Mongolia Investor Update


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What's the deel? 5 of the latest developments in natural resources and infrastructure

The proposed rule on the “double deel ” – where an individual holds two or more political positions leading to a potential conflict of interest – has led to vigorous debate in Mongolia. In April 2014, the “double deel” bill threatened to throw the Mongolian Parliament (“Parliament”) into disarray with 14 ministers – including the Prime Minister – holding dual positions. While the bill failed to pass into law, the Prime Minister Mr. Norov Altankhuyag was in any event removed from his post on 5 November 2014 by a Parliamentary vote of no confidence.

Mongolia’s volatile political environment is likely to keep many investors on the sidelines for the time being, in spite of enormous resources potential. Foreign direct investment (FDI) inflows to Mongolia, which have enjoyed phenomenal growth over the last 15 years, dropped 64% in the period from January to May 2014 (year-on-year).

In an attempt to arrest declining FDI, Parliament has accelerated reform in 5 areas that are relevant to investors, as we have outlined in this issue of BLP’s Mongolia Investor Update. However, it remains to be seen whether the new Prime Minister, once appointed, can move quickly to restore stability and build momentum from the foundation of these recent legislative changes.

1. New petroleum law

The oil industry is generally supportive of the Law of Mongolia on Petroleum (the “Petroleum Law”), which came into effect on 20 July 2014 after lengthy debate in the Parliament. However, it is hoped that the regulations to implement the Petroleum Law will provide further clarity around licence and production sharing agreement terms. The Petroleum Law replaces the previous law governing petroleum activity enacted in 1991, and comes at a time of expanding domestic extraction quantities and plans afoot to develop an oil refinery.

Key changes

The Petroleum Law introduces the following key changes:

  • Different types of petroleum products are now more clearly defined, with the main division between “petroleum” and “unconventional petroleum”. Oil shale, oil sands and coal bed methane are explicitly captured under the law, which is important as Mongolia’s oil shale resources in particular have received attention from investors.
  • Contractors need to apply to the Ministry of Mining for licences to carry out exploration or extraction operations. However, other “petroleum activities” such as prospecting, storage, transportation and sales are subject to less demanding forms of permissions or approvals. Please see enclosed table for a more detailed analysis.
  • In a bid to enhance transparency around production sharing agreements, royalty rates must be agreed within a range of 5 to 15% of extracted crude oil or natural gas, with a range of 5 to 10% for “unconventional petroleum”. However, the law does not prescribe the allocation of profit oil to the Mongolian Government, with this being agreed in each production sharing agreement. Based on publicly disclosed existing arrangements, we would expect the contractor’s share of profit oil to be 60% or less, depending on production rates.
  • Following reserve acceptance by the Ministry of Mining, an exploration licence holder may apply to convert its licence to an exploitation licence. The law specifies only limited circumstances in which an open tender may be held such as where project is state financed or the field has been returned to the state. This compares favourably with other regimes that require an open tender regardless of the original contractor’s role in the discovery.
  • The law sets out 18 different types of sanctions and fines, with fines being calculated by reference to the minimum monthly salary (up to around US $45k).
  • The law does not require the renegotiation of existing production sharing agreements so as to bring terms relating to product sharing, cost recovery and fees in line with the new regime. This comes as a relief to existing oil producers.

2. Amendments to 2006 Minerals Law and repeal of law prohibiting new exploration licences

As the backbone of economic growth, policies governing the realisation of Mongolian mineral wealth continues to lead to vigorous debate and a diverse range of opinions. Nevertheless, in order to reverse declining activity in the sector it is important that Mongolia moves quickly to promote investment and reduce investor uncertainty.

Our clients have expressed a mixed view on the Law of Mongolia on Amending the Minerals Law (the “Amendment”), which from 1 July 2014 amended the 2006 Law of Mongolia on Minerals (the “Minerals Law”). Together with the changes to the Minerals Law, the Amendment requires the Ministry of Mines to pass a number of implementing regulations which investors are keenly waiting for.

As a positive development:

  • at the same time as the Amendment, Parliament nullified the Law Banning the Issue of New Minerals Exploration Licences;
  • on 4 July 2014, Parliament passed a new regulation which provides for the re-issuance by a competitive tender process of the 106 licences revoked in 2013 in connection with the former head of the Mineral Resource Authority of Mongolia (“MRAM”) being found guilty of bribery; and
  • the Amendment extends the maximum term of exploration licences (except for licences for radioactive minerals) from 9 years to 12 years with the introduction of an optional third, three year licence extension.

Some other key changes as follows:

  • the maximum area of an exploration licence has been reduced from 400,000 hectares to 150,000 hectares. It is unclear whether this reduction will require existing licence holders to surrender area that is currently held;
  • additional obligations have been placed on mining licence holders. Notably, they must now give priority to:
  • (i) business entities registered in Mongolia when procuring goods/services or hiring subcontractors; and (ii) Mongolian concentrator plants when selling their extracted, concentrated or semi-processed products. They must also now ensure that 90% of the workforce of any sub-contractor working at their mine is comprised of Mongolian nationals (previously this obligation only applied in respect of the mining licence holder's own workforce); and
  • new powers have been given to the Mongolian Government, the Ministry of Mining and MRAM, with MRAM's functions now split between a newly created National Geology Office and the existing mining departments.

3. Updated list of concession projects

Reportedly, in October 2014 Parliament amended the list of 121 concession projects first approved in 2010. The list is under the purview of the Ministry of Economic Development. We understand that a new project on the list is the exclusion of the northern railway from Ovoot to Kyzyl. Other major PPP projects include the Tavan Tolgoi Power Plant, the Power Plant No. 5, and the renovation of the JSC Darkhan Metal Processing Plant.

By way of background, the Concession Law of Mongolia 2010 (the “Concession Law”) defines the process for the implementation of concession based infrastructure and social service projects, and is based on the UNCITRAL Model Legislative Provisions on Privately Financed Infrastructure Projects and other international guidelines. The Concession Law provides for a generally sound framework for PPPs in Mongolia when taken in isolation, and the multilateral agencies together with the Mongolian PPP Unit have been working towards improving interconnectivity with existing sector specific laws and the business environment generally in terms of enforcement of security and relevant institutional capacity.

4. Rail infrastructure – latest developments

Rail investors’ attention has been sparked by a number of recent announcements in the sector:

  • as we understand from market sources, Parliament has adopted a rail gauge compatible with China for the state funded railway from Tavan Tolgoi to the Chinese border town of Gashuun Sukhait, settling a long running dispute;
  • the Concession List (referred to above) has been amended to include a proposed railway in northern Mongolia; and
  • Chinese sources suggest that a new high speed railway from Russia to China will pass through Mongolia.

We will further update clients once the details relating to the new projects become available. However, bankability, demand and enforcement risk will need to be carefully considered.

5. Proposed new law on pledges

We understand that the Mongolian Minister of Justice has put forward a proposed bill for a new pledge law, which is likely to cover moveable property such as shares. A new pledge law has been on the table for a number of years, with technical advice received from a number of the development agencies, and if passed should significantly improve the secured transaction environment in Mongolia. Among other things, the new pledge law is likely to provide for a modern and accessible register of pledges, which has been lacking under the current environment. However, lenders and other investors will need to look closely at how the new law might improve the process for enforcement of security interests, including the reinforcement of the possibility of out of court enforcement. We will continue to update our clients as more details emerge.

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