* Oyu Tolgoi is key to Mongolia development plans
* Govt eager to push on with expansion
* But dispute with Rio Tinto has put second phase on hold
* Bleak copper markets could cloud project outlook
By David Stanway
BEIJING, Nov 21 (Reuters) - Mongolia hopes the $5 billion expansion of the giant Oyu Tolgoi copper and gold mine can start next year as it works to resolve a dispute with global miner Rio Tinto, its partner on the project, a government source said.
But Rio Tinto may be reluctant to push on too quickly due to bleak market conditions, the source said, with copper prices down more than 10 percent in 2013 and expected to drop further on a flood of new supplies from South America and Africa.
A Rio Tinto spokesman declined to comment.
Copper shipments from the first phase of project started in June, but Rio Tinto in late July put on hold plans to build an underground mine amid complaints by Mongolia that costs had spiraled out of control and that its interests had not been fully served.
Mongolia, looking to find the revenues to fund ambitious social and infrastructure plans, is keen to press ahead with a project that is set to account for a third of its total economy by 2020 once the underground mine is built. Foreign investors also see the way the government develops Oyu Tolgoi as a key indicator of the country’s willingness to do business.
“Our side is committed to starting the second phase as soon as possible and we can agree on certain issues in December or January and plan development,” said the source, who is involved in Mongolia’s discussions with Rio Tinto but did not want to disclose his name.
“Both sides are working on the updated feasibility study. After that, if both sides agree, there will be no challenges. I hope we can agree early next year.”
Rio Tinto has said that it expects the new feasibility study for the second phase of the project to be completed in the first half of 2014.
With Rio’s new chief executive Sam Walsh focused on slashing costs, cutting capital spending and paying down $22 billion in debt, there is some question on how soon the company would want to go ahead with the Oyu Tolgoi expansion.
“That is fine - we can understand that, but what we cannot accept is that the Mongolian government is the only reason for the delay ... I hope the market will understand that,” the source said.
Oyu Tolgoi is 66 percent-owned by Rio Tinto’s Turquoise Hill Resources unit. Rio Tinto is also building and operating the mine, located around 80 kilometres from Mongolia’s southern border with China.
Craig Kinnell, Rio Tinto’s new representative in Mongolia and the chief executive of the Oyu Tolgoi project, said one of his four priorities would be to prepare the project for future growth, but he gave no timeframe for the expansion.
“I am as expectant as everyone for the day that the issues under discussion will be resolved. But speed is not the measure of success,” Kinnell said in his first public speech in the job at a conference in Hong Kong on Tuesday.
Mongolia has complained that costs on the first phase were $2 billion higher than originally planned, and is looking for assurances from Rio that such “investment inflation” will not happen during the second phase, the source said.
He said the overruns would mean it would take longer for the Mongolian government to pay back what it owes on the project, meaning that it would take longer before it started receiving dividends. He said Mongolia also continues to object to Rio Tinto’s financing and management costs.
Erdenes Oyu Tolgoi, the government entity that holds Mongolia’s 34 percent stake in the project, said in a statement on Tuesday that Mongolia remained fully committed to the project and to the terms of the original 2009 agreement.
Some interpreted the statement as a sign that the government is prepared to be flexible to resolve a deadlock that has forced Rio Tinto to lay off 1,700 staff at the mine.
The 2009 Oyu Tolgoi investment deal was hailed as a symbol of Mongolia’s growing engagement with the global economy and its openness to overseas investment, but it has been castigated by nationalist politicians worried that the country was selling off its mineral wealth on the cheap to foreign interests.
Mongolia’s previous government submitted a request to Turquoise Hill Resources to amend the agreement. The source said there remained problems with the original deal but changing it was not currently a priority.