Southgobi to stop coal production at Ovoot Tolgoi

VANCOUVER — SouthGobi Resources (SGQ-T) is ramping down production at its Ovoot Tolgoi coal operation in Mongolia as it faces an uncooperative government and dwindling coal contracts.

The move follows more than two months of uncertainty surrounding the company’s operations and its pending takeover by the Aluminum Corporation of China (Chalco). Problems started on April 16 when the Mineral Resources Authority of Mongolia announced it had requested a suspension of SouthGobi’s mining and exploration activity on certain licenses, while an ongoing election campaign for the Mongolian parliament has only added to tensions.

SouthGobi states that it has received no official notification as to any suspension of activity, and so sees no legal reason stopping it from operating. But the uncertainty about the suspensions has meant that many government departments have not issued approvals and permits to SouthGobi, while customers have been hesitant to sign contracts with the company.

On the permitting side, SouthGobi sited the delay in approval of a revised environmental impact assessment for dry-coal-handling facility from the Ministry of Environment, which if not issued may block the company from being able to operate it.

On the coal exports side, SouthGobi reports that customers were reluctant to sign ‘meaningful’ export contracts because of the lack of clarity on whether SouthGobi will be able to deliver the coal because of the suspension. The company also noted contracts were down because of a lack of border crossing capacity — brought on by government delays, repair issues, and extended holidays — and because of the deteriorating market conditions.

The combined difficulties have led the company to curtail activity at its Ovoot Tolgoi mine, with the company expecting to mine only 200,000 tonnes in the quarter and then halt operations entirely at the end of the quarter. The company expects new coal contracts of between 200,000 and 300,000 tonnes for the second quarter, but has not put out a guidance for third quarter sales because of the uncertainty with its operations and the regional coking coal market in general.

Ovoot Tolgoi, produced 4.57 million tonnes of coal last year, up from 2.79 million tonnes in 2010. In 2011 SouthGobi posted record annual gross profit of US$51.7 million, up 424% from 2010, and record annual revenue of US$179 million — a 124% increase over 2010.

As to the suspensions, SouthGobi reports that at a May 30 press conference the Mongolian Minister of Mineral Resources and Energy stated that “the temporary suspension has been lifted, but, regarding the new law, the licence of Ovoot Tolgoi will be discussed by the cabinet and parliament.” The company has written to the Mineral Resources Authority of Mongolia and the Ministry of Mineral Resources and Energy seeking clarification on the matter, but has apparently been given none.  

The law the Minister was referring to is a new investment law passed on May 17 that will allow the government to assess foreign investments, though exactly what’s in the new law is still unclear. According to University of British Columbia researcher Julian Dierkes, the law includes a listing of strategic sectors it applies to, which includes mining; a minimum ownership threshold that triggers a review, apparently 49%; a minimum transaction value of roughly $75 million; and far lower criteria when foreign state-owned entities are involved, as in the case of Chalco. Dierkes notes that in many provisions the law resembles the Canada Investment Act, which recently allowed Canada to stop the takeover of Potash Corp (POT-T, POT-N).

The Chalco deal, first announced in early April, would see the Chinese aluminum giant buy Ivanhoe Mines’ (IVN-T, IVN-N, IVN-Q) 104.8 million shares of SouthGobi, representing 57.6% of the company, for as much as $889 million. The offering price came in at $8.48 per SouthGobi share, a premium 28% to the $6.62 closing price of the stock the day before the deal was announced.

But on news of SouthGobi’s plans to ramp-down operations, its share price plunged $1.40 or 26% to $4 before a slight rebound to $4.16 the following day.