Mongolia looks at equity for royalties swap to break mining deadlock

* Mongolia plan could break Oyu Tolgoi deadlock

* Oyu Tolgoi copper expansion could boost economy by third

* Rio Tinto (Xetra: 855018 - news) has long been against re-opening investment agreement (Adds comment from analyst, Turquoise Hill, Rio Tinto)

By Terrence Edwards

ULAN BATOR, Feb 5 (Reuters) - Mongolia is looking to revive stalled foreign investment in large mining projects by cutting its equity stake in strategic mines in exchange for more royalties, according to a government plan due to be unveiled on Friday.

The country holds some of the world's largest copper and coal deposits but its economy has been held back by disputes with foreign investors over assets such as the $6.5 billion Oyu Tolgoi copper mine.

Anglo-Australian miner Rio Tinto has stalled a $5.4 billion underground expansion project at Oyu Tolgoi, which could boost the economy by a third, because of arguments over cost overruns and $30 million in tax that the government says it owes.

On Friday, Prime Minister Chimed Saikhanbileg will propose in parliament an amendment to the mineral resources law to allow the government to exchange state-owned equity in "strategic mines" for higher royalties, according to a spokesperson for the prime minister.

Analysts said the move made sense for Mongolia which is keen to boost its revenue in the near term, but without knowing details on the size of the royalty, they said it was unclear whether it would be good for Rio Tinto, whose Turquoise Hill Resources arm owns two-thirds of the Oyu Tolgoi mine.

"Rio would take on more project risk, but they also take on more Mongolia risk. It's a function of returns," said a Sydney-based analyst who declined to be named as he had not seen terms for an equity-for-royalties swap.

Higher royalties would help the government earn more from the mine faster than under the current arrangement. With equity, Mongolia must wait until after investors recuperate their initial costs before receiving dividends for its shares.

"Without phase two there's limited value in the project to a strategic investment," said Nick Cousyn, chief operating officer for Ulan Bator-based broker BDSec. "Going forward with phase two will unlock the option for Mongolia to choose higher royalties or keep their equity."

Mongolia has 16 strategic deposits, including Oyu Tolgoi and the Gatsuurt gold deposit currently licensed to Toronto-listed miner Centerra Gold Inc (Other OTC: CAGDF - news) . These deposits have the potential to generate at least 5 percent of the country's GDP.

The government currently takes a minimum of 34 percent equity in strategic deposits, but could ask for up 50 percent if state funding was used for exploration.

Some Mongolian MPs have repeatedly demanded a larger stake in Oyu Tolgoi. Others have invoked Resolution 57, passed in 2009, which states that the government can negotiate to increase its stake to 50 percent once investors earn back their initial investment.

Turquoise Hill and Rio, operator of the mine, have consistently rejected requests to renegotiate the investment agreement they signed for the mine in 2009.

However, implementing the terms the prime minister has suggested may require some sort of renegotiation.

Rio Tinto and Turquoise Hill declined to comment on the government's plan. (Reporting by Terrence Edwards; Editing by Jake Spring and Vincent Baby)