Journal of Political Risk, Vol. 2, No. 6, June 2014.
Jamian Ronca Spadavecchia 
Founder and President of Oxbow Advisory
Mongolia stands at a critical juncture between the rewards of natural resource development and the challenges of modernization. On the one hand, it offers abundant opportunities in the natural resources sector and is located near growing and resource-starved industrial nations of East Asia. At the same time, the presence of autocratic neighbors impose international instability on this democratic and market-oriented economy.
This article considers two underanalyzed political risks that are necessary for understanding the future of the Mongolian economy: nationalism and pastoral nomadism. In doing so, it proffers an improved analytical framework for resource investors to better assess and mitigate their Mongolia risk.
Finally, the analysis uses selected case studies to demonstrate how nationalism and pastoral nomadism might impact natural resource investment. For nationalism, a study of the proposed acquisition of SouthGobi Resources (SouthGobi) by the Aluminum Corporation of China Limited (Chalco) is offered. The Chalco study is emblematic of the link between nationalism and two dominant trends in Mongolia: resource nationalism and increasing geopolitical risk in the natural resources sector. The section also looks at how pastoral nomadism poses a risk to Oyu Tolgoi, Mongolia’s premier copper and gold mining project, by examining a dispute between Rio Tinto and indigenous communities of Gobi herders that threatened Oyu Tolgoi’s project financing.
Mongolia’s Investment Gap
A persistent condition in Mongolia’s development history is the country’s significant investment gap. In the past, Mongolia relied on Soviet subsidization or international aid for support, but today development assistance cannot adequately address Mongolia’s needs. As the country modernizes, foreign direct investment will play a decisive role in narrowing this gap. Therefore, the attractiveness of Mongolia’s investment climate is highly significant in determining the success or failure of its modernization. This is particularly the case in the context of Mongolia’s natural resources sector.
Mongolia’s small population, poor infrastructure, and nascent political/economic institutions all serve as barriers to market entry. Most direct investors simply cannot balance the risk-return equation in their favor. Instead, investors often view the long-term growth potential of Mongolia’s natural resources sector as favorable to their risk-return calculus. And, as will be chronicled below, investment (at least initially) flowed in.
Mongolia’s economy is driven primarily by the natural resources sector. According to World Bank data compiled for 2012, mineral exports accounted for nearly 89 percent of Mongolia’s total exports with three minerals: copper, coal, and gold, representing 73 percent of those total exports. 2013 World Bank projections placed mineral revenues at over 20 percent of Mongolia’s total government revenue.
The first significant wave of FDI inflows occurred from 1996 through 2006. A relatively friendly investment climate opened the door to natural resources investment during this period; however in 2006 investment decreased with the passage of a Minerals Law and the more financially impactful Windfall Profit Tax. These laws signaled that the Mongolian government demanded a greater share of its natural resources sector revenue. From 2006 through 2010, overall levels of FDI continued to increase but moved at a slower pace as a series of political, regulatory, and socioeconomic constraints deterred foreign investment. In 2010, discontent over the impact of resource investment led militant members of the United Movement of Mongolian Rivers and Lakes (UMMRL) to use firearms against mining equipment located at foreign-owned gold mining facilities. As Figure 1 indicates, FDI inflows increased in H2 2010; peaked in FY 2011; and then remained steady until Q4 2012 when inflows began their precipitous drop through Q4 2013.
Figure 1: FDI inflows to Mongolia Q1 2009 through Q4 2013 in USD millions
Outside observers attribute the decline in FDI inflows to: election cycles, resource nationalism, the end of the commodity super-cycle, the U.S. Federal Reserve tapering, and a decrease in Chinese economic growth. Notwithstanding these prognostications, a historical snapshot of inward FDI is included here to show that the attractiveness of a country’s investment climate matters. In Mongolia’s case, one can extrapolate from Figure 1 that FDI inflows ebbed and flowed with political, economic, and social developments. Driving these outcomes are the determinants that make up Mongolia’s political risk landscape.
This article is divided into three parts. Part I examines the driving, structural forces behind nationalism and pastoral nomadism. Part II examines how the risks of nationalism and pastoral nomadism impact resource investment. Part III concludes by taking a political risk practitioner’s view, looking at how resource investors might best assess and mitigate their Mongolia risk.
Part I: Structural Determinants of Mongolian Political Risk
The Mongol is a self-reliant man. His loyalties are often more personal than institutional. His political thinking is more apt to be in terms of “our people” than in terms of “our ideology.” He is deeply nationalistic in the sense of feeling that all Mongols are his own people, while all Chinese, Russians, and other strangers are “outsiders.” He is convinced that the outsider rarely gives the Mongol a square deal if he can get away with giving him a shabby deal.  – Owen Lattimore, 1949
It may be yet that we shall see a Mongolia in which the Mongols are restored to the control of their own destiny…which the new economic forces of mines, and industrial railways and machines, will be manned not by alien conquerors who have reduced the Mongol to…degradation, but by the free Mongols themselves. – Owen Lattimore, 1935
Nationalism is a highlighted political risk in Mongolia.  Three primary factors driving Mongolian nationalism are Mongolian exceptionalism, xenophobia, and political geography.
Shared cultural, ethnic, linguistic, and racial identities drive nationalistic sentiment in Mongolia. Mongolians’ distinct ideals, history (Genghis Khan is the most salient historical figure), values, and socioeconomic traditions of the steppe form the contours of Mongolian exceptionalism. As John Stuart Mill argued “[t]he strongest cause for the feeling of nationality…is identity of political antecedents; the possession of a national history, and consequent community of recollections; collective pride and humiliation, pleasure and regret, connected with the same incidents in the past.” In other words, Mongolia’s past reinforces its present identity and traditions as a steppe society—distinct from others in the region.
