US fund threatens Rio Tinto with legal action over Oyu Tolgoi finances

The world’s second largest miner Rio Tinto (NYSE: RIO; LSE: RIO) is facing stronger headwinds over how to finance its massive Oyu Tolgoi underground copper project in Mongolia after a U.S. hedge fund threatened the company with legal action.

Pentwater Capital, the second largest shareholder in Rio Tinto-controlled Turquoise Hill Resources (TSX: TRQ; NYSE: TRQ), said today it was ready to file an “oppression” order against the mining giant.

The move is a statutory right available to “burdened” shareholders, empowering them to bring an action against the corporation in which they own shares. They can do so when the conduct of the company has had an effect that is oppressive, unfairly prejudicial, or unfairly disregards the interests of a shareholder.

The Florida-based fund said it would spare the company the legal action if it allowed Turquoise Hill to take on more debt to fund the US$6.8 billion underground expansion.

“We do not undertake this lightly, but enough is enough,” Pentwater CEI Matthew Halbower said in an open letter.

“This mine is a jewel. It will be the third-largest gold and copper mine in the world. It will produce tens of billions of dollars of free cash flow for decades. Its owners should be treated as business partners, not as puppets or pawns,” Halbower stated.

This is not the first time Pentwater has taken issue with the way Oyu Tolgoi’s expansion is being handled. In April, it demanded a shakeup at the operation over what it claimed was “a massive devaluation” of the asset.

Pentwater’s threat comes on the heels of a similar warning issued by Odey Asset Management, a London-based hedge fund. The firm accused Rio last week of holding the “people of Mongolia … accountable for Turquoise Hill’s failings,” after it called the country’s government’s US$7 billion-equity stake in the copper gold mine “worthless”.

Mounting investor activism is just one of the many headaches Rio Tinto has had while building what would rank as one of the world’s three largest copper mines when operating at full tilt – now expected to be by 2025 at the earliest.

In January 2018, Mongolia’s government served Oyu Tolgoi with a bill for $155 million in back taxes —  the mine’s second tax dispute since 2014. The company said at the time the charge related to an audit on taxes imposed and paid by the mine operator between 2013 and 2015.

Shortly after, the mine had to declare force majeure after protests by Chinese coal haulers disrupted deliveries near the border.

The situation prompted Rio Tinto’s former chief executive officer, Jean-Sebastien Jacques, to visit Prime Minister Ukhnaagiin Khurelsuk to discuss how to build “win-win” partnerships. The trip was followed by the company’s announcement that it was opening a new office in the country, focused on exploration and building local relationships.

The issue resurfaced later, when a group of Mongolian legislators recommended a review of the 2009 deal that launched construction of the mine. It also advised revoking a 2015 agreement allowing for an underground expansion. 

In December that year, Mongolia’s parliament unanimously approved a resolution that reconfirmed the validity of all the Oyu Tolgoi mine-related agreement, bringing the 18-month review to a close.

Mongolia has also complained about overruns in the past. Much of Oyu Tolgoi’s copper lies deep underground. When Rio Tinto finally kick off the delayed project, profits from surface extraction were meant to pay for digging up more of the copper below.

With time, it became clear the underground mine alone would cost as much as a third more than the original US$5.3 billion budget.

Rio Tinto cut estimated reserves at the project in July and confirmed it would face delays and higher costs after ground instability forced it to redesign the mine plan.

Once completed, the expansion is expected to lift Oyu Tolgoi’s production from 125,000–150,000 tonnes in 2019 to 560,000 tonnes at peak output, targeted for 2025.

The giant deposit, discovered in 2001, is one-third owned by Mongolia’s government and two-thirds by Turquoise Hill. Rio Tinto has a 51% stake in the Canadian miner.

This article first appeared in MINING.com, part of Glacier Resource Innovation Group.