DBM begins disbursing funds

As of October 30, 2012, the Development Bank of Mongolia has disbursed the funds of MNT 354.4 billion to the following projects: ·         MNT 74.4 billion for 20 auto road construction and 21 design and drawing projects, ·         MNT 40 billion for 6% mortgage loan to the State Bank, ·         MNT 8.2 billion to SME Development Fund, ·         USD 100 million to Erdenes Tavan Tolgoi LLC for railroad project, ·         USD 61.3 million for expansion work of Khutul Cement and Chalk LLC, and ·         USD 5.3 million for the purchase of new airplanes to MIAT LLC. The Bank is planning to disburse MNT 672.7 billion by the end of this year. http://www.dbm.mn/en

DBM receives Bloomberg Award for Debut Bond

Development Bank of Mongolia received Bloomberg Award at the closing reception ceremony of Mongolia Economic Forum 2013 for the issuance of first sovereign bond in the international market. DBM issued US$580,000,000 bond which is due 2017 on March 14, 2012 at a comparatively low interest of 5.75%. This landmark transaction opens international bond market to Mongolian borrowers and it was the cornerstone for the successful issuance of US$ 1.5 billion Chinggis Bond on December 29, 2012.

Coking Coal in Mongolia

Devon Healy

1. Introduction

Mongolia is a developing country in central/eastern Asia. It is about three times the size of France with less than three million people and over 30 million heads of livestock. Mongols are a traditional nomadic people and their economy has been centered on herding and agriculture for hundreds of years (World Bank, 2012).

Mongolia is unique in that it is in the initial stages of completely transforming its economy from agricultural based to mining based. In 2011 Mongolia was the world’s fastest growing economy with 17.2% GDP growth, namely due to of investments in enormous mining projects and increasing exports of coal to China (World Bank, 2012). Though growing very quickly, Mongolia is still a very poor country with 29.8% of its population living in poverty (World Bank, 2012). It only recently graduated to ‘lower-middle-income’ status with real per-capita income at PPP around $3674 (OBG, 2012).

I chose to focus on Mongolia because economists have identified it as an economy that is ready for launch. In 2011, economists Willem Buiter and Ebrahim Rahbari projected that Mongolia would be the world’s fastest growing economy over the next two decades due to its extraordinary untapped mineral reserves, a relatively small population, high levels of foreign investment and proximity China. (OBG, 2012). Though the future looks very promising for Mongolia, its economy is still very vulnerable to negative commodity price shocks and overheating. Mongolia is completely landlocked between two geo-political giants, Russia and China. Mongolia’s geographic isolation makes it very difficult to access foreign markets, which means its economic growth is almost completely dependent on stable commodity prices and sustained growth in China, which currently imports 91.5% of Mongolia’s exports (NSOM, 2012).

This essay will focus on one of Mongolia’s most strategically significant resources, coking coal. Coking coal is a pure type of bitumous coal and is used as a fuel and reducing agent in the smelting of iron ore in a blast furnace. Mongolia has abundant and untapped reserves of coking coal that lie conveniently along its boarder with China, which is the world’s largest and fastest-growing market for coking coal. This essay will focus on the period starting in 2005, when China first became a net importer of coking coal, and up to the present (November 2012). The essay will start with a look at potential consumers in the Asian market and the nature of demand, followed by a look at supply shortages in the global coking coal market, then a look at competition and competitive advantage in transport and ending with a critique of government policy and practice.

Term:

Metallurgical coal: (or met coal) is another term for coking coal.

Mt: million tonnes

2. Nature of Demand

Mongolia currently has no domestic steel production, so all of its coking coal is produced for export to foreign consumers, mainly in China. There are 31 countries in the world that have domestic steel production that is reliant on coking coal (WSA, 2011). China is the world’s largest steel producer, the world’s largest metallurgical coal consumer and the world’s largest met coal producer. Japan is the largest met coal importer, followed by China, South Korea and India respectively.