Exceptionalism drives nationalist pride in Mongolia. It informs how Mongolians view and interact with the wider world. While exceptionalism has inspired positive outcomes, it also leads to more dubious outcomes for non-Mongolians.
A second significant aspect of Mongolian nationalism that is at times disruptive is xenophobia. Its assessment is essential to understanding nationalism as a source of both political and geopolitical risk. As former U.S. Ambassador to Mongolia, Jonathan S. Addlelton describes the phenomena in his 2013 diplomatic history of U.S.-Mongolian relations: “[a]t its best, Mongolia as a society will reflect a strong sense of self-confidence while engaging in positive ways with the rest of the world. More pessimistically, the emergence of latent xenophobic tendencies in Mongolia, as in all societies, could undermine relations with its neighbors both near and far.” Xenophobia either latent or actualized informs nationalistic outcomes in Mongolia, which at best reflect skepticism of outsiders, and at worst are destructive to foreign interests.
Political geography is a third factor in analyzing Mongolian nationalism. Pressed between China and Russia, the politics of Mongolia’s geography is shaped by a long history of Chinese imperial conquest and displacement as well as Tsarist/Soviet hegemony and clientelism. Even today, where Russia’s internal influence and China’s economic dominance sway domestic outcomes, landlocked Mongolians’ nationalistic sentiment is driven by resistance to (and reliance on) Russia and China.
Nationalistic sentiment impacts resource extraction. In particular, exceptionalism and xenophobia play a role in the present day skepticism and (at times) outright rejection of non-Mongolian or “foreign” participation in the natural resources sector. Exceptionalism and xenophobia stoke nationalistic tendencies in the wider populous and within those elites that advocate greater control over Mongolia’s natural resources.
Nationalistic sentiment was on hand during the 1990s when nationalist groups claimed that some Mongolians were not “true Mongolians, and worse, are traitors, because of their excessive links to, and interest in the west…bring[ing] them into conflict with a higher ideal, the nomadic heritage of Mongolia.” At that time, nationalists rejected international aid. Today, expressions of “Mongolness” and “us” versus “them” distinctions influence how Mongolians approach the development of their natural resources.
A survey conducted by the Sant Maral Foundation in March of 2014 reveals that when it comes to “foreign” ownership of natural resources, Mongolians are skeptical at best. Consider Figure 2, indicating that a majority (55.8%) of nationwide respondents believe Mongolians should hold more than 51 percent ownership in strategic mine deposits. A higher degree of nationalistic sentiment is held by nearly a quarter of nationwide respondents who believe that ownership should be 100 percent Mongolian. The survey captures the saliency of nationalistic sentiment when it comes to Mongolia’s natural resources.
Figure 2: Questioning foreign ownership in Mongolia’s strategic mine depositsThe composition of Mongolia’s parliament is an additional illustration of the degree to which nationalistic tendencies vis-à-vis Mongolia’s natural resources inform its polity. As Michael Kohn reported after the June 2012 parliamentary elections: “[m]ore than a quarter of the 76-seat parliament is now held by politicians who advocate local control of mines.” Moreover, Mongolia’s current governing coalition, put together by the Mongolia Democratic Party in order to form the majority needed to rule, includes the resource nationalist Mongolian People’s Revolutionary Party and Mongolian National Democratic Party who “both have sought to reverse policies they believe to be too friendly to foreign mining investors.”
More strident forms of nationalism are found within groups such as “Dayar Mongol” whose members advocate “sav[ing] Mongolians from the threat of foreigners.” Yet, routine remonstrations including those directed at foreign resource investors also exist more broadly within civil society. Remarks such as “[t]he foreigners are stealing our natural resources and nothing will remain for us” are not uncommon. As one reporter notes, “it isn’t only the followers of ‘Dayar Mongol’ who believe they must protect themselves from foreign influence.”
Many outside commentators argue that Mongolia’s resource nationalism is driven primarily by economic factors such as the Mongolian government’s seeking to maximize revenue. Economic drivers are a necessary component to resource nationalism, but they are not sufficient in explaining Mongolia’s recent assertiveness over its resources. The strong sentiment of self-reliance and long history of skepticism of outsiders should not be discounted as drivers in Mongolia’s turn towards resource nationalism.
In another poll, the results of which are shown in Figure 3, the Sant Maral Foundation gauged Mongolian sentiment and preferences in foreign relations.
Figure 3: Determining the best partner country for MongoliaThe polling illustrates how sentiment towards outsiders has shifted at various points in Mongolia’s history. Such shifts in sentiment are a hallmark of history and geopolitics firmly rooted in a political geography dominated by Russia and China. If the question were asked at the height of Mongolia’s democratic revolution in the 1990s, preferences would likely have reflected a pervasive (even violent) anti-Russian sentiment. At that time, the rapid withdrawal of Soviet economic aid and the prospect of an end to 70+ years of (at times) heavy-handed subservience to Moscow fanned anti-Russian fervor. Today, in contrast, a majority (53.3 percent) of respondents chose Russia as the “best partner” for Mongolia. Perhaps the shift in sentiment is attributed to long-standing cultural affinities with Russians or driven more by anxieties over the ascendency of its neighbor to the south. Either way, the results reveal that Mongolian sentiment and preferences are shaped by the relative heft of Russia or China as an influence in Mongolia’s domestic dynamics.
Another dynamic is in place with respect to China. Only 1.2 percent of respondents chose China as their first choice for “best partner.” Likely, this sentiment is a function of Mongolian preferences characterized by a tumultuous history and uneven relationship with China. A low opinion of China as a “best partner” is predictable in a country where Sinophobia runs deep. One Mongolian stated, “[w]e have been enemies from the very beginning. That won’t change.” Indeed, anxiety over China is widespread today in Mongolia, driven more by the fear of economic dependency and domination than territorial absorption. One commentator noted, “Mongolians feel that Chinese workers are taking away their natural resources and jobs.” Sinophobia is an abiding factor in Mongolia’s political, economic, and socio-cultural life.
