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Pit bull or pit bear?

The problems at the Oyu Tolgoi mining project in Mongolia mean the sponsors, Rio Tinto via its ownership of Turquoise Hill Resources, will have to raise $1 billion-plus more debt for the scheme. But is additional debt or a full refinancing the more likely outcome?

Three years on from winning multiple awards for a $4.4 billion multi-sourced project financing in 2015, pretty much everything that could go wrong has gone wrong at the $5.3 billion Oyu Tolgoi copper/gold expansion project in Mongolia.

Sponsored by Turquoise Hill Resources (66%), which is majority-owned by Rio Tinto, and the Mongolian government (34%), costs at the project are spiralling. The mine’s underground expansion is predicted to come in up to $1.9 billion over budget – a figure that does not include the $1 billion-plus of debt that still needs to be raised by the sponsors for the Tavan Tolgo power project, which will both power the mine and provided capacity for domestic use.

Rio Tinto’s new estimate for capex on the project is now $6.5 billion to $7.2 billion, and dependent on which mine design options are used, first sustainable production has been pushed back to between May 2022 and June 2023, a delay of 16 to 30 months on the original feasibility study estimate.

The scheme has also been at the centre of an anti-corruption investigation that has resulted in the arrest of two former prime ministers and a former finance minister. And a parliamentary working group, established last year to examine the original Oyu Tolgoi project agreements, has recommended that the 2015 Dubai Agreement – the basis for the extension project – should be scrapped.

The core of the political row dogging the project is the share of project benefits Mongolia is getting out of the deal. Although Rio Tinto claims to have spent “$8.3 billion in-country in the form of salaries, payments to Mongolian suppliers, taxes, and other payments to the government” between 2010 and 2018, Mongolia will not earn a dividend from the mine until 2041 when the dividend flow is predicted to have repaid the state’s share of the project costs.

Furthermore, a report in 2018 by Dutch NGO the Centre for Research on Multinational Corporations (SOMO) claimed that tax arrangements in the Oyu Tolgoi investment agreement resulted in a $230 million tax revenue loss for Mongolia. The report, which was arguably flawed, nevertheless added fuel to an already heated dispute between the project sponsor and the Mongolian tax authorities over withholding tax payments.

Despite all the problems at the project, Rio Tinto’s credit rating remains solid, with Fitch affirming its rating on 29 July and stating that it "did not have any earnings from the block cave expansion in its rating case forecast for Rio Tinto due to the complexity of the project and lack of full visibility around the commissioning schedule.”

The ratings affirmation makes sense. Although the project’s cost increase will mean Rio Tinto and Turquoise Hill having to raise new debt, the debt service undertaking in the project documentation has an agreed capacity of $6 billion with an option of an additional $1.6 billion debt – in short, the sponsors built some leeway into the original deal.

The $4.4 billion expansion financing – a five-tranche deal signed in 2015 with tenors ranging from 12 to 15 years – has some very solid backers. The deal was lead-arranged by the IFC, EBRD, BNP Paribas, EDC and Standard Chartered. The facilities comprise: an $800 million 15-year A loan priced at a margin of 378bp over Libor pre-completion and 478bp post-completion; a $1.6 billion 12-year B loan provided by the same commercial banks and priced at 340bp over Libor pre-completion and 440bp post-completion; a $700 million 12-year MIGA-guaranteed loan priced at 265bp over Libor pre-completion and 365bp post-completion; a  $900 million 14-year ECA-backed tranche priced at a margin of Libor plus 365bp pre-completion 465bp post-completion; and a $400 million 13-year tranche from US Exim with a margin at the fixed commercial interest reference rate based on US Treasury rates determined at time of first disbursement.

The full lender line-up for the deal includes EDC, EBRD, IFC, US Exim, EFIC, BNP Paribas, ANZ, BNP Paribas, CIBC, Credit Agricole, FMO, HSBC, ING Bank, Intesa Sanpaolo, KfW IPEX, MUFG, National Australia Bank, Natixis, Societe Generale, Standard Chartered and SMBC.

Eric Rasmussen, director of Natural Resources at the EBRD, stated last week that the DFI was willing to provide more funding for the project, an updated financial model for which is expected to be available by October.

But a full refinancing rather than just an add-on facility is very likely under consideration. The project may be delayed but it still has 3.5 years of construction under its belt since financial close and, according to Rio Tinto, a more detailed understanding of the technical risk.

Furthermore, given all-in pricing on the 2015 deal was 600bp over Libor (including upfront and ongoing fees, and an annual completion support), there is clearly room for a margin cut and tenor extension on at least some of the debt, albeit if the sponsors and Mongolia can come to an agreement that mitigates the political risk on the project, which, given the bickering over the Dubai Agreement, is much higher than it needs to be at the moment.

Oyu Tolgoi is a hard sell – but remove much of the political risk and the scheme becomes eminently bankable, particularly given the original extent of DFI and ECA support. And initial signs suggest there is appetite, at the very least at the EBRD, for upping that backing.


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