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Rio’s Mongolian jeopardy

Cost blowouts and a royalty stoush are threatening to delay Rio Tinto’s (ASX: RIO) massive US$11.3 billion Oyu Tolgoi copper, gold and silver project.

Rio is managing the development of the massive mine, and owns a 51% stake in Turquoise Hill, a Canadian listed miner (formerly Ivanhoe Mines), which in turn holds a 66% stake in the project. The Mongolian government owns the remaining 34%.

Rio has revealed that a significant blowout that has wiped out US$1.5 billion in value, reduced forecast production and raised the expected operating costs. The government is concerned that the second stage of the project, which was estimated to cost more than US$5 billion, could see costs blow out even further due to a rapid rise in construction costs.

The second stage has since been redesigned, scrapping plans to expand concentrate output and build a dedicated power station, in an effort to cut down the costs. However, it also means Oyu Tolgoi will be smaller and less profitable once it begins operating, although it could be expanded at a later stage.

Turquoise Hill also said it was in discussions with the Mongolian government over royalties, with the government including a progressive royalty scheme in its 2013 budget, despite the investment agreement stipulating a stabilised royalty rate of 5% over the life of the agreement. A World Bank analysis of the government’s budget is reported to have found that the nation was expecting at least an extra $303 million in royalties from the project.

Rio hopes to begin commercial production from the first phase of Oyu Tolgoi by the end of June this year, but the ongoing tensions could delay the start and potentially risk the second phase of development.

Foolish takeaway

Mongolia has to tread a fine line, with Oyu Tolgoi expected to account for 30% of the country’s GDP alone. While it’s unlikely that Rio or its subsidiary Turquoise Hill will walk away from the project, if pushed too far, they may cut back on their investment and even abandon the second stage of the project. It could also spook other foreign investors from investing in the country, including ASX-listed miners Haranga Resources (ASX: HAR), Aspire Mining (ASX: AKM) and Xanadu Mines (ASX: XAM).

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The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.  This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool writer/analyst Mike King owns shares in BHP.

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