The curious case of Khan Resources exposes how Mongolia seized uranium mine deposits from their Canadian legal owner and transferred them to Russian government control. And with elections imminent, the Mongolian government is now trying to clean up the mess. (Part One of a Three Part Series)

Mongolia is racing against time to make friends.

After years spent reneging on mining deals with the likes of Rio Tinto, the government has suddenly begun to settle its disputes with the promise of compensation and fresh projects.

The reason? Here too, it’s election time. And if you think America’s Democrats face a hard time defending their record, pity Chimediin Saikhanbileg. Mongolia’s Prime Minister has presided over one of the world’s most spectacular nosedives in economic growth – from 17% five years ago to near zero now.

Not all of this is the government’s fault, of course. More than any other country on Earth, Mongolia’s economy relies upon China, with 90% of its exports flowing to its southern neighbor. Sales and prices of its copper, coal and other commodities have crashed with the Chinese slowdown.

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But many of Mongolia’s economic troubles are self-inflicted. The government has sent foreign investors packing with punitive new laws to seize their assets. As a result, giant joint mining projects remain idle. Now, under the weight of disappointment from 3 million increasingly impoverished Mongols, the regime is scrambling to mend bridges to foreign investment. After freezing out Rio Tinto in its clamor for a bigger slice of copper and gold projects, the government struck a deal in 2015.

And after years of contesting international court orders, it has finally agreed this month to settle its long-standing dispute with a small Canadian mining company called Khan Resources. Khan’s story reads like an international espionage thriller, and is perhaps the most enlightening in assessing whether Mongolia really is changing – or just papering over the pre-election cracks.

The $70 Million Question

A decade ago all was going well for Khan – a relatively junior company in Mongolia, then known in international mining circles as the land of opportunity.

Khan was issued exploration rights to mine uranium in Dornod, the easternmost of Mongolia’s 21 aimags, or provinces. Its licenses from 2005 were extended for a further three years in 2008. And in 2007 Khan published a feasibility study that confirmed a substantial uranium deposit, with an expected annual production rate of 2.9 million pounds of U 3 O 8 and an expected mine life of over 15 years.

But the next year, everything changed. Under its recently-passed Nuclear Energy Law, Mongolia designated uranium as ‘a strategic mineral,’ which retro-actively gave its government control over all existing and future investment agreements.

In an adolescent democracy, prone to bouts of nationalism and inherent in tribalism, this should have rung alarm bells in Vancouver, the global center of the mining industry. Companies like Khan had every reason to fear the ambiguities in the new law.

And it wasn’t only the Mongolian government that they needed to watch. The national media had revealed only months before the law’s enactment that the country was being “courted” (actually, targeted) by its uranium-hungry neighbor and creditor to the north – Russia.

Khan’s Eviction Notice

By April 2010, such fears had been realised. The government suspended Khan’s two licenses, then reinstated them, then suspended again, and finally revoked them following an investigation.

Viewed jealously within the country, Khan’s 58% stake in the rich Dornod province deposits was also openly coveted by Khan’s junior joint venture partner, Atomredmetzoloto. The company, also known as ARMZ, is the mining unit of Rosatom, the Russian state-owned nuclear energy company.

Khan was informed by Mongolia’s Nuclear Energy Agency that it had failed to address violations of the 2009 law and that as a result its licenses had abruptly been invalidated. The company’s chairman, James Doak, responded with a question: “[It’s] difficult to understand why only the Canadian partner should be investigated when there are two other partners in the joint venture. Are they to be investigated as well?” But no answer was forthcoming from the Mongolian government.

Khan sued for $326 million on the basis of ‘expropriation and unlawful treatment.’ That sum was reduced to $100 million in international tribunals before a finding was passed in Khan’s favor – in two separate arbitration hearings. Still, Mongolia rejected the settlement, dismissing appeals in Ottawa which placed the country in breach of the multilateral Energy Charter Treaty.

And now, four years on, it seems the government has had a change of heart. Just two days before a major mining convention in Toronto this month, Mongolia’s Finance Minister announced that the government would pay a reduced fee of $70 million to Khan. Settlement would be completed by May 15, a few weeks before Mongolia’s parliamentary elections. Of course this sudden change of heart was driven by cold-hearted pragmatism. With the country’s finances in a dire state, and its sovereign bonds trading at toxic levels, the finance ministry was desperate to raise money from investors. Yet, while the Mongolian government may not have given a second thought to investor sentiment until now, even they realized that they would have been laughed out of Canada had they not offered closure on the Khan affair.

So, all’s well that ends well? Signs from within the country suggest otherwise.

The nationalist rottweiler is tugging at the government’s leash. When hospitals are cramped and Mongolians are struggling for a roof over their heads, a large payment to a foreign mining company won’t shower the government in glory just six weeks before the general election. In our view, final payment is far from assured.

The curious case of Khan Resources continues tomorrow, documenting a deal between Moscow and Ulaanbaatar that traded Khan’s uranium mines for hundreds of millions of dollars. Click Here to Read Part 2

Phill Hynes and Mark Burke are analysts at ISS Risk, a frontier and emerging markets political risk management company covering North, South and Southeast Asia from its headquarters in Hong Kong.