Breakingviews – New Rio Tinto boss has a Mongolian ball to bite
LONDON (Reuters Breakingviews) – Jakob Stausholm will need a travel guide to Ulaanbaatar. Rio Tinto’s new chief executive has a tough to-do list and at the top of it is the miner’s $ 10 billion Oyu Tolgoi copper and gold project, located 700 kilometers from the Mongolian capital. . Trying to keep all interested parties happy at once is probably a wild ride.
It’s surprising that all this sticky mess, along with the high tensions between Australia and China and Rio’s frayed relationship with indigenous peoples, did not deter Stausholm from taking the job. Turquoise Hill Resources, the Canadian-listed company that owns two-thirds of Oyu Tolgoi, lost one-fifth of its market value on January 11 after hinting that the Mongolian government may not pursue the project. Turquoise shares, in which Rio owns 51% of the capital, have fallen by two-thirds since 2016.
Oyu Tolgoi should be a real asset. It is expected to produce 500,000 tonnes of copper per year later this decade. This would make it the world’s fourth largest producer. And red metal prices have climbed 70% since March and are expected to remain high as demand for electricity, and therefore copper cabling, skyrockets.
The project is however crippled by a shaky business structure and a major funding problem. Large excavations typically involve private sector entities holding the equity capital, with generous annual royalties paid to the host state’s treasury. Besides Rio, Oyu Tolgoi has three main stakeholders: the state, the non-Mongolian minority shareholders who own 49% of Turquoise, and Odey Asset Management, an arrogant British hedge fund that is an investor in Rio and has a short position in Turquoise. . Ulaanbaatar owns 34% of Oyu Tolgoi LLC and Turquoise owns the remainder.
The main puzzle is that Mongolia, with a GDP of just $ 14 billion and limited liquidity, has long funded its share of the project’s capital investment with loans from Turquoise. This is a large chunk of the $ 7 billion advanced to Oyu Tolgoi over the past decade, according to information released by the company, at an annual interest rate 6.5 percentage points above the interbank offered rate. in London. It also borrowed an additional $ 1.3 billion from Turquoise to finance its purchases of Oyu Tolgoi shares. All of this must be paid back before Mongolia can receive dividends. Even if the project had been on time and on budget, Ulaanbaatar would have faced a long wait.
As it stands, project costs recently climbed to $ 6.75 billion, so any payment could take decades. Unsurprisingly, this causes a political stench in Mongolia. Meanwhile, Turquoise faces a funding gap of at least $ 3 billion between the time in 2022 when its remaining $ 1.3 billion runs out and the date a few years later when the main underground phase dies. ‘Oyu Tolgoi begins to waste money.
EQUITY OR DEBTS?
Stausholm can choose between an incremental solution and a radical solution. The first, favored by certain minority shareholders of Turquoise, would deploy various measures to fill the financing gap. Extending the maturity of about a third of the $ 4.4 billion in financing obtained by Oyu Tolgoi from international lenders in 2015 would reduce management costs. The issuance of other debts, the pre-sale of some of the mine metal, and higher copper price assumptions would do the rest.
Odey prefers a more daring approach. Rather than increase Turquoise’s debt, he thinks Rio should be pushing for a big rights issue. This makes sense as the $ 3 billion funding gap could actually increase if Turquoise were to end up paying for a power plant to supply power for the mine, which is currently supplied by China. But given that Turquoise’s market cap is less than $ 2.5 billion, any investor who didn’t participate in the fundraiser would be heavily diluted.
Stausholm will not be eager to upset Turquoise’s minority shareholders, nor to put even more money from his company into a call for capital linked to Oyu Tolgoi. With minimal net debt, however, Rio is able to push for the most sustainable long-term solution. His company is already guaranteeing the $ 4.4 billion project finance facility and consolidating the $ 8.3 billion in loans. An increase in equity would leave Rio with more project cash flow without increasing the debt it takes out.
The Rio boss must also move cautiously around Ulaanbaatar. Mongolia’s nuclear option would be to reject the project’s $ 140 billion miner and call in one of its rivals instead. Breaking such an important contract could hurt foreign investment flows into the country, but the importance of Oyu Tolgoi could be worth the risk. In addition to closing the funding gap, the host country wants more money from the mine than it believes it owns.
Stausholm’s least bad strategy is therefore probably two-fold. First, Rio should support an increase in equity capital to close the funding gap. If Turquoise’s minority shareholders are optimistic about Oyu Tolgoi, they should be prepared to back a rights issue.
Second, Stausholm should rework the loan structure to appease Mongolia. One option is to spend 75% of the money generated by Oyu Tolgoi on debt reduction and use the rest for payments in Ulaanbaatar. It may even take a 50-50 split to facilitate the relationship between the minor and the state. Under this approach, in addition to having to respond to angry Turquoise owners, Rio could suffer a financial blow. But it is likely to do so in almost any solution.
There is no way for Stausholm to make everyone happy. As a new broom, he at least has a freer hand compared to his predecessor Jean-Sébastien Jacques, who was so closely associated with the project. He may as well use it.
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