Yet, a closer look at Figure 3 reveals a discontinuity between respondents’ first and second choices. Due to Mongolian angst with China, one would not expect the Chinese to be chosen as Mongolia’s second “best partner.” The paradoxical nature of the results is explained by the conflicted approach Mongolians have historically taken when it comes to preferences versus needs. For instance, in the late-1990s many nationalists opposed international aid at the time of greatest economic need—equating western financial assistance to neo-colonialism. Such contradictions are found in today’s debate over natural resource extraction, due to parallels between Mongolia’s need of foreign capital/know-how to develop its natural resources and the rejection of foreign resource investors.
Economic realities go a long way in explaining why in the second “best partner” category, China leads with a plurality of 16.1 percent. Chinese investment and trade are substantial drivers of Mongolia’s macroeconomic growth. In 2012, China imported 92.6 percent of Mongolia’s total exports, and of those exports, minerals accounted for 89 percent. The economic imbalances and dependences in the relationship likely account for the dichotomous nature of Sant Maral’s results. Mongolians are neither willing to widely accept, nor reject Chinese participation in natural resources development.
Nationalistic sentiment is not the only factor driving Mongolia’s embrace of resource nationalism. Observers rightly point to numerous political, economic, and social factors influencing Mongolian preferences for control and state participation in resource investment. Yet, within the prevailing discourse on resource nationalism the factors of exceptionalism, xenophobia, and political geography are insufficiently linked to Mongolian policymakers’ nationalist decisions.
The Role of Nationalism in Driving Resource Policy and Regulatory Outcomes
Emblematic of Mongolia’s embrace of resource nationalism is the Strategic Entities Foreign Investment Law (SEFIL). SEFIL not only restricted foreign investment in the mining sector, but also made select foreign-related transactions subject to government (cabinet/parliament) approval. While SEFIL is viewed by some analysts as a vehicle to increase Mongolian government ownership in its resources sector; or to placate voters (SEFIL was passed on the eve of the 2012 parliamentary elections) this article posits that a few additional factors were at play.
On one level, Mongolian policymakers plainly sought to guard against risks associated with state-capitalism by passing SEFIL. The law expressly delineates between “privately-owned” foreign entities and “state-owned” foreign entities, with stricter limitations and Mongolian government approval requirements for state-owned resource investors. As such, the legislation confers an added layer of economic security and leverage to Mongolian government against any powerful, well-capitalized state-owned resource companies attempting to dominant Mongolia’s nascent natural resources sector.
Nevertheless, even beyond the letter of the law, SEFIL’s intent is clearly aimed at restricting Chinese state-owned enterprises (SOEs). The chronology of SEFIL’s passage (May 2012) and the timing of a proposed M&A deal (April 2012) between Canadian-owned SouthGobi Resources and the Aluminum Corporation of China Limited help to illustrate the true aims of the law. SEFIL’s passage came just weeks after Chalco’s April 1st proposed a purchase of SouthGobi, which would have given it a controlling interest in Ovoot Tolgoi (one of Mongolia’s largest coal mines). Thus, by passing SEFIL policymakers created the legislative means to block the Chinese-SOE acquisition to which they were opposed. Of course, Mongolian policymakers could not escape the fact that SEFIL’s timing, letter, and spirit all feature a reactionary nationalist, or even anti-Chinese, sentiment. As one observer concluded, “Beijing has been assiduously excluded from investing in the crown jewels of Mongolian mining assets.”
Indeed, the salience of nationalistic sentiment is further demonstrated by the fact that SEFIL’s xenophobic component has outlived the law itself. Notwithstanding SEFIL’s repeal in October of 2013, restrictions and Mongolian government approval requirements remain in place for state-owned foreign investors. As an official in Mongolia’s mining department put it, “[w]e do not intend to regulate all foreign-affiliated companies, but state-run companies working very closely with their governments are posing problems.”
Nationalist sentiments do not exist in a bubble. National identities, histories, pride and humiliations are sharpest when juxtaposed with other nations and peoples. In the case of Mongolia, nationalism is heightened when it comes to relations with Russia and China. Because Russia and China are dominant players in Mongolia’s natural resources sector, investors are uniquely exposed to the geopolitics risks within the triangle of China-Mongolia-Russia relations.
A barrier and longstanding frustration of foreign investors is that geopolitics drive economic outcomes in Mongolia’s natural resources sector. Investors are perplexed over what they perceive as a sector plagued by economically “irrational” decisions, namely limits on foreign direct investment or anti-Chinese policy and legislative actions that undermine the relationship between Mongolia and its largest direct investor and export market. Policymakers have also consistently blocked the development of new railway connections between Mongolia’s natural resource deposits and China, preferring instead to build railroads to less competitive seaports in Russia in lieu of more economically rational port facilities in eastern China. Mongolian decision-makers are not alone in their ability to baffle resource investors.
In 2013, despite China’s high resource demand and Chinese contracts for copper concentrates from Oyu Tolgoi, Chinese customs officials held up delivery approvals at the border, prompting questions over whether the delays were a result of bureaucratic red tape or a more subtle geopolitical reminder of the leverage held by Mongolia’s biggest resource customer. Geopolitics was also a suspect in 2011 when Russia (one of the world’s largest oil producers) cut diesel exports to Mongolia. Russia’s action raised the question of whether the move was based on actual scarcity of supply or a lesson in geopolitics. For investors, such decisions by Mongolians, Chinese, or Russians controvert economic rationalism.Yet, when decisions are viewed through the lens of nationalistic preferences or security needs, such outcomes are rationalized within the calculus of geopolitics. Nationalistic preferences and needs, driven by factors such as exceptionalism, xenophobia, and political geography, often trump “rational” or market-driven decision-making.
