Wall Street Journal examines struggle to start mining in Mongolia

Mongolia Is Roiled
By Miner's Huge Plans

World-Class Deposits
Spur Battle for Spoils;
Makeover for 'Toxic Bob'

By Patrick Barta
The Wall Street Journal
Thursday, January 4, 2007

OYU TOLGOI, Mongolia -- When Robert Friedland first set foot on this desolate land in 2001, the mining magnate saw a windswept desert, some rocks, and the opportunity to turn Mongolia into the world's next big natural-resources play.

Since then, his Vancouver-based company, Ivanhoe Mines Ltd., has spent more than $400 million to develop what may become one of the world's biggest copper and gold mines. More than a thousand workers are on site, performing exploration work and preparing to dig a hole deep enough to fit the Eiffel Tower. If all goes well, Oyu Tolgoi could double Mongolia's gross domestic product -- and help lift the landlocked nation of nomadic herders out of poverty.

Mongolia's response? Protesters have burned Mr. Friedland's image in effigy in the capital city of Ulaanbaatar. Last spring, the Mongolian Parliament imposed a tough new windfall tax on copper and gold exports. And government officials still haven't approved a final investment agreement for Ivanhoe and its partners -- a pact they need to begin large-scale production. That means it could be several years before the project gets off the ground, if ever.

Mongolia's conflicted approach to Mr. Friedland and other foreign mining investors reflects a dilemma that's emerging across the developing world, as poor nations grapple with the dazzling opportunities -- and mounting pressures -- of a global commodity boom.

The surge in commodity prices in recent years has triggered an avalanche of new investment in mines, much of it in economically stagnant nations like Mongolia. But the lessons of past commodity cycles suggest that many resource-rich nations don't benefit from their natural bounties in the long run, either because of rampant local corruption or the rapacious behavior of foreign companies. This has made governments more cautious about dealing with would-be investors and created many new headaches for ambitious mining companies.

In the case of Mongolia, ordinary citizens are finding it particularly hard to know whom to trust. Many of the country's new foreign investors are companies from China and Russia with murky corporate structures and little apparent desire to employ Mongolians. Local critics fear such companies will have little accountability for their impact on the environment.

'Toxic Bob'

Then there's Mr. Friedland, whose estimated $5 billion project would create the largest mine Mongolia has ever seen and be the country's biggest-ever foreign investment.

The American entrepreneur brings his own baggage along with his promise of mining riches. Environmental activists and others in the U.S. and elsewhere have often referred to Mr. Friedland as "Toxic Bob." The nickname derives at least in part from his alleged role in the contamination of a Colorado river in the 1980s and 1990s. He vigorously contests the allegation.

Ivanhoe also has a joint venture with a state-owned mining company in Myanmar, which is ruled by a military junta decried by the U.S. and others as one of the most oppressive regimes in the world. In 2003, a London-based advocacy group known as Mines and Communities called him "by far the most roguish of all mining entrepreneurs," in part because of his Myanmar investments.

Ivanhoe is nurturing a different image in Mongolia. It is spending heavily to bring doctors to rural Mongolia and to restore an important Buddhist monastery destroyed by Communists in the 1930s. It has helped Mongolia repay millions of dollars in debts to the former Soviet Union. More than 80% of Ivanhoe's employees in the country are Mongolian. If it proceeds, Oyu Tolgoi could yield billions of dollars in tax revenue.

Moreover, many Mongolians believe that Ivanhoe -- whose stock is traded on the New York and Toronto stock exchanges -- is more transparent and accountable than the Chinese and Russian alternatives. Its credentials became even stronger in October, when Ivanhoe announced an agreement with Anglo-Australian miner Rio Tinto to jointly develop its project. Rio Tinto is among the world's largest mining companies.