Potential Asian Consumers: Top Steel Producers and Metallurgical Coal Importers

	Steel production 2011 (Mt)*	% of total 2011 world steel production	Coking coal imports 2011 (Mt)^
PR China	683.3	45.8	38
Japan	107.6	7.2	54
South Korea	68.5	4.6	32
India	72.2	4.8	19

*World Steel Association (2011)

^World Coal Association, (2012)

Coking coal consumption in Asia has been mainly driven by rising production of steel in China, which is being used to build infrastructure, railways, roads, skyscrapers, factories, cars and appliances (WSA, 2012). The production of steel represents an important basis for the rapid growth and urbanization seen in China over the past decade. China’s rising demand for coking coal imports even as prices rise suggests a low responsiveness of demand to changes in the coking coal price, especially in developing economies. This price inelasticity can be explained on a macro level because developing economies tend to spend more on large-scale infrastructure projects that are steel intensive and governments tend to subsidize these infrastructure projects in order to target infrastructure bottlenecks that restrict growth, as China began doing September 2012 to avoid an economic slow down (Business Standard, 2012).

Steel is 100% recyclable, which represents a substitute for metallurgical coal. Recycling steel is extremely cost effective, which is why recycled steel represents 50% of total steel production in the United States. But these levels of recycling are harder to attain in developing economies where growth in demand outpaces the steel scrap cycle, which is why China’s recycle rate was only 8% in 2009 (China Daily, 2010). Therefore, this option for substitution is much more limited in developing economies, further emphasizing the price inelasticity of demand.

Long and short term price elasticity of demand for metallurgical coal in Asia

	Price ($/ton) adjusted to 2005 prices *	Demand represented by import demand^	Price Elasticity (yoy)
2011	96.86	147 Mt	1.46
2010	105.95	168 Mt	0.83
2009	75.65	110 Mt	-0.26
2008	71.34	128 Mt	-0.73
2007	85.71	114 Mt	-0.13
2006	48.15	127 Mt	--
2005-2011			0.15

* Y Charts, (2012)

^ World Coal Association, (2012

The income elasticity of demand for metallurgical coal is derived from the income elasticity of demand for steel, which is very high. On a micro level, individual consumers tend to spend more on steel products like cars and appliances as their incomes rise above a certain level. For instance, the income elasticity of demand for automobiles is very high at 2.98 because consumers tend to spend a disproportionately high percentage of their income on a car once they have reached a certain income level (Xin Deng, 2006).

China’s consumption of coking coal grew 158% from 2006 to 2011 rising from 210 Mt per year to 542 Mt, an average rate of 31.2% per year, and China now consumes well over 50% of the world’s coking coal (The Washington Post, 2012). China has its own domestic coking coal reserves, but these reserves only account for about 13% of the global total and are being depleted rapidly to meet growing domestic demand (CEFIP, 2012). China’s export demand for met coal was 38 Mt in 2011, down 20.8% on 2010 but up 322.2% over the past 5 years. Import demand in China is expected to remain relatively high even as the pace of economic growth slows, mainly due to the limitations of China’s domestic supply.

Other markets in Asia will buoy demand for coking coal. South Korean demand has risen over the last five years a rate of 10.5% per year, while Japan’s coking coal consumption has fallen 37.2% over the same period, a rate of -7.4% per year (WCA, 2012). The most significant new player is India, which is expected to follow China towards rapid industrialization over the next decade and is projected to become the world’s second biggest producer of steel and consumer of met coal by 2015 (Economic Times, 2012). India has substantial coal reserves but like China is a net importer of coal.

Japan, South Korea and India are currently excluded from the market for Mongolian coking coal, though all could potentially become consumers over the next five years. In 2011 and the first ten months of 2012, 99.7% of Mongolian metallurgical coal was exported to China because of the proximity to steel producers in northern and eastern China and inadequate railway infrastructure to export to other markets (NSOM, 2012).

