of the Soviet Union and its allies. Though mining-related activities never reached today’s scale, some work in that sector was undertaken by Soviet and Czech state-owned firms, and their activities were governed exclusively under bilateral treaty.
With the collapse of the Soviet Union, the newly created Russian Federation did take responsibility for all of the USSR’s legal obligations, treaty and otherwise. For the first half of the 1990s, the situation remained unchanged, with no indigenous laws regulating mining in Mongolia. Then in 1994, the first Minerals Law was adopted, and it entered into force on the 1st of January 1995. Several revisions were pushed through the Ikh Hural in 1996-7, leaving the taxation and royalty burdens for investors very low, while making conditions for foreign investment in the mining sector very favorable. For almost a decade that law was the authority on all things related to mineral resources extraction.
Ten years later, the millennium was in full swing. Unprecedented economic growth around the world fueled demand for commodities and natural resources, including gold and copper, which though not exactly common in Mongolia are found in very large deposits. From 2000 to 2005, the price of gold per ounce almost doubled from US$272.15 to $513.00. At the same time, the market price of copper per pound has exploded, more than quintupling from $0.60 in 2000 to $3.50 in April of this year.
For any country, but especially for one whose GDP ranked 147th out of the nations of the world, failing to take advantage of this rise in prices would be almost criminally negligent. Moreover, in a democracy where GDP per capita in 2007 ranked 138th worldwide, failing to direct at least some of this potential wealth to the electorate would be politically fatal. Thus in the first half of 2006 the 1997 Minerals Law was subjected to parliamentary review and a new version was legislated in the middle of that year.
New Laws, New Problems
This new version of the Minerals Law was much less welcoming to investors from abroad, requiring all new applicants for mining licenses to be legal persons established under and regulated by Mongolian law, and for them to be Mongolian taxpayers. Effectively this prohibited foreign investors from directly owning mining licenses, though they could still establish wholly-owned local subsidiaries to acquire said licenses. However, this is a comparatively minor obstacle.
In another significant development, the revised law has also modified the licensing requirements and license transfer procedures. Under the revised law an applicant for an exploration license must be eligible to hold the license as mentioned above. Only the exploration license holder is entitled to apply for a mining license in the area licensed for exploration. Also, there are now limits on the size of exploration areas which can be applied for under to this law. The size of a proposed exploration area must not be less than 25 hectares and must not exceed 400,000 hectares, Minerals Law, Article 17.4.
A license holder may transfer its license to its subsidiary companies in the event of a merger and may also sell it to another person eligible to hold the license, Minerals Law, Article 49.
To provide security for financing of their investments and for the operations of a particular project, a license holder can pledge their licenses to a bank or other financial organization. The license holder submits a copy of the pledge agreement, together with the license certificate and an application, to the Mineral Resources and Petroleum Authority. The Authority then records the pledge of the license and allows the pledgee to keep the license certificate. If the license holder fails to fulfill its obligations under the pledge agreement, then the pledgee has the right to first propose a transfer of the license to a person eligible to hold such a license, Minerals Law, Article 51.7.
The revisions in the law also raised royalty rates on the sale of certain national resources from 2.5% to 5% of the total sales value of those resources. Mining license holders pay royalties to the treasuries of the central and local administrative bodies on sales of all products sold, shipped for sale, or used, which were extracted from mining claims. This royalty rate varies depending on the type of the mineral resources, and their use. Royalties for domestically sold coal, to be used for energy, and common mineral recourses is two and one-half (2.5) per cent of its sales value. However, royalties for other extracted products other than those mentioned above, meaning coal sold abroad and uncommon mineral resources, are now five (5.0) per cent of the sales value of those products, according to the revised Minerals Law, Article 47.