Mr. Friedland, a 56-year-old with wavy brown hair who also holds Canadian citizenship, said in an interview that he's confident a deal will be signed with the government. He says his controversial past has little or nothing to do with the debates surrounding mining in Mongolia and insists that Oyu Tolgoi represents a golden opportunity for the Mongolian people. "When [a mine is] big, it's normal, it's absolutely normal -- to use the French, it's de rigueur -- to see a fairly extensive period of time under which these things are discussed," he says.

"We're quite sanguine" about the situation in Mongolia, he adds. Whatever happens, the deal "has to evolve as a win-win situation" for everyone.

The outcome certainly is important for Mongolia, a nation four times the size of Germany, but with just 2.8 million people, little industry and no ports. Mongolia's annual GDP is about $1.5 billion, which is less than the annual earnings of Walgreen Co., the American drugstore chain. Its per capita income of $1,900, adjusted for differences in relative living costs, is lower than Bangladesh's. Scores of former nomads now live in sprawling camps that ring the hills outside of Ulaanbaatar, many of them unable to find work.

But Mongolia is blessed with coal, iron ore, copper and gold. As commodity prices have soared, these resources have become more important. Over the past 18 months, Mongolia has entertained visits from President George W. Bush, then-Japanese Prime Minister Junichiro Koizumi, and senior envoys from China and Russia.

Mr. Friedland, meanwhile, is one of the richest men in the world, with an estimated net worth of $1.2 billion, according to a recent Forbes magazine survey.

His background is not that of a typical mining executive. In the late 1960s, he was a student activist. He spent much of the 1970s traveling in India, where he studied Sanskrit, Hindu culture and Buddhism. He also lived on an Oregon apple orchard with his friend Steve Jobs -- who eventually co-founded Apple Computer Inc. -- according to news accounts.

Mr. Jobs and an Apple spokeswoman didn't respond to requests for comment about Mr. Jobs's relationship with Mr. Friedland.

In an interview with The Wall Street Journal in the 1990s, Mr. Friedland said he became interested in mining after stumbling upon an abandoned gold mine on property he was developing for a timber venture with Mr. Jobs.
In the mid-1980s, Mr. Friedland helped open a gold operation in the Colorado mountains known as Summitville. According to the U.S. Environmental Protection Agency, runoff from the mine carried toxic materials, including copper, into the nearby Alamosa River, killing aquatic life and threatening irrigated farmland downstream.

In 1993, Summitville's parent company filed for bankruptcy and left the site. U.S. officials declared the area a Superfund site and sued Mr. Friedland. To date, the EPA and Colorado have spent about $200 million to clean the area and the EPA says regulators will have to build a water treatment facility -- to be operated in perpetuity -- to finish the job.

An attorney for Mr. Friedland says environmental problems in the Alamosa River were caused by natural phenomena and drainage from past mining in the area, not troubles at Summitville. He says the EPA unfairly singled out Mr. Friedland as a scapegoat, in part because of his wealth.

Mr. Friedland reached a voluntary settlement with the U.S. and Colorado governments in 2000 through which he paid $20.3 million, without admitting wrongdoing. U.S. officials now say Summitville was a major source of contamination in the area but not the only one. The U.S. government reimbursed Mr. Friedland $1.25 million in legal fees.

By the time of the settlement, Mr. Friedland was on to bigger and better things, including a giant nickel find called Voisey's Bay.

A company Mr. Friedland invested in discovered the deposit in the 1990s while searching for diamonds in Canada. The company then sold out to Canada's Inco Ltd. for about $3 billion. The deal was so big that it made Mr. Friedland an instant hero among mining speculators world-wide.

Mongolia was a natural choice for Mr. Friedland to try next. For decades it had survived on handouts from the Soviet Union, which treated the country as a satellite state. When the Soviet Union fell, Mongolia hoped mining would stabilize its reeling economy and it approved generous incentives to attract foreign miners.

One of the more promising sites was Oyu Tolgoi, a haunt of camels and nomads close to the Chinese border south of Ulaanbaatar, which was mined for copper as far back as three thousand years ago.

