Cakir, S. and A. Klemm, 2007, “Long-Term Fiscal Sustainability in Mongolia,” in Mongolia, 2007 Selected Issues, IMF Country Report 07/39 (Washington: International Monetary Fund).
Fraser Institute, 2007, Fraser Institute Annual Survey of Mining Companies 2006/2007, (Vancouver), available at http://www.fraserinstitute.org/commerce.web/publication_details.aspx?pubID=3195.
Ivanhoe Mines, 2007, Oyu Tolgoi Gold and Copper Project, Southern Mongolia, (Ulaanbaatar, Mongolia), available at http://www.ivanhoe-mines.com/s/TurquoiseHill.asp.
Open Society Forum, 2007, “Analysis of Proposed Investment Agreement between the Government of Mongolia and Ivanhoe Mines Mongolia Inc,” (Ulaanbaatar, Mongolia.
Wakeman-Linn, J., C. Aturupane, S. Danninger, K. Gvenetadze, N. Hobdari, and E. LeBorgne, 2004, Managing Oil Wealth: The Case of Azerbaijan (Washington: International Monetary Fund.
Prepared by Daehaeng Kim.
The development of the OT mine is currently delayed due to the slow progress in the negotiation and Parliament’s ratification for the Investment Agreement between the license holder and the government. The Investment Agreement is the first major attempts under the new Minerals Law (2006).
Currently, all WPT on copper is collected from the Erdenet copper mine, which produces only copper concentrate. The Mongolian government owns 51 percent of the company, and the Russian government owns the rest. In contrast, WPTs on gold are mostly collected from several small gold mines, which accounted for about 4-5 percent of the total WPT revenue in 2006. The largest gold mine—Boroo—is exempted, as it is covered by a stability agreement with the government made under the 1997 Minerals Law.
The WEO price projections for 2008, available in March 2008, are US$7,000 per ton of copper and US$960 per ounce of gold.
The rules for the state equity participation are currently under review in Parliament, and the ceiling for the state equity share would likely be lifted.
Throughout the paper, US$ refers to constant 2007 U.S. dollars, unless otherwise indicated.
WEO price projections published in March 2008 are used throughout the paper.
The model assumes that the GOM will take a 34 percent equity interest at the beginning of the project development, and it will be responsible for a third of future equity financing if it wants to keep the same share. The model makes an additional assumption on the government cash contribution: private partner(s) finances the GOM’s cash requirements, and the GOM pays for its equity (plus interest on the carry) out of its share of dividends. The interest rate of LIBOR+3.3 percent applies to the debt. If the project never earns sufficient profits for the GOM to pay for its carried interest, the GOM would not be liable for the unpaid debt (nonrecourse loan).
Total benefits are conventionally defined as gross revenues less operating costs and replacement expenditures, which signify the amount available to pay taxes, service debt and reward investors. Due to data unavailability, however, total benefits are defined in this study as gross revenues minus operating costs.
This is the main reason why the WPT share in total GOM revenue increases over time in the model.
There are various factors that could affect pre-tax IRRs, including investment and operating costs. In this paper, we consider price-induced profitability changes only.
As prices rise beyond a certain level, the WPT payment erodes the bases for CIT and dividends payable to the GOM.
The government’s desire to take an equity position in projects would also reduce the competitiveness of Mongolia’s fiscal regime, while its effect is difficult to quantify.
The average prices considered in this simulation range from US$1,542 per dmt of copper to US$4,009 per dmt. At this price range, Zambian WPT, which has relatively high trigger prices, would not be effective for most of period and price ranges under consideration.
The high government share in the analysis is mostly driven by state equity participation and the WPT, which applies exclusively to copper and gold sales.
See Fraser Institute (2007). The survey covers 65 jurisdictions around the world, on every continent except Antarctica, including sub-national jurisdictions in Canada, Australia, and the United States. Indexes for Mongolia do not take into account the possibility that the 20 percent dividend WT can be reduced by treaty.
In particular, Mongolia is placed low in the areas of uncertainty concerning the administration, interpretation and enforcement of existing regulations; regulatory duplication and inconsistencies; tax regime; infrastructure; and socioeconomic agreements.
This is the main reason why the WPT could be distortionary. According to the current rule, the WPT burden of a copper mining company would increase with copper prices even when its profit shrinks (or even disappears) due to cost increases. On the contrary, a highly profitable company would not be subject to the WPT if the profitability improvement results from cost reductions.
While imposed on sales of copper ore and concentrate, the WPT does not apply to sales of domestically refined copper, which would create an incentive to build smelter and refinery.
Even in the government’s point of view, state equity participation has several important shortcomings, including: (i) the government exposes itself to risk; (ii) taxation could be more effective in revenue maximization, in particular, given that dividends may never be paid; (iii) equity may require the government to divert funds that otherwise could finance other priority development projects; and (iv) there can be a conflict between the government’s role as a shareholder and its role as a regulator.
Staff understands that a production sharing agreement (PSA) is one of the alternative fiscal regimes that the government is examining, although it is not commonly used in the copper sector. The mechanics of production sharing are, in principle, straightforward: for example, the PSA can specify (i) the royalty payment to the government, (ii) a portion of total production to be retained by the contractors for cost recovery; and (iii) the formula to divide the remaining production, often termed “profit production”, between the government and the contractors. If the sharing of the profit production is based on the IRR earned by the contractors, the PSA can be designed to mimic the RRT regime.
The procedure here treats the CIT as a deduction in calculating the RRT. It is equally possible to calculate the RRT first and treat it as a deduction in calculation of income tax.
Despite these difficulties, Mongolia is thought to have appropriate administrative capacity to implement the RRT, given the recent progress in tax administration and enforcement.
The choice of tax parameters such as accumulation rates and corresponding tax rates should be guided by policy objectives, and thus the parameters simulated here should be considered as an example, not the Fund’s specific recommendation.
Some countries borrowed heavily against their anticipated future revenues (e.g., Venezuela), while other countries granted large wage and social welfare spending increases (e.g., Nigeria) or implemented ambitious public investment projects, which turned out to be able to yield low economic rates of return (e.g., Algeria and Iran). For details, see Wakeman-Linn and others. (2004).