Furthermore, this law for the first time connected Mongolia’s mining industry to that country’s concept of national security. If a mineral deposit found by privately funded exploration is designated to be of “strategic importance,” then the government, invoking this law, can acquire a 34% stake in that deposit. “Strategic importance” is defined in the law. A deposit will be declared “strategic” if: 1) It may have an affect on national security, 2) It may affect the economic and social development of the country, or 3) It produces or has the potential to produce more than 5% of the country’s GDP in a given year, Minerals Law, Article 4.1.11. Of course, these are rather vague conditions, but they have for the moment placated some investor panic.
On the 18th of February of this year, the Great Khural declared 15 deposits as “strategic,” including the following: Tawan Tolgoi (coal); Baganuur (coal); Mardai(uranium); Dornod (zinc); Tumurtei (iron); Tsagaan Suwarga (copper and molybdenum); Erdenet (copper); Asgat (silver); Oyu Tolgoi (copper and gold); Nariin Suhait; Shiwee Owoo; and Gurwan Bulag. Out of these projects, the government is still working what the size of their share in the Tsagaan Suwarga, Asgat, Tawan Tolgoi, and Oyu Tolgoi deposits will be.[ Unen News, 18th February, 2007.] In every case, the deposit is substantially large, but the market values and potential uses of the minerals in question vary widely.
It is also unlikely that the government would take their 34% (which is a maximum limit, they could take a lower share if they wished) by expropriation. Instead, they have promised to take their share through accepted financial means, like purchasing shares or equity participation. Though this has again calmed alarmists on the side of foreign investors, it has generated quite a bit of dissatisfaction among those same groups who pressured the government into revising the law. Those groups, the largest of which is the Civic Movement, would prefer a more unilateral course of action to the current practice of negotiating “investment agreements,” sometimes called “stability agreements,” concluded between the government and a particular given mining corporation. In fact, another group called the National Soyombo Movement is actually taking the government to the Constitutional Court over just such an agreement.[ “PM Sued over Draft, Protestors Overturn Ivanhoe Minibus,” Ulaanbaatar Post July 26 2007, Page 1.]
Investing in Stability and Stabilizing Investment
A firm becomes eligible to negotiate an investment agreement if they plan to invest more than US$50 million in their project in the first five years of its operation in Mongolia. Such an agreement, once concluded, would be in effect for up to 30 years, Minerals Law, Article 29. This is different from the maximum term of an investment agreement for enterprises unrelated to mining, which are governed by the Law on Foreign Investment. However, the process of negotiating these agreements is at times proving to be both protracted and difficult, as it requires the direct involvement of the Ikh Khural, who must give their approval. In the cases of Ivanhoe Mines and others, negotiations began over a year ago and are still ongoing today.
Furthermore, these agreements do not simply cover the acquisition of a stake in a given project by the government. They are also supposed to address a further seven issues of concern to both the mining companies and the government, Minerals Law, Article 29.1.:
1) The establishment and maintenance of a stable tax regime. This is where the term “stability agreement” comes from. Essentially the corporation in question and the government agree to a set level of taxation for the duration of the agreement which will remain unchanged for that corporation even regardless of whether Mongolia’s tax laws change. Thus a hike in general taxes would not drive out a given firm, as their tax obligations would be covered instead by their bilateral agreement with the government.
2) The sale and export of product at international market prices. This has the potential to prevent both price gouging by corporations and government discounts.
3) A guarantee of the right of the investor to dispose of the income gained. Note that this guarantee, in its generic form related here, does not include how such income would be disposed, simply that the investor is entitled to repatriate it.
4) The amount and period of the investment. Again, the minimum must be US$50 million in the first five years. In some cases, large mining projects have a potential lifespan extending across several future generations, perhaps for more than a century.
5) The effect of mining operations on public health, environmental protection, and the eventual rehabilitation of the land used. The commissioning of environmental impact studies is already a standard practice for legitimate mining undertakings in Mongolia, so this is not a particularly harsh requirement. However now instead of dealing with mid-level officials in the ministries of the environment and public health, a given firm is likely to find its work scrutinized by the ministers themselves.