Thus, assumptions relying on even the most obvious economically rational outcomes are often skewed by an entirely distinct set of incentives. For foreign investors such outcomes will likely continue to mystify those that persist on viewing Mongolian decision-making solely within a framework of market-driven or rational-economic bounds.
We badly need more analysis of the interaction between mobile livestock property and immobile territorial property… – Owen Lattimore, Studies in Frontier History, 1928-1958
There are five mines in my soum. With too many mines, there will be no livelihood in my soum. There will be no camels in my soum. I represent 4,000 people. If that fifth mine opens, there will be no more livelihoods in my soum. – Anonymous Gobi Herder, 2012
Pastoral nomadism is firmly rooted in Mongolian society. Mobility, the dominant characteristic of nomadism, is underwritten by a livelihood enabled by the herd and its pastoral lands. The herder profits most from animal husbandry and the input factors essential to their livestock’s viability: grazing lands, water supply, and the ability to move between seasonal pastures. Pastoral nomadism is not only a long-standing source of socioeconomic stability in Mongolia, but the norms it engenders (e.g., self-sufficiency and respect for the land) are axiomatic to Mongolian identity today.
Pastoral nomadism can be deconstructed into three distinct driving forces with the aim of identifying the concept and how it poses a political risk to natural resource extraction.
First, pastoralists in Mongolia are often affected by deprivation of land ownershipas a result of resource extraction. There is an intrinsic conflict between the exclusive use of land and the fundamentals of pastoral nomadism with its tradition of mobility. For the herder, it is the deprivation of ownership that drives disaffection with, and resistance to, those that seek to deprive their freedom of mobility.
Resource extraction can also be viewed as a threat to socioeconomic livelihoods of pastoralists. The extractive industry’s land use requirements, water usage, and constraints on the natural environment are antithetical to the elemental needs of the herder. As one commentator asserts “social mobilizations emerging around mining can be understood as a collective response to loss (or its risk) of the material, environmental, and cultural base of the livelihood.” As incidents of social unrest demonstrate; delimitations on land, unsustainable water consumption, and environmental degradation drive sociopolitical resistance in Mongolia.
Dissonance within Mongolians’ collective consciousness over the development of their natural resources, or collective dissonance, is a third factor driving the risk of pastoral nomadism. At the risk of generalization, one may persuasively argue that it is the connection to the steppe that makes many Mongolians, Mongolian. An autarkic existence along the steppe creates a deep sense of self-reliance. Yet, the steppe as a source of economic growth has largely failed to deliver sufficient economic returns at the national level. In fact, the stark reality of Mongolia’s recent macroeconomic history is one of external dependency, first upon Soviet subsidization and then during the democratic era on international aid.
Today, the development of Mongolia’s natural resources holds the greatest opportunity to deliver economic growth. The dilemma for Mongolians is that the imperative of natural resource development runs head-on with their traditions. This clash between traditional norms and the lack of any viable economic growth alternative to resource extraction creates widespread dissonance in contemporary Mongolia. Many Mongolians see their country as presented with what amounts to a Hobson’s choice. The take-it-or-leave-it choice is to either develop Mongolia’s natural resources or return to the self-sufficiency of the steppe. There are some who might choose the latter, but for the majority of Mongolians who are in the process of embracing modernity—there is no choice. As a result, exploitation of natural resources, inimical to a pastoral society whose culture is wedded to communal and sustainable land use, is a necessary but distressing externality of modernization.
The Political Risk of Pastoral Nomadism and its Outcomes: Increased Sociopolitical Discontent, Activism, and Unrest Aimed at Mining
A number of individual Mongolians and civil society groups have mobilized in resistance to mining. These mobilizations vary from loosely organized grassroots associations to structured coalitions at the national-level. Discontent and incidents of activism and unrest demonstrate the linkages between pastoral nomadism and the sociopolitical risks it drives. Mobilizations against mining adversely impact both resource investors and the Mongolian government. Figure 4 lists selected sociopolitical incidents and events targeting mining between 2010 and 2013.
Figure 4: Selected incidents of sociopolitical activism/unrest 2010-2013 
An example of the inconsistencies in Mongolia’s approach to resource development is found within current wrangling over the 2009 enactment of the Law to Prohibit Mineral Exploration and Mining Operations at Headwaters of Rivers, Protected Zones of Water Reserves and Forested Areas. Colloquially known as the “Law with the Long Name” (LLN); it and its progeny prohibit mining in environmentally sensitive areas. According to one account, the guiding purpose of the LLN is “to set aside most vulnerable areas associated with water sources…and to reduce conflict between miners and indigenous communities of herders.” But at the same time, the constraints imposed on the mining sector, and in particular constraints on gold mining, are economically destabilizing. The Mongolian Ministry on Mines estimates that 123.8 tons of gold deposits are rendered void as a result of the various license suspensions and revocations required by LLN. At the same time, the law’s adverse impact on inward FDI has led many policymakers to change their positions. Preferences have shifted towards loosening constraints on resource extraction with the aim of recapturing the economic returns natural resource development promises. In this way, the debate over Mongolia’s resources is ongoing, creating long periods of policy instability and regulatory risk to come.Pastoral nomadism drives policy instability and regulatory risk in Mongolia’s natural resources sector. It is an influential determinant in the divergent political, policy, and regulatory outcomes that have resulted from the contradictory approach Mongolian policymakers have taken in regulating their natural resources. On one hand, policymakers have enacted proscriptive regulations aimed at increasing environmental protection and shielding herders from the negative impact of resource extraction, yet they have also advocated loosening constraints on mining and rolling back legislation deemed too restrictive and disruptive to economic growth.Although Figure 4 lists only a handful of incidents, the selected events represent growing discontent and resistance to natural resource extraction. The Rio Tinto case study is instructive. Gobi herders have mobilized against the environmental and social impact of the global mining behemoth’s operations in the south Gobi Desert. The restive nature of Mongolian attitudes towards natural resource development is also reflected in the country’s policy and regulatory actions.
