* Mining giant looks to build power plant for Oyu Tolgoi
* Domestic electricity has to be secured by 2022
* Political instability a key issue - former govt official
By Barbara Lewis and Munkhchimeg Davaasharav
LONDON/ULAANBAATAR, Sept 13 (Reuters) - Nearly 10 years on from the launch of a giant copper and gold project in Mongolia, Rio Tinto RIO.L RIO.AX is still looking to secure a domestic power source it needs for the mine under an agreement with the government.
Oyu Tolgoi, located in the South Gobi region near landlocked Mongolia's southern border with China, is scheduled to complete a $5.3 billion underground expansion for first production by 2020, creating one of the world's biggest copper suppliers.
The project, launched in 2009 and 34 percent-controlled by Mongolia, is set to transform the country's tiny economy, and is also key for Rio as the biggest potential growth area for its copper business. But it has been beset by squabbles over cost overruns and claims of unpaid taxes. an agreement with the government, by 2022 a domestic power source must be found for the project, currently running on power imported from China. But while Rio has invited three state-owned Chinese firms to submit bids to build a power station at a cost of up to $1.5 billion, it has yet to make a final decision on a go-ahead.
Rio also has yet to have its permits for the plant renewed by the Mongolian government, according to a government source.
"The main challenge remains the same: political instability and unpredictability," said Otgochuluu Chuluuntseren, a former government official who also served as an Oyu Tolgoi board member.
Oyu Tolgoi has suffered repeated delays amid government wrangling, the reshuffling of officials, disputes over Mongolia's share of the returns and opposition to foreign participation among nationalist politicians. the power project has been the Mongolian government's desire to kickstart the nearby Tavan Tolgoi coal project, one of the world's biggest deposits with an estimated reserve of more than 6 billion tonnes, which lies just 150 km (93 miles) from Oyu Tolgoi.
Rio had originally planned to build its own power plant, but it suspended construction plans in 2012 after it was encouraged by the government to switch to a proposed plant at Tavan Tolgoi, where it would be an off-taker rather than investor. in February this year, the government cancelled a 2014 agreement setting up a framework for co-operation on a shared power plant, with Rio saying the project still lacked a credible lead investor and could not be completed on time.
DIFFICULT TIMEFRAME
Oyu Tolgoi currently pays about $100 million a year to buy electricity from China, according to an industry source with knowledge of the matter.
The project is now looking at options for a domestic power source, said Luke Colton, chief financial officer at Turquoise Hill Resources TRQ.TO , the Rio-controlled unit that owns 66 percent of the project.
"An Oyu Tolgoi-based plant is currently the most feasible option that could deliver a domestic power source within the shortest timeframe," Colton said in a call on second quarter earnings at the end of July.
Rio Tinto said it was working with the government and other stakeholders to progress the building of a new power station.
"Rio Tinto and its partners are committed to securing a domestic power supply within the agreed timeframe," a spokesman said.
Some government officials have expressed impatience about the power plant delays, underscoring the political challenges facing the project.
"Oyu Tolgoi should stop playing with the Mongolian state!" Mongolia's energy minister Davaasuren Tserenpil said on the ministry's official Twitter account last month, in extracts from an interview to local media.
"Oyu Tolgoi got permission from the ministry in 2012 to build the power plant on its site but it has done nothing."
Otgochuluu said transporting power from a Tavan Tolgoi plant to Oyu Tolgoi would be more efficient than transporting coal to a likely coal-fired plant at the Oyu Tolgoi mine.
Of the three contractors invited by Rio to tender for the project, Power Construction Corp of China 601669.SS spokesman Sun Jianli told Reuters the bid was "preliminary" and the project was still "very far away".
The others, China Machinery Engineering Corp 1829.HK and Harbin Electric International 1133.HK , declined to comment.
If the plant is not built on time, Rio and the government would need to negotiate on alternative supply arrangements, potentially a sensitive task as discord continues to rumble around the project.
"It is a huge and prized project. Rio Tinto and the Mongolian government would do everything to avoid any major disruption to supply," said Shairaz Ahmed, Manager of Statistical Analysis, International Copper Study Group