3. Nature of Supply

Demand for coking coal is out pacing the rate of supply, which is restricted by scarcity of reserves and high transportation costs. Scarcity of supply was evident in late 2010 and early 2011 when floods in Australia’s Bowen Basin caused a shortage of supply and a dramatic spike in seaborne coking coal prices. The price of premium hard coking coal reached $378/Mt in January 2011, up from $145/Mt in the previous month. This supply breakdown led the Chinese government to categorize coking coal as a strategic resource that is now protected “through incentives to optimize production and industry consolidation” in China (Platts, 2011).

China is the largest coking coal producer in the world and produced 504 Mt in 2011, 52% of global production. The second largest producer is Australia at 146 Mt in 2011, 15.1% of global production. Australia is the world’s largest exporter of coking coal and currently is the most important supplier to Asia. The United States was the second largest exporter in 2011 (63 Mt) followed by Russia (1 Mt)

Mongolia has large reserves of high-quality coal, most of which are close to the Chinese border and largely untapped. Mongolia currently has eight operational coal mines, which are producing below full capacity because of infrastructure bottlenecks in the national and regional economy. Ovoot Tolgoi and Tavan Tolgoi (TT) are Mongolia’s largest deposits, TT being the largest untapped coking coal reserve in the world with an estimated 6.4 billion tonnes. When it comes online in 2014 it is expected to produce 20 Mt per year. Mongolia produced about 20 Mt of coking coal in 2011. The Mongolian Coal Association predicts that the country will export 50 Mt of coking coal by 2015 and 100 Mt by 2025 (MAD, 2012). These supply predictions are dependent on the development of adequate infrastructure to reduce transport bottlenecks.

Coal mining is very capital and labour intensive and usually requires infrastructure development to support export. Sources of supply usually take years to develop to full capacity, meaning that the short-term price elasticity of supply is very inelastic. Long-term elasticity of supply is much more elastic because long-term rises in price can make large scale mining projects more feasible and will attract high levels of investment. Similarly a fall in prices over time will deteriorate feasibility and deter investment. The Australian Bureau of Agricultural and Resource Economics calculated the short-term and long-term elasticities of supply for coking coal in Australia at 0.4 and 1.9 respectively in 1991 (ABARE, 1991).

Analysts see supply side issues relaxing over the end of 2012 and 2013 as Australia returns to normal levels of production, as mining in Mongolia, Russia and Mozambique ramp up and diversify the supply market and as China’s growth slows and demand stabilizes. They expect international coking coal prices to remain relatively constant at around $220/Mt over 2013 (BT Invest, 2012).

4. Competition and market power

Mongolia’s location has the potential to improve its market power but not necessarily its ability to affect international prices. Mongolia’s comparative advantage lies in its proximity to the world’s largest markets for coking coal; China, Japan, South Korea and India. But because Mongolia is landlocked and sandwiched between two political giants, its ability to access coal markets other than China is extremely limited.

Currently Mongolia is at the mercy of Chinese demand and has limited ability to maneuver. It has no rail infrastructure adequate to move large amounts of coal and currently trucks its 20 Mt of annual coal exports across the Gobi desert to Chinese border stations, where the coal is put on trains and shipped to steel producers in Inner Mongolia (a province of China). Mongolia’s rail infrastructure projects have secured financing and are currently in the planning stages, but the first rail lines are not expect to be operational until 2014. For now Mongolia is a price-taker with China, which is why China’s consumers purchased Mongolian coal at about 50% below market value in 2011 (The Gold Report, 2012).