6) Regional development and the creation of local employment. In addition to negotiating investment directly into a mining project both by a mining firm and the Mongolian government, negotiations may encourage the firm to contribute funding, or fund entirely on their own, local training facilities including, but not limited to, establishing schools, scholarships or other programs for Mongolian nationals. Ivanhoe Mines, though their stability agreement has not yet been approved by the Ikh Hural, has taken the initiative on this point by establishing a scholarship program for interested Mongolian nationals with a certain level of proficiency in English to travel to Australia and study in one of many mining-related fields. This point is enforced by a restriction in the Mining Law that limits companies engaged in mining or exploration to hiring a workforce which is at most 10% foreign. For every foreign employee, there must be nine Mongolian nationals, thus providing a rather large incentive to train locals.
7) Compensation for any damages caused. Again, in this generic form it is unclear whose liability is to be negotiated. However, if both sides can come to a mutual understanding regarding their specific spheres of responsibility and obligations within those spheres, then this will in turn create mutual trust and understanding.
The Windfall Tax
At the same time, specifically in May of 2006, that the mining law was revised, the Mongolian parliament passed the separate Windfall Profits Tax Law, which though innocuously named was targeted explicitly at enterprises engaged in gold and copper mining and their revenues. The simplified version of how this tax operates is that at times when the market price of gold exceeds US$500 per ounce or the price of copper exceeds US$2,600 per ton then a 68% tax on the profits from the sale of the metal in question is imposed, Law on Windfall Profits Tax, Article 7.1. According to this law, “profits,” or taxable income, are determined differently for gold and copper.
For copper, the profits are equivalent to the total income per unit from the sale of copper minus what is in the law called the “base price of copper” and the “copper smelting costs.” The former is defined as the sum of the cost of extracting ore and producing a concentrate and 100% equivalent of profits, and the latter as the costs of smelting, refinement, and other direct costs related to this process, both per unit of copper, Law on Windfall Profits Tax, Article 4.1.2.
For example, suppose that the market price of copper was US$15,000 per ton, the base copper price US$5,000 per ton, and the copper smelting cost also US$5,000 per ton. The taxable income would be US$15,000 minus US$10,000 (the combined total of the base copper price and the copper smelting cost). That is, US$5,000 from the sale of every ton of copper would be subject to the Windfall Profits Tax, and the remaining US$10,000 would be exempt.
The rules for determining profits on gold are much simpler. The taxable income for profits from the sale of gold is determined by subtracting US$500 from the market price of gold per ounce as established by the Bank of Mongolia. For every ounce of gold sold, US$500 received is exempt from the Windfall Profits Tax. The remaining profits, however, are subject to a 68% tax. For example, if the market price was (hypothetically) US$2,000 per ounce, the tax is only applied to US$1,500 per ounce sold. If the government-dictated price of gold falls below US$500, then the tax will not be collected and no one will be obligated to pay. How exactly the Bank of Mongolia determines the price of gold on a given day is not entirely clear. They have stated in various media outlets that they will take into account the world market price of gold, but they are under no legal obligation to do so, , Law on Windfall Profits Tax, Article 4.1.4.
It has been implicitly recognized by members of the Mongolian political establishment that this tax is essentially a stopgap measure to appease the discontented citizenry. Even President Enkhbayar has been quoted as saying the tax does not address possible “bad times.”[ “Commodity Prices Continue to Fall; Legislation Coming?” Luke Distelhorst, June 19, 2006. http://mongolia.neweurasia.net/?p=269] If commodity prices sink below a level where the Windfall Profits Tax is no longer profitable for the government, its existence would be something of an embarrassment and a possible deterrent to future investment. Also, though it is not mentioned in the law, in practice companies are exempt from this tax if they conclude a bilateral investment agreement with the government, effectively rendering enforcement of it optional. It has been said that the most permanent remedies are those which were meant to be temporary. However, there has been enough discontent both from economic nationalists and spooked investors that this situation is not guaranteed to remain the status quo forever.
