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May 19, 2015, 3:13 a.m. EDT

Breakthrough for Rio Tinto's $5.4B mine expansion

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By Rhiannon Hoyle

SYDNEY--A US$5.4 billion expansion of one of Rio Tinto PLC's biggest mining projects looks set to go ahead, after the company reached a deal with the Mongolian government that ends two years of tense negotiations.

The Anglo-Australian company described the agreement--which paves the way for construction of an underground mine at the site of an existing open-pit operation--as a significant step forward for the Oyu Tolgoi project. Oyu Tolgoi is mostly owned by Turquoise Hill Resources Ltd., which in turn is controlled by Rio Tinto.

The deal with the government settles disagreements around tax and royalty payments that had held up the underground expansion of the copper-and-gold deposit. It also lays out how the further development of the mine will be funded.

The first convoy of trucks carrying copper to China departed from the existing US$6.2 billion open-pit mine in July 2013. The project's expansion has been delayed since then as talks floundered, among other things, over Mongolia's demand for higher royalties from the sale of resources.

Oyu Tolgoi, 66%-owned by Turquoise Hill, is central to Rio Tinto's efforts to tap new minerals in developing countries to help reduce its dependence on iron ore, the price for which has fallen sharply over the past year. For the government, which owns the rest of the project, proceeds from the mine at full capacity could account for as much as a third of the country's gross domestic product.

"Mongolia is back to business," said Prime Minister Chimediin Saikhanbileg in a statement Tuesday, after three-way talks between Rio Tinto, Turquoise Hill and the government finally yielded fruit. "Unlocking Oyu Tolgoi's underground mine will have a significant impact on the Mongolian economy, which will benefit Mongolian citizens for generations to come."

Under the agreement, the trio reached an accord on the past cost of developing the open-pit mine. That issue was a central part of the dispute, after the government became concerned that cost overruns on that first stage of the project would eat into its profit and accused Rio of overspending.

But Rio Tinto copper Chief Executive Jean-Sébastien Jacques said that all sides now agreed "all the costs were legitimate."

Rio Tinto meanwhile agreed a 5% sales royalty from resources dug up at the mine would be based on Oyu Tolgoi's gross revenue, rather than calculating it off net revenue as the miner had proposed, he said.

The agreement also resolved that Oyu Tolgoi LLC, which oversees the project, would pay roughly US$30 million to settle a continuing tax dispute, a fraction of an earlier estimate of US$127 million.

Rio Tinto said the deal means that expansion work can now get under way. "With a new pathway to development of the underground mine agreed, the focus now shifts to finalizing the project finance, the feasibility study and securing all necessary permits so that the underground mine development can proceed," it said in a statement.

Mr. Jacques said the underground mine would take between five and seven years to get up-and-running once all finances and approvals were in place.

Turquoise Hill said it was already holding talks with global financial institutions, export-credit agencies and commercial banks to secure roughly US$4 billion in project finance. The company has estimated that up to 80% of the value of the project--located in the southern Gobi Desert, about 50 miles north of the border with China--is tied to its underground operations.

When fully operational, Oyu Tolgoi is set to produce an average of 450,000 metric tons of copper and 330,000 troy ounces of gold a year, in addition to vast quantities of silver and molybdenum.

Write to Rhiannon Hoyle at rhiannon.hoyle@wsj.com

Access Investor Kit for Rio Tinto Ltd.

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Access Investor Kit for Turquoise Hill Resources Ltd.

Visit http://www.companyspotlight.com/partner?cp_code=P479&isin=CA9004351081

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