Oyu Tolgoi funding puzzle shows Rio Tinto between a rock and a hard place

Turquoise is hardly an independent entity despite its separate listing as Rio controls 51% and operates the mine, where there have been embarrassing cost overruns and rows with Ulan Bator about the future profits carve-up.So severe have the disputes been that work on the underground mine was suspended between July 2013 and May 2016. That wasn't the end of it. A further two-year parliamentary enquiry concluded last year, but there was a demand for changes to earlier agreements, so the matter is by no means resolved.For investors, there are several more unknowns. For instance, how to quantify the level of jurisdictional risk in Mongolia as legal/financial matters are still up in the air, and secondly - after last year's disclosure by Rio of a multi-billion dollar cost blow-out at the underground project, how will it plug the funding gap variously estimated between $2.5 billion and more than $4 billion?That's where the rights issue comes in.According to a confidential "funding support document" seen by Mining Journal, and signed by Rio and TH in December 2015, Rio has a right to force the Canadians to raise more cash via a rights issue that would severely dilute the minorities, paving the way for a possible take-out by Rio of the entire listed Canadian entity.But will it happen? The market thinks so as the share price has dived to under a dollar. But to answer this question, something else needs to be noted. Turquoise Hill and Rio have said it won't be till the second half of 2020 until we get a final estimate on the cost of the underground project, not to mention finalisation of the mine development plan in the light of a number of geotechnical issues that have delayed first production from the underground operation by up to 30 months, until 2023.In the interim, TH has said the money runs out in the first quarter of 2021, and lenders are getting twitchy; they will want to know well before that date where the additional funds are coming from.Investors will cast a more critical eye on the project if the price of iron ore tanks leaving Rio vulnerable to increasingly forensic questions about what's gone awry at Oyu TolgoiOver to Jean-Sebastien Jacques, Rio's CEO who, together with the board, must make a decision on funding in the near future.A rights issue (accompanied by more debt finance from Rio) could open the door to a take-out of TH, but that may not be as easy as it sounds. Yes, a takeover giving Rio direct control of the mine and a bigger share of the asset's cash flow makes sense in principle as all the balance sheet risk is with Rio even though ownership of Oyu Tolgoi is 66% with TH and 34% with the Mongolian government.But will the minorities play hard ball and demand a very large premium if a rights issue is viewed as a way of Rio taking full control, rather than being merely a fund-raising exercise? Worse, perhaps they would mount a legal challenge to try and stop Rio taking control, something they have always feared. So Rio could be forced to rely solely on debt financing to rescue the project, and forgo direct control.There is an even bigger issue here for Jacques.True, greater exposure to copper and other minerals is just what investors want as criticism of Rio has turned on it being too much of a one-trick pony with over-reliance on its extremely profitably iron ore operations in Australia. On the other hand, greater exposure to Mongolia, a very poor country, where resource nationalism has come frighteningly close to killing off Oyu Tolgoi's underground operation altogether, could go down like a lead balloon with cautious investors.Another potentially thorny issue is that the deal with Ulan Bator means Rio is on the hook to provide the mine with a coal-fired power station and associated infrastructure estimated by analysts to cost anything between $800 million and $1.2 billion at a time when fund managers are nervous about being seen to bankroll thermal coal.Investors will cast a more critical eye on the project if the price of iron ore tanks leaving Rio vulnerable to increasingly forensic questions about what's gone awry at Oyu Tolgoi.Shareholders in London would like to see a funding announcement go hand in hand with an agreement with Ulan Bator that settles legal and profit-share matters once and for all.Rio looks as if it's between a rock and a hard place when it comes to assessing the way forward, and yet this thing needs sorting. The company can't operate fixed heavy capital assets in a country with an antagonistic government. The Mongolians must tread carefully, too, as Rio is the country's biggest taxpayer, paying about $2 billion so far, and directly employing more than 15,000 people with a further 45,000 involved in the supply chain.If this all looks like a bit of a trapeze act for both sides, it's because it is.

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Oyu Tolgoi funding puzzle shows Rio Tinto between a rock and a hard place

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