The Mongolian energy industry: filling in the gaps - (Mongolia)

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Mongolia is attracting great interest thanks to its astonishing, barely exploited mineral wealth and its rapid economic development:  the International Monetary Fund forecasts Mongolia’s gross domestic product will grow on average by 14 percent every year between now and 2016. 

Its economic transformation brings with it a critical need to modernize the country’s aging energy infrastructure and expand its power and heat distribution systems.  Since the third quarter of 2009, indigenous power generation has failed to meet Mongolia’s ever-increasing electricity needs.

The Government of Mongolia (GoM) and the private sector are actively addressing this shortfall.  Significant opportunities exist for developers and financiers looking to participate in the modernization of the country’s energy sector through a range of procurement methods, including public-private partnership (PPP) or purely private financing models.

Two major power projects illustrate the scale of this effort and the diverse procurement methods being promoted by the GoM: the Combined Heat and Power Plant Number 5 (CHP#5) in the capital city of Ulaanbaatar (to be developed in two phases, with phase one a 450MW CHP), and the Salkhit wind farm in the Tuv region, 75 kilometers south of Ulaanbaatar.  Financing for Salkhit recently closed and the plant is now under construction.

Both CHP#5 and Salkhit are being developed on a project finance basis, but using different methods.  CHP#5 is being tendered as a PPP to the private sector by the State Property Committee of the GoM, with the assistance of the Asian Development Bank, under a government concession model.  In contrast, Salkhit was developed privately by the Clean Energy division of the Mongolian conglomerate Newcom LLC.

For these projects and others, Mongolia is committed to providing the regulatory structures and incentives to attract international investment and financing.

Market overview: Mongolia’s need for large-scale power plants

It is anticipated that without any new large-scale power plants such as CHP#5, the total power shortfall within the Mongolian central power grid will grow to as much as 600MW by 2015, and then, by 2020, to 900MW.  Even with the proposed addition of 820MW from CHP#5, by 2030 Mongolia’s electricity shortfall is expected to be 700MW.  Additional demand will come from the development of the Sainshand Industrial Complex in southern Mongolia (where the GoM wants the private sector to process the output from surrounding coal and copper-gold mines and various other mineral deposits).

As a result, various power projects are under development, such as a 60MW power plant for the Mogoin Gol coal deposit, a 12MW power plant for the Khushuut coal deposit, an 800MW power plant for the Sainshand industrial cluster and two 50MW wind farms (including Salkhit).  Construction and upgrading of transmission lines and other infrastructure, in particular the central grid distribution system, will also be needed to support all this new capacity.

Mongolia’s existing CHPs were all government-funded and constructed with the help of the Soviet Union during the country’s Socialist era of the 1960s, 70s and 80s.  All these CHPs are currently government owned and operated.  The country’s shift to a multi-party political system and market economy in the early 1990s led to the implementation of new policies and legislation to provide alternative means of constructing, financing and operating infrastructure projects, including power plants.  These efforts have borne fruit in the mining sector.  Foreign multinationals and investors of all kinds have flocked to the country to exploit its vast mineral and coal deposits.

In contrast, public-oriented power sector reform and development has lagged behind.  The GoM is championing various approaches to remedy the shortfall, each of which promotes strong private sector participation.

The Concessions Law: a framework for financing concession projects

The Concessions Law provides a complete framework for implementing concessions in Mongolia.  This includes provisions relating to:

  • Approving projects to be developed using the concession model
  • Recognizing a variety of concession structures, including BoT, BOO, BOT, DBFO and others
  • Putting in place a tender process managed by the State Property Committee for state assets or by local governors or aimags (administrative subdivisions) for local assets.

The Concessions Law addresses several elements that the GoM recognizes are important in order to achieve a successful international project financing.  These include the structure of the concession tariff, security interests regarding the project and its revenues, and GoM support in the form of guarantees or other financial support.

When an applicable law comprehensively addresses critical structuring and financing issues, then PPP transactions, including the project financing structures that underpin them, are inevitably facilitated.  The Concessions Law goes a long way towards establishing a viable legal framework to encourage private sector investment in infrastructure projects.  It remains to be seen how effective it will be in attracting further international investment into Mongolia.

The Renewable Energy Law and private sector project financing

One objective of the GoM’s new policies and legislation in the energy sector is to encourage the development of purely privately financed power projects and to buy electricity generated by such projects.  The GoM also wants to encourage alternatives to the development of coal-fired large-scale power projects and is doing so by promoting renewable energy.

The Renewable Energy Law, approved in January 2007, offers feed-in tariffs for renewable energy power projects, which allow recovery of capital and investment costs and make investment attractive to developers and financiers alike.

TABLE 1 - MONGOLIA FEED-IN TARIFFS FOR RENEWABLE ENERGY POWER SOURCES*

 

Hydro

Wind

Solar

up to
0.5MW

from 0.5 to
2MW

from 2 to
5MW

Grid-connected

4.5 - 6

4.5 - 6

4.5 - 6

8 - 9.5

15 - 18

Stand-alone

8 - 10

5 - 6

4.5 - 5

10 - 15

20- 30

* Prices are given in US cents per kWh

The Renewable Energy Law has effectively helped kickstart private sector involvement in the financing and development of power projects in Mongolia.  One good example of this is Salkhit – construction for this wind farm came about thanks to project financing by Newcom through its renewable energy subsidiary, Clean Energy, and the European Bank for Reconstruction and Development.  Wind farms are generally small in size (Salkhit is 50MW, which is relatively large by wind farm standards), but despite this it is anticipated that Salkhit could ultimately generate as much as 5 percent of Mongolia’s electricity.

For Salkhit and similar projects, the GoM is committed to providing the right incentives to attract private sector participants by retaining most of the buyer’s risk events that are customary in the international independent power producer market, such as demand and political risks.  This will help to ensure that projects similar to Salkhit are also “bankable” and attract investment and debt financing from international financial institutions.

The road ahead

Through the Concessions Law and the Renewable Energy Law, the GoM has provided a solid basis for developing and financing infrastructure projects in Mongolia under both PPP and purely private initiatives.  Many new projects are being considered and discussed in the marketplace.

The development and implementation of some of Mongolia’s first major energy projects is giving the GoM and private sector participants (and their legal and financial consultants) valuable experience.  Inevitably, their experiences will allow the country to refine aspects of its legal framework.  Undertaking the necessary legislative or regulatory amendments will improve Mongolia’s access to international capital and technology and accelerate its ambitious and exciting development plans.

For more information about energy development in Mongolia, please contact Stewart K. Diana.