QGX weathering Mongolia’s tax storm (September 04, 2006)

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

QGX (QGX-T, QGXLF-O) began 2006 with a cup that overflowed with optimism for Mongolia. And why not? Metal prices were climbing unabated, the company’s shares were trading well north of $4.00, and its significant deposits in the country were being proven up.

But David Anderson, co-founder and executive chairman of QGX, has instead been 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 neighbourhood of $25 million for development and exploration in 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 copper when the price is higher than US$1.40 per lb., and on gold once the price exceeds US$500 per oz., unless the metals are refined in Mongolia — a prospect that would require vast amounts of capital that Western investors are now leery of investing in the country.

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

While the definition of what qualifies as strategic is still murky, deposits that could affect 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 — 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 are 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, Ont. Anderson was running Quantec Geoscience at the time, but by 1994, he acquired the first Western-granted lease 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 role of an informal ambassador for Mongolia, 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 some time (starting in the mid-1990s), market forces — namely the market collapse 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 that have been joint ventured to Ivanhoe Mines (IVN-T, IVN-N), it’s the Baruun Naran gold project and the Golden Hills copper, gold and silver project, that define its portfolio.

The wholly owned Baruun Naran project is situated in the southern portion of the country. Acquired by the company in 2002, the 953-sq.-km project is located within a single licence.

An initial resource estimate outlined 107.5 million tonnes of measured and indicated coal and an additional inferred 48 million tonnes. The deposit is a mix of metallurgical and thermal coal, and while coal-quality data is not yet 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 licence area of 70 sq. km, and a 100% stake in surrounding licences covering roughly 6,000 sq. km.

The copper, gold and silver sulphide deposit, known as the Central Valley zone, was discovered by QGX in 2002. Currently, the deposit’s resource stands at 655 million lbs. copper, 1.1 million oz. gold and 6.9 million oz. 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, the Baruun Naran 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 there are two factors that stand in the project’s favour.

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

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

While it still might be many months away, Anderson believes industry will be able to sit down with the factions of government that 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.”