Nationalism and Pastoral Nomadism: Structural Political Risks to Resource Investment
Identification of nationalism and pastoral nomadism as political risks yields a comprehensive analytic framework for assessing Mongolia’s risk landscape and track Mongolian behavior, preferences, and needs. This article contends that the concepts are insufficiently considered by foreign investors, market participants, or analysts as risk factors in Mongolia’s investment climate. Risks inherent to the natural resources sector are not adequately assessed without recognizing the role nationalism and pastoral nomadism play.
In particular, it is evident that nationalism and pastoral nomadism constitute structural political risks in Mongolia. While the outcomes they drive are not predetermined, the causal linkages that nationalism and pastoral nomadism have with adverse political, policy, and regulatory developments are strong and lasting. As a consequence, nationalism and pastoral nomadism are long-term risks for resource investors.
In the context of resource nationalism and geopolitics, all too often, nationalistic sentiment is characterized as a function of cyclical events. The danger, however, in the context of political risk analysis arises when resource nationalistic outcomes (such as SEFIL) are viewed merely as byproducts of election cycles or populist pandering and not embedded features in the risk landscape. The same holds true for risks associated with pastoral nomadism. Protests, policy instability, and regulatory risks engendered by Mongolia’s ongoing struggle between its traditions and resource extraction are residual. Mongolia’s risk landscape will continue to result in dislocations reflecting abiding contradictions within the country’s resource-led modernization.
Part II: Case Studies
In 2012, Chinese state-owned Chalco proposed a $938 million bid to acquire a 60 percent ownership stake in SouthGobi. SouthGobi focuses on exploration and development of the Ovoot Tolgoi coal mine in the South Gobi region of Mongolia. SouthGobi is a public company listed on the Toronto and Hong Kong stock exchanges with a 58 percent shareholding by Canadian miner Turquoise Hill Resources (Turquoise Hill). Within a month of Chalco’s bid for SouthGobi the Mongolian parliament passed SEFIL, which inter alia contained restrictions and government approval requirements for foreign “state-owned” direct investors in Mongolia’s mining sector. As emphasized in Part I, SEFIL amounts to what in effect is a bill of attainder directed at Chinese SOEs. Acknowledging the political opposition to the deal, its unraveling is euphemistically recounted in Turquoise Hill’s Q3 2012 MD&A.
After careful consideration, both Turquoise Hill and Chalco concluded that the proposed transaction had minimal prospect of obtaining the necessary regulatory approvals within an acceptable timeframe. As a result, Turquoise Hill and Chalco agreed to terminate the lock-up agreement, including Chalco’s obligation to make a proportional offer.
Why did this happen? Certainly the timing of the bid, announced prior to Mongolia’s June 2012 parliamentary elections was problematic. Increasing populist discontent (a fair share of it anti-Chinese) and the politicization of nationalistic sentiment against foreign participation in Mongolia’s natural resources sector were widespread before and during the run-up to the June elections. Thus, on the eve of Chalco’s bid—several risk factors weighed against the political acceptance (and probable success) of any foreign acquisition, let alone a Chinese one. Selected pre-deal risks included:
- Nationalistic sentiment in the populace and political elite against foreign ownership of Mongolia’s natural resources.
- Cultural, historical, and xenophobic aversions to China increased Chalco’s liability of foreignness and the probability of political action negative to the deal.
- Chinese SOE vulnerability to the imposition of policy or regulatory constraints due to economic nationalist concerns over the dominance Chinese SOEs in Mongolia’s natural resources sector as well as risks associated with the more overbearing aspects of Beijing’s particular form of state capitalism.
If Chalco’s political risk exposure is viewed through the analytical framework of nationalism it is not difficult to foresee an adverse policy outcome flowing from its pre-election bid. This is not to say that if Chalco waited until after the election to make its bid for SouthGobi that parliament would not have reacted in the same way. But, the lesson learned is that in making a pre-election bid in the first place at the height of political sensitivity to foreign resource investment, Chalco failed to understand the strength of political opposition or salience of nationalism as a risk to the deal.
This analysis has the benefit of hindsight. Yet, the causal linkages between the presence of nationalistic sentiment against foreign participation in the mining sector; the reactionary enactment of nationalist legislation to control “state-owned” foreign resource investors (SEFIL); and, SEFIL’s express language codifying the power of Mongolian policymakers to ultimately approve or veto Chalco’s acquisition on political grounds (read nationalistic grounds) makes an understanding of the role that nationalism plays vis-à-vis resource investment in Mongolia not only critical to analyzing the failed transaction between Chalco and SouthGobi, but to assessing the potential success or failure of future M&A resource deals (especially where those M&A deals involve a Chinese SOE counterparty). Good political risk analysis would not have prevented nationalist legislation such as SEFIL or the xenophobic pushback on Chinese SOE investment that made government approval of the deal impossible, but it would at least have given dealmakers a tool to anticipate the possibility of such adverse outcomes.
Thus, a risk analytic that included an assessment of how nationalistic sentiment might impact the proposed acquisition would have weighed against announcing the bid two months prior to the parliamentary elections. In making a post-election bid, at least the dealmakers would have displayed a more nuanced understanding of Mongolia’s political risk landscape and gone a long way in mitigating the subsequent losses flowing from the failed deal.