Mongolia’s proximity to China greatly reduces transport costs for Chinese consumers. Mongolia’s greatest competitor for Asian markets is Australia, which has to ship all of its exports overseas. Seaborne transport costs usually exceed the value of the coal being delivered, which is why steel producers almost invariably favor consumption of domestic coking coal supplies above overseas ones. Mongolia enjoys a considerable transport and pricing advantage over its Australian rival when exporting coking coal to China. In the case of Australian coal being delivered to a consumer in Eastern China in November 2012, the price at the Australian port was $82.40/mt while the delivery price at the Chinese steel plant was $205.53/Mt. That equals $123.13/Mt in overseas transport costs, 149.9% of the value of coal. On the other hand, in November 2012 the average price of Mongolian coal upon delivery at the Chinese border station was $88.29/Mt, 56.4% less than the Australian price (CCR, 2012). In 2011, Mongolia overtook Australia as China’s number one supplier of coking coal. Because of Mongolia’s subordinate relationship to China, Chinese consumers reap most of the benefits from the difference in transport costs. 

Lastly, Mongolia’s dependence on a handful of commodities makes for export to a single national market make the country extremely vulnerable to a drop in commodity prices or a considerable economic slowdown in China. This risk was most evident during the most recent global economic crisis, when Mongolia was hard hit by a dramatic plunge in copper prices. Government revenue, export earnings and foreign direct investment collapsed as a result and the country was only able to stay afloat thanks to a loan from the IMF (OBG, 2012).

5. Government policy

In 2005, Robert Friedland, Chairman of Ivanhoe Mines Ltd., said in a speech about Mongolia to investors, “And the nice thing about the Gobi is, there’s no railroad tracks in the way, there are no people in the way, there are no houses in the way…there’s no NGOs…You’ve got lots of room for waste dumps without disrupting populations…” (Mining Watch Canada, 2011). At the time Ivanhoe was on the verge of an agreement to develop Oyu Tolgoi, a copper and gold reserve in the Gobi desert. When the quote was translated in the Mongolian press it set off a firestorm and initiated an intense public debate about the growing mining industry.

The government responded to the public outcry by renegotiating almost all of its mining contracts and renationalizing many of the mining reserves that had been privatized. The new government policy pursued partnerships between government controlled mining firms and international firms, with the government holding a stake of just over 50%. In the case of Tavan Tolgoi, the government decided to create a new public company, Erdenes Tavan Tolgoi, which is licensed to manage the project. In 2010, the government decided to sell 30% of TT’s shares to its new subsidiary, it kept 40% stake and gave 10% to Mongolian citizens and 20% to Mongolian companies (Bloomberg, 2010). These moves are improving the image of mining amongst the population by giving people a stake in the industries development. On the other hand, investors see view the moves with skepticism and fear that the renegotiations are delaying projects, extending payback periods on investments and disrupting the Mongolia’s favorable FDI environment.

The government of Mongolia is also taking steps to address its dependence on China through its “Third Neighbor Policy.” In accordance with this policy the government has sought to create stronger ties with international partners in Japan, India, South Korea and the United States in order to promote trade cooperation and increase Mongolia’s access to foreign markets. As part of this policy Mongolia signed a cooperation agreement with India in 2012 to build the first steel plant in Mongolia and export the first shipment of Mongolian coal to India by 2014 (Business Mongolia, 2012). Mongolia also has planned railway infrastructure projects to extend railway lines from its mines in the South Gobi to connect with Russia’s trans-Siberian to Vladivostok and markets abroad, but funding for the projects has yet to be secured.

The last major concern is the Mongolian government’s budget deficit, which is particularly concerning given the near collapse in the balance of payments in 2008. The government is weighing risk between long-term Dutch Disease and short-term fluctuations in revenue. To combat Dutch disease the government is trying to expand its revenue base so that it can increase spending on infrastructure. In the process it is struggling to honour its Fiscal Responsibility Law, which will reign in spending when it goes into effect on 1 January 2013 (World Bank, 2012).  Uncertainty became stronger still after the 2012 Parliamentary Elections in June which was the first time the opposition party won more seats that the Mongolian People’s Party (former communist party) since the transition from communism to democracy in 1990.

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[Accesssed on 6 December 2012]

Bloomberg, (2010), Mongolia Plans to Offer 30% of Tavan Tolgoi Company.

