Renewable energy sector offers bright spot for Mongolia

With intensely cold winters and deteriorating energy infrastructure, Mongolia is looking to renewable energy to help ween it off the need for energy imports from Russia and China. The government has used tax incentives and the investment law, enacted in 2012, to attract the outside money that will be necessary to achieve this and upgrade the power generation industry generally. However, investors should be aware of the political, legal, financial and employment obstacles to putting money into Mongolia.

 Opportunities available

Battushig Batsuren

While they are only moving gradually, foreign investors are looking to Mongolia for opportunities in the power sector. “The government has been quite supportive of renewables and in the 2016-2020 action plan, the new government has added hydropower as another renewable energy source to support,” says Battushig Batsuren, partner at GTs Advocates. “We’ve seen investors interested in renewables coming from various countries like Japan, Korea, China and Germany. Tax incentives for equipment and technology are available in addition to green tariffs for energy production. The investment law created in 2012 offers the same treatment between domestic and foreign companies. Compared to other countries, there is more unused land for renewable projects developments.”

Baker & McKenzie.Wong & Leow in Singapore advised Newcom and Softbank Group, the sponsors of the development and financing of the construction of the 50 megawatts Tstesii wind farm in southern Mongolia, the country’s latest renewable energy project and the second private sector wind farm in the country. The firm also successfully advised on the first wind farm in Mongolia in 2013. Allen & Overy’s Tokyo office advised the lenders on the Tsetsii project. With the project being one of the earliest adopted in Mongolia, there are a number of obstacles that were faced, which investors can reflect upon when deciding to invest in Mongolia.

Political uncertainty

Martin David

Part of the challenge comes from the risk of initiating a new project and unfamiliarity with bureaucrats. “There are four to five wind power projects on the horizon but I think only one is at an advanced stage of development,” says Martin David, principal and head of the projects practice at Baker & McKenzie.Wong & Leow. “There is still a lot of uncertainty over the Mongolian economy which, when added to the arrival of a new government, has spooked institutional investors.”

Dispute resolution mechanisms

Investors may be faced with potential jurisdictional problems in resolving disputes because of how some contracts are regarded in Mongolia. Under the General Administrative Law, certain contracts are deemed as administrative in nature and are within the exclusive jurisdiction of the administrative courts of Mongolia. “Under this scenario a power purchase agreement may be deemed an administrative agreement and any dispute under such a power purchase agreement may need to be settled at the administrative courts of Mongolia irrespective of the dispute resolution clause in the power purchase agreement providing for foreign arbitration,” says Batsuren. “However, due to the recent enactment of the General Administrative Law it is not clear how Mongolian courts will view this.”

“Dispute resolution is always a key issue for international investors and lenders to a developing country. Mongolia like many similar emerging markets is keen to develop its own courts and arbitration system and is keen for disputes to be resolved domestically,” says David. This is not something the international investment world is generally willing to accept.”

Lack of tariff guarantee

Another risk is the absence of government guarantees. “The Tstesii project didn’t have a government guarantee for the obligations of the state utility to buy power but despite that it was considered bankable. This is a very positive message as many countries across Asia are not financeable without such a guarantee,” says David.

Currency risk

Mongolia requires that all payments under contract be in local currency while investors favour more stable currencies. Mongolia has been hit hard in the past few years and with a tumbling currency, the country has had to raise the key interest rate to 15%. “Investors are faced with a currency exchange risk that prohibits conversion of the local currency into US dollars and this is a tricky issue when structuring agreements,” says David. But plans to overcome this could be on the horizon. “The government and the Bank of Mongolia are planning to amend current currency laws so that companies can hedge currencies and there are plans to have contracts denominated in foreign currency in the government’s 2016-2020 action plan,” says Batsuren.

Capacity shortage

Even if there is investment flowing into the renewables sector, the hardware and software needed to make projects happen still need tweaking. “Depending on the project, foreign investors should be aware that there are certain quotas which require domestic workers to be employed,” says Batsuren. “Right now the human capacity may not be enough to meet technical needs. The power grid infrastructure is also weak. But the government has signed economic partnership agreements with countries such as Japan, and most recently signed an investor protection agreement with Canada.”

Looking ahead

It would be nice to think that once the wind farms and solar plants are built, demand will come. In reality, there is a limited energy need in Mongolia due to a low population, so to scale up the industry, a bigger plan is needed. “Asian countries such as Japan, South Korea and China are talking about realising a plan to export renewables in Mongolia to other Asian countries by creating a pan-Asian supergrid,” says Batsuren. “This has great potential for Mongolia.”

With the availability of solar and wind potential in the Gobi desert, Mongolia’s installed power generation capacity is only at 7% for renewables, so there is a big opportunity for the sector to develop. The country’s low population could limit the development of the renewables sector, future investments in the industry may be buoyed by the success of private sector projects, if combined with more encouraging policies and incentives, and an optimistic but achievable roadmap towards a pan-Asian energy grid.