To illustrate one type of financial impact that the risk of nationalism had on the deal, an informative metric to use is a historical snapshot of SouthGobi’s stock price against the chronology of nationalist developments (here SEFIL and the June elections) surrounding Chalco’s bid. Figure 5 sets forth selected Toronto Stock Exchange (TSX) market close prices for SouthGobi (SGQ) March 2, 2012 through September 27, 2012. On April 2,2012, SGQ closed at a high of 7.52 Canadian dollars (CAD)—a day after the announced takeover bid by Chalco. A rough track of the stock price reveals that after making its high, SGQ declined thereafter. Three significant troughs coincided with: 1) the passage of SEFIL in May; 2) the June parliamentary elections; and, 3) the September 4, 2013 lock-up termination. From SGQ’s high of 7.52 CAD (Chalco’s bid announcement) to its low of 2.02 CAD on September 27, 2013 (post lock-up termination) SGQ’s stock dropped. See Figure 5.
Figure 5: A snapshot of SouthGobi’s stock performance on the Toronto Stock Exchange (TSX) in Canadian Dollars (CAD) from March to September 2012.Looking at the historical snapshot of SGQ’s stock price against political, policy, or regulatory outcomes in Mongolia’s risk landscape demonstrates connections between nationalist outcomes; the failed deal; and such outcomes’ financial impact. As illustrated by the above figure, events such as SEFIL’s enactment or the outcome of the June parliamentary elections (events both driven by nationalistic driving forces) were clearly viewed as negatives by market participants. Adverse political, policy, or regulatory outcomes impact markets. Using historical stock performance (or market capitalization) to quantify the financial impact of political risk is one way to conceptualize linkages between Mongolian risks and their potential financial impacts.
Gobi Herders and Rio Tinto
Rio Tinto’s experience with the opposition of Gobi herders to its Oyu Tolgoi copper and gold mine in southern Mongolia is useful in demonstrating the impact of pastoral nomadism. At full production Oyu Tolgoi is projected to generate approximately a third of Mongolia’s GDP. It is owned jointly by Turquoise Hill Resources (66 percent) and the Mongolian government (34 percent) through Erdenes Oyu Tolgoi, LLC, although Rio Tinto ultimately controls and manages it through its ~51 percent shareholding interest in Turquoise Hill.
Pastoral nomadism posed a risk to Oyu Tolgoi’s project financing. Several multilateral development banks are slated to participate in Oyu Tolgoi’s project financing; however, this case study is limited to project financing commitments by the International Finance Corporation (IFC). Specifically, IFC loan proposals include a direct loan in the amount of $400 million and an additional $1 billion in loan syndication. This financing was placed at risk when a dispute between Rio Tinto and a coalition of herders arose over the social and environmental impacts of Oyu Tolgoi.
Local herders and supporting civil society groups charged Rio Tinto with failing to adequately address a number of social and environment issues related to the project. Their claims centered around seven areas of concern. Three of the seven are summarized here as highly relevant to the driving forces behind the risk of pastoral nomadism. They include:
- Oyu Tolgoi’s failure to properly implement social and environmental commitments;
- Oyu Tolgoi’s water demand is approximately 20 million gallons per day amid water scarcity;  and
- Stakeholder engagement and impacts on herder livelihoods.
In addition to asserting claims directly against Rio Tinto and its subsidiaries, the Gobi herders held that the project’s inadequate consideration of environmental and social impacts violated IFC lending standards, thereby threatening IFC project finance approval. Although the project financing was ultimately approved, that approval was not without its caveats as the United States abstained from the approval decision citing “environmental policy concerns.”
The herders filed additional claims against Oyu Tolgoi with the World Bank’s Office of the Compliance Advisor Ombudsman (CAO). While the CAO mediation process is independent of the IFC loan approval process, the claims mirror the driving forces of pastoral nomadism. Selected claim language includes: “Loss of livelihood; [w]e are mobile pastoralists dependent on pastures for our livelihoods; and, [loss of] access to water and land that is essential for us to carry on with our traditional lifestyle.” The Gobi herder claims coupled with their challenge to IFC financing approval are representative of the salience of pastoral nomadism as a risk factor. Indeed, in November 2013 the claimants again asserted that the IFC should hold its loan disbursements until “herders are guaranteed access to clean water, clean air, and adequate pastureland…” indicating the residual nature of the risks to the project.
Pastoral nomadism’s impact on corporate decision-making and financial outcomes is supported by Rio Tinto and its subsidiaries’ corporate social responsibility and social investment expenditures related to the project. According to Oyu Tolgoi LLC’s 2012 Social Investment Review, $27,773,344 was allocated to social investment in Mongolia. Select distributions include monies to economic development in the South Gobi, the environment, and cultural preservation. The report further states that “$126m [was] committed to the largest ever training programme in Mongolia over five years.” The level of Rio Tinto’s social investment illustrates the degree to which pastoral nomadism matters in Mongolia. It is one way of quantifying project expenses, corporate commitments, and the stakeholder engagement required to manage the risk of pastoral nomadism.
The costs of corporate social responsibility and social investment are best understood and anticipated by examining the degree to which stakeholders’ preferences and socioeconomic needs for such investments are driven by the given risk landscape. The fact that the risk of pastoral nomadism is a structural component of Mongolia’s investment climate necessitates risk-owners to plan, budget, and prioritize social investment and corporate social responsibility initiatives at higher levels in the Mongolian context. Furthermore, as the tradeoff between Mongolia’s traditions and resource extraction accelerates, Mongolians are likely to demand not only a greater economic share from resource investors, but also an increasing contribution from investors to the country’s wider socioeconomic development.
