Mongolia chose U.S. miner Peabody Energy , a venture between China's Shenhua <1088.HK> and Japan's Mitsui & Co <8031.T>, and a Russian-led consortium as preliminary winners to jointly develop the prized Tavan Tolgoi coal deposit, a senior government source said on Monday.

The project, which may require initial investment of more than $7 billion, is seen as vital to kick-start the land-locked nation's economy. It will also generate billions of dollars in revenue for the companies involved and add tens of millions of tonnes of increasingly rare coking coal used by steel makers.

Mongolia's parliament is likely to consider the decision before July 11, the source said.

They are the preliminary winners and all the negotiation materials have already been submitted to the parliament for discussion, the official from Mongolia's Resources and Energy Ministry told Reuters by telephone.

It only needs an approval from the parliament ... the intention is to have all three parties jointly develop Tavan Tolgoi, said the official, who did not want to be identified as the news was not public.

Tavan Tolgoi has estimated reserves of 7.5 billion tonnes of coal, including the world's largest untapped deposit of steel-making coking coal, attractive as a source of supply to steel makers such as ArcelorMittal and India's Jindal Steel

China, Japan and South Korea are scouring the world and snapping up iron ore and coking coal assets to diversify from heavyweight suppliers such as BHP Billiton and Rio Tinto .

The focus has shifted to undeveloped Mongolia, which some analysts say could be one of the fastest-growing economies of the next decade because of its vast quantities of untapped mineral wealth.

Last week, the Mongolian government said it had halved the shortlist of bidders for the western Tsankhi block to three from six, but it did not say whether it would cut the list further.

Mongolian Prime Minister Sukhbaatar Batbold said last month that the government may share its Tavan Tolgoi project between three or four of the six bidders, media reports said.

On Monday, Peabody and Shenhua were not available for comment, while a government official that oversees Korea Resource Corp said he had not been informed of any decision.

Shares in Shenhua hit an intraday one-month high and closed up 3.2 percent in Hong Kong in a broader Hong Kong market <.HSI> up 1.6 percent. Mitsui climbed 1.5 percent in a strong Tokyo <.N225> market.

Mongolia relies heavily on China for its commodities exports, but is in talks to access Russia's railways and ports as it looks to build new trade ties with other countries in the Far East.

If the parliament were to vote down Peabody's participation due to details in its proposal, the government would then look at the other mining groups that had been previously short-listed -- Vale or Xstrata Plc -- to replace the U.S. coal miner, the source said.

He said there was no deadline for parliament to vote on the winners, but he reckoned a decision should be reached before July 11, before the parliament adjourns.

IPO IN SIGHT

Members of the Japanese-Korean-Russian consortium include POSCO <005490.KS>, utility firm KEPCO <015760.KS>, trading firm LG Corp and Daewoo International, state-owned Russian Railways and Japanese trading houses Itochu Corp <8001.T>, Sumitomo Corp <8053.T>, Marubeni Corp <8002.T> and Sojitz Corp <2768.T>.

The tender is to develop the western Tsankhi block, which holds around 1.2 billion tonnes of reserves, 65 percent of which is coking coal. It has an estimated production life of more than 30 years at 15 million tonnes a year.

However, with the deposit located in the middle of a vast desert that has hardly any access to roads, rail lines and power, some observers have estimated that winners might need to pump in over $7 billion as an initial investment.

Separately, the eastern Tsankhi coal block will be developed by state-owned Erdenes-Tavan Tolgoi Ltd. The government plans an initial public offering that could raise as much as $10 billion in funds to develop the field.

The process of developing Tavan Tolgoi had dragged on over the past two years.

This time, however, with the government planning to kick off the Erdenes-Tavan Tolgoi IPO to international investors by late 2011, it will be anxious to wrap up the auction of the western block to help underpin the valuation of east Tsankhi's coal resources, analysts said.

Mongolia originally planned to sell as much as 49 percent of the whole Tavan Tolgoi field to a foreign bidder, but canceled the sale early last year in favor of 100-percent state ownership, with plans to only sign a development contract.

Now, it has divided the deposit in its eastern and western parts, with the eastern section kept for Mongolia.

GEOPOLITICAL

The selection process has been heavily laden with political concerns, as Mongolia looks to boost its roughly $6 billion economy.

So far it feels like more of a geopolitical decision and commerce is sort of second, said Dale Choi, chief investment strategist at brokerage Frontier Securities in Ulan Bator.

The government is trying to involve all three, have a cooperation between all three groups. It will be complicated, since there are so many companies.

Still, some analysts said the combination makes sense as both the Shenhua-Mitsui venture and the Russian-Korean-Japanese consortium lack experience in developing coking coal deposits.

Peabody can help to fill that gap, said Helen Lau, UOB-Kay Hian's senior metals analyst.

(Additional reporting by Elzio T. Barreto Jr. in HONG KONG; Editing by Jason Subler and Anshuman Daga)

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