Australian miner Broken Hill Proprietary, now BHP Billiton, drilled exploratory holes there in the late 1990s, including one that stopped 30 meters short of a rich deposit. But it didn't find enough minerals and decided to sell out.

Ivanhoe executives decided to take a chance and paid nearly $50 million for rights to the area. The company kept drilling holes, and in 2001, it detected significant copper and gold deposits. By 2003, independent assessments confirmed the find.

An enthusiastic Mr. Friedland appeared in Mongolia astride Gobi camels and wearing fur hats. At the site, Ivanhoe built a spacious Mongolian "ger" tent camp for workers and visiting dignitaries as further exploration cranked up.

But Ivanhoe lacked one critical document: a long-term agreement with the Mongolian government to guarantee tax rates, royalties and other legal frameworks for the project. Financiers and mining companies often demand such arrangements in high-risk areas before they commit money.

Ivanhoe moved quickly to demonstrate its commitment to the country. It bought $50 million in Mongolian government securities to help Mongolia retire old debts to the Russian government. It began a series of charitable efforts, including one that recently paid expenses for a Mongolian woman to scale Mount Everest.
Ivanhoe also worked the political aisles. In early 2006, former U.S. Secretary of State James A. Baker III, whose law firm, Baker Botts LLP, represents Ivanhoe, spoke to senior Mongolian officials about the benefits of foreign investment. In a news release, Ivanhoe touted Mr. Baker as an "especially close friend of Mongolia" and "welcomed" the government's cooperation in completing a long-term agreement.

A spokesman for Mr. Baker said he was unavailable to comment, but he confirmed that Mr. Baker's visit to Mongolia included Ivanhoe business and that the firm still represents Ivanhoe.

By 2006, however, a deal still wasn't done. Political tensions over how to exploit Mongolia's natural resources were growing. Other mining companies were sweeping across the country. Reports circulated that Chinese investors were making under-the-table deals for mining rights. Shiny black Humvees driven by Mongolians and foreigners cashing in on the incipient mining boom began snaking through the Ulaanbaatar streets.

Many Mongolians feared their democratically elected government was too corrupt to manage the land grab or to ensure the benefits were broadly dispersed. Some also worried the mining projects would cause extensive environmental damage.

Ivanhoe's Oyu Tolgoi project does pose environmental challenges. The mine will require huge quantities of water, and some Mongolians fear this could alter the desert area's fragile ecology. Ivanhoe says it can operate without depleting local water sources.

"Mining isn't going to help us," grumbles 30-year-old Battsogt Batkhuyag, who was found packing up a tent on a grim hillside in Ulaanbaatar one recent afternoon. He had wandered to the capital a year earlier after failing to get a job at a mine in another city.

Closer to Oyu Tolgoi, locals say they're happy to see more mining, because it will mean more economic development. Still, "I can't tell which [company] is the worst and which is the best," says J. Badamtsoo, a 60-year-old nomad, sitting in her tent on a hill several hours across the desert from Oyu Tolgoi. "I'd prefer it if it were Mongolians," she says.

Comments by Mr. Friedland at a 2005 Florida investor conference didn't help. Touting the Oyu Tolgoi project, he predicted that developing part of the mine would be like making "T-shirts for five bucks and selling them for $100." Copies of the speech surfaced on the Internet and later were cited by critics of foreign mining companies in Mongolia and elsewhere.

Tensions came to a head last April, when protesters gathered in Ulaanbaatar's central square. Although they had a number of complaints against their government, not all of them related to mining, Ivanhoe and other foreign mining companies became easy targets. The protesters burned a doll representing Mr. Friedland in a top hat, along with effigies of several top government officials.

Strange Turn

The debate took a strange turn when antimining forces organized a chaotic news conference in Ulaanbaatar to denounce Ivanhoe's work elsewhere. One speaker called Mr. Friedland a "Canadian Grave Digger," according to a transcript provided by Ivanhoe, and displayed photos of bullet-riddled bodies allegedly related to Ivanhoe activities in Myanmar.