Part III: A Political Risk Practitioner’s View
Mongolia’s investment climate is characterized by both risk and opportunity, particularly in the country’s natural resources sector. Among the structural risks associated with investment in Mongolia, however, are nationalism and pastoral nomadism. The genesis of this article is the void in the prevailing discourse on how identity, national sentiment, and socioeconomic traditions not only influence Mongolian behavior, preferences, and needs, but also shape political, policy, and regulatory outcomes. Conventional analysis tends to either inadequately weigh such factors as drivers of risk, or dismiss them as “soft.” In contrast, this analysis demonstrates the salience of nationalism and pastoral nomadism as political risks to resource investment, while at the same time providing an improved analytical framework for investors to manage their Mongolia risk.
To the extent that this analytical framework is implemented, resource investors will have a competitive advantage over those that fail to understand or choose to ignore the full spectrum of political risk in Mongolia. Resource investors will not only be in an advantageous position to better assess how they “fit” within Mongolia’s resource investment climate, but have the management tools to anticipate and prepare for those political risks that threaten exploration and production, stakeholder relations, project finance, revenues, or returns.
1. Strengthen learning and institutional knowledge about your company’s fit within Mongolia’s investment climate. Improving understanding of underanalyzed political risks such as nationalism and pastoral nomadism presents an opportunity to deepen knowledge not only of the risks resource investors face, but of Mongolia itself.
2. Plan for long-term political, policy, and regulatory constraints. In the near-term, the Mongolian government will attempt to stabilize policy and regulatory regimes to attract investment. Yet, political, policy, and regulatory risks abide. For resource investors, strategically planning for risk outcomes will improve resiliency and adaptability in the face of long-term constraints in Mongolia’s investment environment.
3. Beware of Cognitive Biases. Both the Mongolian government and Mongolian citizens do not “see” their emerging economic opportunities in the same light as foreign investors. Mongolians operate under a distinct set of perceptions. It is in foreign resource investors’ interest to view Mongolia’s investment climate not through universal or home-country constructs, but from the perspective of a Mongolian citizen. When taken from this point of view, anticipated behaviors, preferences, and needs shift dramatically.
When putting capital at risk in frontier markets such as Mongolia, resource investors should think the unthinkable. Shocks occur when we least expect them. For resource investors in Mongolia managing geopolitical, country-level, or project-level investments, risk mitigation requires the organizational capacity and agility to respond and adapt. As the aforementioned case studies demonstrate, countering the dangers of normalcy bias is about developing situational awareness and response capacity that both acknowledge and anticipate the unexpected.
Jamian Ronca Spadavecchia is the founder and President of Oxbow Advisory, a Washington DC-based political risk consultancy. He has an MA from the Monterrey Institute of International Studies and has previously worked as a researcher at the United Nations, as a visiting scholar at the Shanghai Academy of the Social Sciences, and as a foreign policy adviser to a 2012 US senate campaign. Nominsuren Munkhuu contributed valuable research assistance for this article. Dr. Anders Corr and Matthew Michaelides provided editorial oversight of this article. JPR Status: working paper, archived 6/3/2014.
 The above article is intended for informational purposes only, does not constitute professional advice or any services to its readers, and does not necessarily reflect the opinion of Oxbow Advisory or any of its employees or clients. Oxbow Advisory does not provide investment advice, including but not limited to; rating or recommending any security, providing advice as to the value of any security, or the purchase, or sale of any security. This article is not intended as any investment service or advice in any jurisdiction. Nothing in this article is to be considered as either creating a client relationship between the user/reader and Oxbow Advisory or as rendering of any research, professional advice, or service for any specific matter.
 Jonathan S. Addleton, Mongolia and the United States, A Diplomatic History (Hong Kong: Hong Kong University Press 2013), p.68-69.
 The World Bank Group, “Mongolia Economic Update April 2013,”April 2013, 18, http://www.worldbank.org/en/news/feature/2013/04/30/mongolia-economic-update-april-2013.
 Ibid., p.24.
 For purposes of comparison total FDI inflows to Mongolia for the period 1996-2005 equaled $694.4 million. As the chart indicates FDI inflows in 2008 alone reached $844.7 million.
 “Mongolia: Eco-Warriors Call Attention to Economic Development Dilemma,” EurasiaNet.org, October 2010, http://eurasianet.org.
 Data collected from the Bank of Mongolia, http://www.mongolbank.mn/eng/default.aspx. Note that Q4 2013 is preliminary.
 Owen Lattimore, Studies in Frontier History: Collected Papers 1928-1958 (New York: Oxford University Press 1962), p.271.
 Ibid., p.426.
 At the risk of conflation, here the use of the term “nationalism” does not exclusively denote allegiance to the nation-state, but also serves to describe those sentiments associated with a shared sense of what makes Mongolians, Mongolian, and “outsiders” as Lattimore describes, not. The term not only serves as a vehicle to capture the phenomena of state ownership and participation in the natural resource sector (i.e. resource nationalism) but also aims to characterize sentiments and attitudes such as exceptionalism and xenophobia.
 John Stuart Mill quoted in Karl Deutsch, Nationalism and Social Communications (New York: MIT Press and John Wiley1953), p.5.
 Addleton, Mongolia and the United States, p.146.
 “Resource nationalism” is a widely used term without the benefit of a clear or generally accepted definition. However, the term is nonetheless used here, because of its utility (at least in this author’s view) to describe a very real source of political risk. For the purpose of this article, and in the context of Mongolia, the term “resource nationalism” is used to characterize the phenomenon whereby the state using various political, policy, legislative, and/or regulatory means imposes greater control over the ownership and management of its natural resources.
 Christopher Kaplonski, “Reconstructing Mongolian Nationalism: The View Ten Years On” in Mongolian Political and Economic Development During the Past Ten Years and Future Prospect, Mongolian and Tibetan Affairs Commission, Taipei April 23-24, 2000, p.360, http://www.chriskaplonski.com/downloads/nationalism.pdf.
