QGX weathering Mongolia’s tax storm (August 25, 2006)

It takes a lot of blood, sweat and tears to develop a deposit in a young democracy. Sometimes all the work gets rewarded, other times the rug gets pulled out just when things are coming into alignment.

QGX (QGX-T) began 2006 with a cup overflowing in optimism for Mongolia. And why not? Its shares were trading well north of $4.00, metal prices were climbing unabated, and its significant deposits in the country were being proven up.

But David Anderson, co-founder and executive chairman of QGX, is now left to grapple with the repercussions of a windfall tax that has effectively killed exploration in the country.

“Was I disappointed?” Anderson says of his reaction to news of the tax earlier this year, “Absolutely.”

Anderson says as long as the windfall tax hangs over the country, exploration has been called to a halt. QGX had anticipated spending in the region of $25 million for development and exploration for 2006, but have scaled that number back to between $12 and $14 million as a direct consequence of the change to the mining laws.

If it remains in place the windfall tax will hammer gold and copper production in the country. It levies a 68% tax on anything above US$1.40 a pound copper, and US$500 an oz. gold, unless the products are refined in Mongolia a prospect that would require vast amounts of capital which western investors would be leery of putting into the country given the lack of confidence the windfall tax has inspired.

In addition to the tax, changes to the Mining Law made in July of this year could also allow for the government to acquire a 34% interest in deposits it deems to be “strategic”.

While the definition of what is strategic and what isn’t is still murky, deposits which could impact the country’s national security, economic or social development, those that were historically mined by the Mongolian government, and those that will reap profits greater than 5% of the country’s gross domestic product which is a relatively small sum of US$2 billion could all be targets.

The move comes from a government in which no party holds a clear majority, making negotiations difficult. Still Anderson says he believes some in government to be acting in good faith, and genuinely striving to find the correct balance. The problem, he says, is many of those responsible for the tax have little mining experience.

“It’s a young democracy and it can be painful watching a young democracy that’s still forming,” Anderson says. “But I have a lot of patience and confidence from discussions (with government officials) that this will be resolved in the end. Some of them do realize they shot themselves in the foot.”

Anderson is a bit of a pioneer in Mongolia. He first visited the former Soviet Satellite back in 1990 after a Mongolian official approached him at a mining conference in Sudbury. Anderson was running Quantec Geoscience at the time, but by 1994 he acquired the first lease granted to a western mining company in Mongolia and established QGX.

Taking such an early position in what was largely an unknown country to the west meant that Anderson also took on the roll of an informal ambassador for the country, spreading the word of its mineral riches to the investment community back home.

But all that effort took a serious blow when a populist faction of the Mongolian electorate was able push the new tax through on the pretext that the general population wasn’t benefiting from western investment, despite the ratification of an investment friendly mining code in 1997.

Anderson explains that in the case of QGX, while the company had been in the exploration phase for sometime starting in the mid 90s market forces, namely the collapse market in the late 90s, took the wind out of the company’s sails. But those winds have picked back up.

“We see a good metals cycle now, and we were thinking ‘this is what we need to build the infrastructure in the country for when prices do soften. This is the time, let’s go guys,'” he recalls.

The irony, of course, is that just as companies like QGX began to get nearer to production the government effectively cut them down at the knees.

“They got impatient because there was no tax revenue,” Anderson says. “They jumped the gun because it took so long to get through the exploration phase but that is a function of market cycles.”

While QGX has three advanced-staged exploration properties which have been joint ventured to Ivanhoe Mines (IVN-T), it’s the Baruun Naran gold project and the Golden Hills copper, gold and silver project, that define its portfolio most prominently.

Baruun Naran is wholly owned by QGX and is situated in the southern portion of the country. The project is within a single license, acquired by the company in 2002, and is 953 sq. km.

An initial resource estimate outlined 107.5 million tonnes of measured and indicated coal and additional 48 million tonnes of inferred. The deposit is a mix of metallurgical and thermal coal, and while coal-quality data still has to be fully completed, early indications are that much of the deposit has coking properties.

Golden Hill is in northwestern Mongolia, and QGX has an 80% interest in the initial license area70 sq. km. and a 100%stake in surrounding licensing making up roughly 6,000 sq. km.

The copper, gold and silver sulfide deposit, known as the Central Valley zone, was discovered by QGX back in 2002. Currently the deposits resource stands at 655 million pounds of copper, 1.1 million oz of gold and 6.9 million oz of silver.

And while Golden Hill is the most susceptible to the new laws because of its high copper and gold content, Anderson is intent on pushing ahead with Baruun Naran.

Based on projected annual revenues Baruun Naran, the project could fall under the “strategic deposit” category — which would mean the government would have a right to buy up to 34% of the company at market price.

But two factors mitigate in the projects favour.

One is that there are serious question as to whether the Mongolian government has the capital to buy in to all of the projects that would qualify as being strategic deposits.

Secondly, and more importantly for Anderson, Baruun Naran has the potential to have a 20 to 30 year mine life with annual production in the neighborhood of 5 to 10 million tonnes per year. Such big numbers allow QGX to look at the current tax issue from a more long term perspective.

While it still might be many months away, Anderson believes industry will be able to sit down with the factions of government who support the tax and come to reasonable terms.

“In the end, they need investment and they need mine development,” He says. “I’m confident that we can do business in Mongolia end of story. It’s just a question of when.”