Mongolia drops tax bombshell

Vancouver — From left field, and late on a Friday night, Mongolia’s parliament shocked Western mineral explorers by passing a windfall profit tax, which calls for a 68% levy on copper and gold operations when prices for the metals top US$1.18 per lb. and US$500 per oz., respectively.

The move has stunned foreign mining companies active in the north-central Asian country, which have been awaiting a revised foreign investment and taxation policy. The legislation was rushed through with little debate and without any industry comment or contribution, catching almost everyone off guard.

Reportedly, only 45 of the 76 parliamentarians were in attendance for the Friday vote, with a majority of those present (35 of the 45) passing the motion. Reasons for the absence of 31 members, believed mostly from the ruling Mongolian Peoples Revolutionary Party (MPRP), were not known at presstime. The measure comes after weeks of vocal protests in Ulaanbaatar’s Sukhbaatar Square by groups demanding the state retain a greater share of the country’s natural resources.

Put forward by the minority Democratic Party, the bill looks to cleave an exorbitant 68% taxation on mining revenues. Both the definition and application of the tax are vague, but details are expected to be released within the week.

There is speculation that the tax was put forward to garner its immediate “windfall” from the operating Erdenet copper mine, owned 51% by the Mongolian government and 49% by the government of Russia. The cash grab will likely perturb the country’s northerly neighbour; Mongolia remains strongly reliant on its former Communist-bloc parent for trade and energy.

The potentially disastrous political strategy may gain the government points with local nationalist groups, but foreign investors could halt further investments pending clarification or revocation of the policy. Mongolian President Nambaryn Enkhbayar has five days to veto the law, currently being polished at the Ministry of Justice, although whether he will stick his neck out against the strong nationalistic sentiment among Mongolians is uncertain.

Mongolia has attracted hundreds of millions of dollars in mining investment over the last several years. Ivanhoe Mines (IVN-T, IVN-N) alone has spent $370 million on exploration and development of its massive Oyu Tolgoi copper-gold deposit in the southern Gobi Desert. Ivanhoe’s capital investment only came after the Mongolian Parliament rescinded a 10% value-added tax on gold in 2001. The company has been working with the government on developing a stability agreement to move Oyu Tolgoi into production.

With its current 68% rate, the windfall profits tax would be a deathblow to any new mining operation in Mongolia. At copper prices of US$3-US$4 per lb., the tax would equate to a net smelter return (NSR) of up to 40-50%.

Fickle risk capital

The move will hurt Mongolia financially; risk capital can be fickle and lack of policy stability will likely drive the dollars to other, friendlier jurisdictions. Potential development of many mineral projects in the country could be deferred for years, possibly missing the current metals cycle entirely. The move could also jeopardize Mongolia’s debt ratings with the International Monetary Fund and the World Bank, both of which have lent huge sums to the country.

Company reactions were predictable, with Ivanhoe Mines sending a letter to the Mongolian government expressing “surprise and disappointment that such legislation might be passed without consultation with the industry, and that a lack of openness and transparency seems to have marked the process.”

Although the newly tabled law has only focused on gold and copper, other minerals, including coal and uranium, could also be targeted at a later stage.

Trading in most of the companies active in Mongolia was off significantly following the news on May 15. Ivanhoe Mines closed down 22% at $8.03 per share in TSX trading, Entre Gold (ETG-T, EGI-X) was off 24% at $1.58 per share, Erdene Gold (ERD-T, ERDGF-O) dropped 21% to $1.07, QGX (QGX-T, QGXLF-O) traded down 27% at $2.55 per share, Western Prospector Group (WNP-V) gave up 21% to trade at $3.00, and Asia Gold (ASG-V, AGLCF-O) closed 23% lower, at $2.21 per share.