 Sant MaralFoundation, PolitBarometer #13(47) (March 2014), http://www.santmaral.mn/en.
 Michael Kohn, “Mongolia Democratic Party in coalition talks with anti-mining group” Reuters, July 2012, http://www.reuters.com/article/2012/07/17/us-mongolia-election-talks-idUSBRE86G05620120717
 Nicole Graaf, “Rampant racism a growing problem in Mongolia,” DW, April 2012, http://www.dw.de/rampant-racism-a-growing-problem-in-mongolia/a-15888287.
 Sant MaralFoundation, PolitBarometer #13(47) (March 2014)
 Nicole Graaf, “Rampant racism a growing problem in Mongolia,” DW, April 2012.
 Koichiro Ishida, “Mongolia looks to Japan to get out of China’s economic shadow,” The Asahi Shimbun, April 2013, http://ajw.asahi.com/article/asia/china/AJ201304010090.
 Christopher Kaplonski, “Reconstructing Mongolian Nationalism”, p.360.
 The World Bank Group, “Mongolia Economic Update April 2013,” p.18.
 Justin Li, “Chinese Investment in Mongolia: An Uneasy Courtship between Goliath and David” East Asian Forum, February 2, 2001, http://www.eastasiaforum.org/2011/02/02/chinese-investment-in-mongolia-an-uneasy-courtship-between-goliath-and-david/.
 Ishida, “Mongolia looks to Japan to get out of China’s economic shadow.”
 Lattimore, Studies in Frontier History: Collected Papers 1928-1958, p.551.
 As quoted in Michelle Tolson, “Mining and Human Rights in Mongolia: Gobi Herders Speak Out,” UB Post October 12, 2012, http://ubpost.mongolnews.mn/?p=1442.
 Dalaibuyan Byambajav, “Mobilizing against Dispossession: Gold Mining and a Local Resistance Movement in Mongolia,” 北方人文研究Journal of the Center for Northern Humanities 5 1 (2012): 14.
 Addleton, Mongolia and the United States, p.68-69.
 Curated from various media reports 2010-2013; including, “Mongolia: Eco-Warriors Call Attention to Economic Development Dilemma,” EurasiaNet.org, October 2010, http://eurasianet.org; “Protect Mongolian Rivers from Mining,” News.mn, November 2013 http://english.news.mn/content/163001.shtml#; “A Hunger Strike By the Herders of UVS Against Canadian CGBEM Company,” InfoMongolia.com, March 2012,http://www.infomongolia.com/ct/ci/3710; see generally “New Uranium Mining Projects-Mongolia,” Wise Uranium Project, November 23, 2013, www.wise-uranium.org/upmn.html; and, “Protest at the Government Palace leads to arrests and evacuations,” UB Post, September 2013, http://ubpost.mongolnews.mn/?p=6102.
 “The Short History of The Law with Long Name,” Rivers without Boundaries Coalition, http://www.transrivers.org/documents/rivers-and-mining/the-short-history-of-the-law-with-long-name/.
 “End of confusion over ‘long-titled’ law in sight,” Mining Mongolia Journal, October, 2013, http://en.mongolianminingjournal.com/content/51624.shtml.
 Theodore H. Moran, “Avoiding the ‘Resource Curse’ in Mongolia, Policy Brief No. PB13-18, Peterson Institute for International Economics, July 2013, http://www.piie.com/publications/pb/pb13-18.pdf.
 “Third Quarterly Report, September 30, 2012,” Turquoise Hill Resources, Ltd, http://www.turquoisehill.com.
 Data from Morningstar Research, Morningstar, http://www.morningstar.com.
 Such simple quantitative renderings should not be relied on too heavily—as the adage between correlation and causation holds fast. As they say in the investment world: past performance is not a guarantee of future results.
 Rio Tinto Group, see generally, http://www.riotinto.com. Due to Rio Tinto’s ultimate control and management of Oyu Tolgoi, this case study shall refer to “Rio Tinto” exclusively, but in doing so incorporates by reference Turquoise Hill and Oyu Tolgoi, LLC.
 According to a consultant report prepared for Turquoise Hill Resources, preliminary estimates for total site water demand for Phase I and Phase II will average at a future processing rate of 918 liters per second (L/s) and 1,081 L/s peak for each phase. By this author’s rough calculation this amounts to site demand of an average of ~20 million gallons and ~24 million gallons (peak) per day for each Phase. See, “Oyu Tolgoi Project IDOP Technical Report,” http://www.turquoisehill.com/i/pdf/IDOP_2012Mar29_Tech_Rpt.pdf.
 Accountability Counsel, “Civil Society Review of Oyu Tolgoi audit and Operation Management Plans,” November 13, 2013, http://www.accountabilitycounsel.org/wp-content/uploads/2012/05/CSO-review-of-the-OT-OMPs.pdf.
 The U.S. Treasury Department, “United States Position: Mongolia—Oyu Tolgoi Mining Project. European Bank for Reconstruction and Development Proposed Investment-February 26, 2013 and International Finance Corporation/Multilateral Investment Guarantee Agency Proposed Investments-February 28, 2013,” http://www.treasury.gov/resource-center/international/development-banks/Documents/OT%20Position%20for%20Web%20Posting%20Feb%2028.pdf.
 The World Bank Group, CAO Assessment Report “Complaint Regarding the Oyu Tolgoi Project (IFC#29007 and MIGA #7041),” http://www.cao-ombudsman.org/cases/case_detail.aspx?id=191.
 Letter of Complaint, October 12, 2012, available at http://www.cao-ombudsman.org/cases/document-links/documents/OyuTolgoiCAOComplaint_Oct122012_Redacted.pdf
 OT LLC’s “2012 Social Investment Report,” Oyu Tolgoi LLC, http://ot.mn/en.