Possible Futures
Recently, two possible directions for further mining-related legislation have been discussed in Parliament. One proposed plan greatly increases barriers to mining on environmental grounds. On the first of November of this year, the Mongolian newspaper Odriin Sonin (Daily News) reported that certain MPs have introduced a new bill to Parliament which would introduce an “ecological green zone” to Mongolia where no new mining licenses would be granted. Existing licenses would remain untouched, but would not be renewed following their expiration. The green zone, in its not yet negotiated form would cover all of Mongolia’s territory above the 47th parallel, above which can be found 80% of Mongolia’s water resources and 90% of its forests. For reference, this line cuts just south of the capital, Ulaanbaatar, and would most significantly affect the mining projects around the city of Erdenet in Bulgan Aimag. As mentioned above, the Erdenet copper deposit is one of Mongolia’s fifteen deposits currently designated as “strategic,” and it remains to be seen whether this will be taken into account should this bill become law. Even if it does, Mongolia’s largest deposits are mostly concentrated in the south, in the Gobi aimags, and thus the damage to the mining industry as a whole would be small, though certain projects would be effectively sunk.
The other set of suggestions was recently posted on the website of the Mineral Resources and Petroleum Authority.[ Available online at: www.mram/index.php?coid=568cid=71] Their envisioned goals are paraphrased as follows:
1) To amend the Minerals Law and the Law on the Preservation of Land in order to allow for geological surveys on protected land and in Mongolia’s border zones.
2) To amend the Minerals Law in order to sell mining and exploration licenses more freely and to allow for initial public offerings in mining exploration projects and the sale of shares on the stock exchange.
3) To amend the Tax Law and the Minerals Law in order to attract more attention from foreign and Mongolian companies engaged in exploration for precious metals, including gold.
4) To resolve issues regarding tax breaks to encourage the activities of surveying companies engaged in activity in remote areas.
5) To amend the Minerals Law such that factory resources and state-owned assets become better integrated with and more active in the economy at the expense of the state budget.
These objectives are rather noble on paper, but these are all long term goals. The more pressing concern at the moment for large foreign investors is the negotiation and conclusion of investment agreements with the government. This has finally become a practical solution, as the tax plan portion of Centerra Gold’s agreement for their Boroo goldmine project was finally completed in the early days of November of this year. This agreement will set Centerra’s corporate income tax at 25% (well below the 68% indicated in the Windfall Profits Tax Law), while keeping their royalties at 5%. This arrangement will remain in effect until 2013, well short of the maximum 30 years, but enough to at least begin production at the Boroo goldmine site.[ “Mongolia, Centerra Gold agree on tax plan thru 2013,” http://www.mongolia-web.com/content/view/1462/2/ Mongolia Web, November 2, 2007.] On the other hand, wrangling over the agreement between the Government and Ivanhoe mines is dragging on, much to the chagrin of Ivanhoe’s part-owner, Rio Tinto.[ “Rio Tinto warns Mongolia over plodding mining deal,” Reuters News Service, November 8, 2007.]
Both of the above described plans appear to go in different directions, one favoring greater restriction and the other greater incentive. However, while they are being discussed by certain parts of the Mongolian government, other parts are concluding hugely significant stability agreements with major foreign investors. Mongolia is most definitely a civil law country, and as such precedent does not carry the same legal weight that it might in certain other countries. However, the practical precedent being set in Mongolia’s mining sector today is that of the stability agreement. If this process plays itself out without investors fleeing Mongolia en masse, both those investors and the government will have survived a protracted period of very close dialogue and intense negotiations. If those two groups can learn to trust each other and consult with each other before suddenly launching huge new taxes or brashly threatening to completely give up, then it is likely that Mongolia can reverse its trend of frightening its resident businessmen and continue its position as the single most business-friendly country in Inner Asia.