Courtesy of Foreign Affairs, a look at Mongolia’s mining industry and overall economy:

Mongolia is mining’s last frontier. The country is one of a small handful of places left in the world with major untouched mineral deposits. Its best — and perhaps its only — hope for broad-based economic development lies in recruiting foreign miners to help develop these resources. The problem is that it has been so difficult for Mongolia’s leadership to get along with foreign mining companies that the country’s whole development strategy is at risk.

The Oyu Tolgoi mine, the largest investment in Mongolia’s history, has become a test case for all foreign investment in the country. It is a mixed deposit of copper and gold being developed by Rio Tinto, the world’s second-largest mining company. Production will not start for another month or so, but even in the preparatory stages, Oyu Tolgoi was almost entirely responsible for Mongolia’s world-leading 17.3 percent GDP growth in 2011, as suppliers and contractors arrived and spread benefits across the wider economy. When fully operational, the mine will account for a third of Mongolia’s GDP. After more than a decade of exploration and preparation, however, Ulaanbaatar wants to renegotiate its share of the profits, and Rio Tinto has threatened to shut down the mine.

Mongolia is not the only country demanding a greater share of profits from mining within its territory. The trend is prevalent enough to have earned a nickname: resource nationalism. But foreign investors in Mongolia are more likely to succeed if they pay attention not to what makes the country similar to others but rather to what makes it different: geography.

Mongolia is landlocked between Russia and China, both of which exploit their neighbor’s vulnerable position. Rosneft, Russia’s state-owned energy company, is Mongolia’s only significant supplier of fuels, and Moscow has a history of using energy exports as a political tool. Rosneft charges above-market rates to Mongolian importers and often supplies less than demand, periodically sending prices skyrocketing throughout Mongolia’s economy. Moreover, because there are so few transportation routes from Mongolia to the rest of the world, China is essentially Mongolia’s only foreign customer for its existing mining output. Consequently, in negotiations over prices, China always has the upper hand.

Mongolia seeks bilateral partnerships beyond Russia and China whenever possible. This goal, known as the “third neighbor” policy, influences almost every decision Ulaanbaatar makes. Foreign investors who fail to account for it — even those who observe local laws and regulations to the letter — often find themselves caught in the crossfire between Mongolia and its neighbors. Mongolia is a place where making a profit requires not only understanding the legal environment but also anticipating how authorities are going to act on an ad hoc basis. (It is the spirit of the laws — and, in some cases, the spirit of the laws officials might have wanted to pass in hindsight — that count most in Mongolia.) In the past, Ulaanbaatar has blocked investors from selling mines and mining licenses to state-owned Chinese firms and, in one case, even confiscated a mine from a company that tried to sell it.  

Although Mongolia’s mining potential has exacerbated its lopsided relationships with its neighbors, it also seems to be the only viable solution to the country’s problems. Mongolia’s cold winters and difficult geography rule out other modes of development such as manufacturing, tourism, and services. That leaves mining as the only possible means of generating enough revenue to address the problems holding back development, which include a housing shortage and a lack of transportation links.

Solutions to both are far beyond the country’s existing means. Oyu Tolgoi, however, is the breakthrough investment that could finally set Mongolia on the right path. If the mine progresses as expected, it will become one of the world’s largest and most important. Canada’s Turquoise Hill Resources, which has been developing the site on behalf of Rio Tinto for more than a decade, will have spent $6.6 billion on the project by the time production commences in the coming months. The mine could bring in enough revenue on its own for Mongolia to start addressing its problems and help establish the country as a place where foreigners can do business.

Mongolia, however, seems to have seller’s remorse: Most Mongolians, including an influential block of parliamentarians, think the state should get a larger share of the profits. Rio Tinto claims that Mongolia is getting a great deal — according to a 2012 advertising campaign, the company owns 66 percent of the mine, but the Mongolian government will end up with 71 percent of the profits. (The latter number is actually based on the International Monetary Fund’s projected range of 55 percent to 71 percent.)

Unfortunately, there is no way to know whether it is a good deal. No statistics are available to the general public that establish, for example, the average profit split between mining companies and host countries worldwide. But Oyu Tolgoi is not the country’s last chance. The next massive mineral resource Mongolia wants to develop is Tavan Tolgoi, a coal deposit in the south of the country that is one of the world’s largest remaining sources. The state-owned mining company has established a trickle of production, but large-scale production will not be possible until an east-west railroad is built, which would connect as many potential mines as possible. By making transportation affordable, such a rail system would turn thousands of remote mineral deposits in the far-flung steppe into commercially viable mines.

This would not only give Mongolia many more exporting options but also open up the possibility of developing new industries in new places, such as Sainshand, a village where the proposed east-west rail line would intersect with the existing north-south line. An industrial zone there could create jobs and keep more of the profits from Mongolia’s resources in the country. Sainshand is also a possible location for an oil refinery, which could lessen Mongolia’s reliance on Rosneft for fuels. Affordable fuels, in turn, would make everything cheaper in Mongolia, opening up economic opportunity across the board. This is Ulaanbaatar’s vision. It is easy to see how mining could trigger a virtuous cycle of economic development.

Although it is unlikely Ulaanbaatar has enough money to build a major east-west rail line, the potential profits from Tavan Tolgoi are so great that foreign investors have shown a willingness to help with infrastructure and logistics in exchange for participation. Firms and governments in China, Japan, Russia, and South Korea have all expressed interest in such an arrangement. If Ulaanbaatar can ramp up production at Tavan Tolgoi — and in doing so generate substantial new revenue — the next steps include jump-starting mining operations at other state-owned mineral deposits, alleviating the housing shortage, and moving on to building the oil refinery at Sainshand.

In the past few months, unfortunately, the focus has been on problems, not potential. A recent coal-supply contract was voided, the state-owned mining company in charge of Tavan Tolgoi is facing a cash crunch, and foreign investment has largely been on hold since last April because of an uncertain legal environment. Mongolia could be the next development success story, or progress could be halted altogether if foreign investors flee, depriving the state of the revenue it needs.

But in the past few weeks, there have been some positive signs. On April 19, the government followed through on its promise to soften the restrictions of a foreign investment law passed a year earlier, narrowing its objections to entities owned by foreign governments. This means life should get easier for private firms (especially mining companies) and harder for China’s public-sector buyers. The change is expected to result in the speedy resumption of about 100 foreign investment plans.

Mongolia’s proposed revision did not, however, clarify confusing passages, and local attorneys still say the law is too vague. So although this specific threat to private-sector investment is gone, Mongolia remains a place where simply following the rules might not be good enough.

Foreign investors typically claim that they need a clear legal environment in which to operate. But in this case, they seem willing to pile on without one. A quick resumption of those on-hold investments would underscore the magnitude of potential profits in mining’s last frontier — gains lucrative enough for foreign investors to tolerate conditions far less than ideal.