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Desertification on the fringes of the Gobi.

90% of Mongolia is vulnerable to desertification according to the United Nations. The delicate ecosystem that traditional herdering families rely on is being put at risk by the rapid economic development and lack of suitable infrastructure to support it. The lack of railway lines and paved roads forces large trucks to drive across the desert and grasslands, kicking up dirt that smothers plants and can lead to increased rates of desertification at the fridges of the Gobi desert. Herders are feeling the impact and say that it is becoming increasingly difficult to find suitable grazing land for their herds, something they couldn't have imagined a decade ago when good land was abundant. Development has winners and losers and these herders and their thousand year old traditions are losing out in a country where there are over ten times more heads of livestock than there are people. This issue highlights the need for responsible, equitable and sustainable development in the world's fastest growing economy.

Problems for Land-Locked Countries

Mongolia is one of the 48 countries in the world that are land-locked. About one quarter of the world's 205 countries are land-locked and these countries tend to have lower human development statistics compared to the rest of the world. Being land-locked is regarded as a disadvantageous because it can severely limit a country's access to global markets and global trade.  In general, coastal regions tended to be wealthier and more heavily populated than inland ones. Paul Collier in his book The Bottom Billion wrote, "If you are coastal, you serve the world; if you are landlocked, you serve your neighbors." Mongolia is no exception to these difficulties. The country has only two neighbors in China and Russia, and both countries have a very strong influence over Mongolia's economy. China for instance, controls the price of Mongolia's copper and coal exports and competitive pricing is restricted by Mongolia's limited access to international ports. China's recent growth has spilled across the border and is the main driver in Mongolia's mining driven development. 

With regards to the cross-boarder transit, there are international regulations that have been established in order to protect the rights of land-locked countries' to access global markets. In 1965 there was a 'UN Convention on Transit Trade of Land-locked States,' which granted special protections to land-locked countries with regards to access to sea ports and world trade. In 1982, there was a United Nations Convention on the Laws of the Sea, which protects the freedom of transit for land-locked states. Unfortunately both conventions are subject to bilateral, sub-regional or regional agreements. In other words, the rights of transit must be agreed upon with the transit neighbor in a formal trade agreement. In practice the protections granted in the UN conventions are not always honored by the transit country. The rights of transit of land-locked developing countries (LLDCs) remains an unresolved issue in international economic policy. Mongolia held a conference for LLDCs to discuss these trade issues in 2007. 

Mongolia is currently looking for ways to gain access to Korea and Japanese markets to sell its coal exports. The most direct route to these markets is through China and the port city of Tianjin, which has a free trade area. There is also the possibility of going through Russia, through Vladivostok, but it is not certain that Russia's rail network can support the quantity of coal that Mongolia is expected to export from its Tavan Tolgoi mine. Also, going through Russia will have significantly higher transit costs given the distance that needs to be traveled. Vladivostok can be reached from Mongolia by either going directly north to Russia and then circling around Manchuria, or by going Northeast and cutting through Northern Manchuria. Either way the distance that needs to be traveled by rail is significantly higher than the route through China to Tianjin. 

Mongolia will need to negotiate with China or Russia to set up some kind of transit agreement. China has no incentive to grant free transit because it already enjoys control over Mongolia's  coal exports. However, if Russia is approached first, it might be possible to pressure China into a more favorable agreement (Plan A). If China does not budge then plan B would be to secure a deal with Russia and accept the higher transit fees. The UN conventions will most likely help Mongolia's case at the bargaining table, but once again they hold little clout because they are not often followed and have no history of enforcement. Mongolia might also be helped by the World Trade Organization, of which Russia, China and Mongolia are members. However, it would be important to isolate Russia and China in negotiations in order to reduce the chance that they might collaborate to restrict Mongolia's export markets. 

DBM is currently raising funds for a railroad project that will run directly from Tavan Tolgoi to a Chinese border station. A later phase in the National Rail Project will connect TT with to the Russian boarder station.