Later, it turned out the man was operating under an assumed identity. The organization he worked for, an advocacy group with offices in Washington, D.C., and Thailand called EarthRights International, confirmed he was an employee but said it could not stand by the man's claims. Ivanhoe launched an ad campaign to counter what it called "disgraceful lies."

Mr. Friedland says Ivanhoe is proud of its work in Myanmar and that its operations there have had a positive local impact. (The company has also said it intends to divest itself of its joint venture there in the future). The Florida speech, Mr. Friedland says, was taken out of context and "used for domestic political purposes" by protesters who misunderstood that he was talking about a high-grade portion of the mine that is more profitable than the overall project.

He says the effigy-burning was "quite an honor" but says the protests were "ludicrously" blown out of proportion, adding that street rallies are common in Mongolia's rambunctious young democracy, especially when the country emerges from its bleak winter.

"We don't have any problem at all with an intense dialogue or these young groups of people that are expressing their opinions, even if they're misguided," he says. "It's all OK, because over time, the truth will out."

In May, however, Mongolian government officials acted. In a surprise move, the Mongolian parliament approved new windfall taxes on gold and copper exports. Mongolia later revised its investor-friendly mineral laws to allow the government to take up to 50% stakes in certain mining assets. It's unclear how compensation would be determined.

Mining companies and industry analysts decried the changes, and Ivanhoe's stock price fell by more than one-fourth, though it has since recovered.

Mr. Friedland stepped aside as Ivanhoe's chief executive officer. The company elevated John Macken, a former executive at Freeport-McMoRan Copper & Gold Inc.'s giant Grasberg mine in Indonesia, to take over. Mr. Friedland became executive chairman and says he is no longer taking part in the negotiations with the Mongolian government.

Mongolian officials are divided over the wisdom of the government's mining-policy changes. In an interview in August, Mongolian Prime Minister M. Enkhbold worried that the windfall tax was "not good" for the country's future. Government officials are currently debating possible revisions.

Yangug Sodbaatar, deputy minister of Mongolia's Ministry of Industry and Trade, took the other side. "If it's so terribly bad, [the mining companies] should leave. But I think the serious investors will stay," he said.

Unveiling a Surprise

In October, Ivanhoe unveiled its own surprise: the deal with Rio Tinto.
Under the terms of the arrangement, Rio Tinto agreed to buy a $303 million stake in Ivanhoe with the option to invest an additional $1.2 billion or more in the future -- enough to make it Ivanhoe's largest shareholder. Tom Albanese, an executive at Rio Tinto who was recently tapped to be its next CEO, says the company was keen to get in on the ground floor of one of the world's biggest new mining projects. He says Rio Tinto was heartened by recent talks with senior government officials who have reiterated support for foreign investment and a long-term mining agreement. Many analysts believe that Rio Tinto's involvement in the mine increases the odds that an agreement will be reached soon.

Even so, Rio Tinto -- which reported $5 billion in profit in 2005, the most recent full year for which data is available -- structured the deal so it can exit if the project fails to make headway. "Before we put more in, we're looking forward to working with the Mongolian government to get" a long-term agreement, Mr. Albanese says.

Whatever happens, the slow progress to date likely means Oyu Tolgoi can't be operational until 2009 at the earliest. Meanwhile, copper prices are slipping. After hitting a peak of more than $8,500 a metric ton last year, prices have since retreated to below $6,500 a metric ton. Many analysts believe copper prices will go lower -- though remain above historical averages -- in the coming years.

Mr. Friedland says Ivanhoe will keep plugging away -- but on Mongolia's schedule. "The last thing to do or for our company to do [is] to lecture the Mongolians about their policies," he says. "We are very bullish on Mongolia getting it right, through their own internal, democratic process."

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