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Energy & Mining | Metal Mining: Foreign Investment More Necessary than Ever

Indonesia is a leading producer and exporter in a wide range of industrial metals and is home to the world’s largest gold mine. Metal mining accounts for a significant share of state revenue and foreign direct investment; though critics say the sector could attract much more capital if not for the changeable regulatory environment. A government push to develop domestic mineral processing industries has provoked strong criticism from upstream producers, but it could lead to attractive investment opportunities.

Metal Mining: Foreign Investment More Necessary than Ever

Indonesia’s metal mining sector continues to hold immense resource potential, and growing domestic demand means more metal will be processed within Indonesian borders

 

Global economic concerns prompted a prolonged retreat in commodity prices following the highs reached in mid-2011. Slowing GDP growth in China and other major import countries resulted in lower demand for metal minerals from Indonesia. Roughly a year later, the gold price also began to weaken markedly. While these external market conditions obviously affected local business performance, growing domestic industrial activity should make the sector less dependent on global demand in the long run.

Based on its geological formations, Indonesia has the potential to vastly increase output. The country has significant deposits of lead, zinc and silver, but its most important metal minerals are nickel, bauxite, tin, copper and gold.

Nickel: Nickel mine output took a toll in the global credit crisis of 2008/2009 but grew strongly in the years that followed. In 2011, Indonesia exported more nickel ore than any other country in the world, with the Sulawesi region dominating national output. Major producers include government-controlled PT Antam and PT Vale Indonesia. While some of the ore is processed into nickel matte and ferronickel before export, the bulk is shipped in raw form, mostly to China, where it is used primarily in the production of stainless steel. However, Ibris Group reportedly plans to build a $1.8 billion nickel smelter in Indonesia, and Australia’s Direct Nickel in July 2013 signed a preliminary agreement with Antam to develop the country’s first nickel laterite processing plant.

Bauxite: As with nickel, Indonesia is also China’s largest supplier of bauxite, the main raw source of aluminium. The trade dependence runs both ways, with China buying most of Indonesia’s bauxite exports. Antam is the dominant player in the sector and – in cooperation with Japan’s Showa Denko – leads the way as the industry is compelled to invest in bauxite processing. The world’s largest aluminium producer, Rusal from Russia, meanwhile, reportedly wants to build a $2 billion refinery in Kalimantan, while Chinese firms have announced similar plans. The processing of bauxite into alumina is the missing link in the aluminium production chain, as the country’s only aluminium smelter relies on alumina imports from abroad.

Tin: While China is by far the largest producer of tin, Indonesia is the world’s number one exporter and boasts the second-largest reserves. Its dominating export position gives Indonesia substantial potential sway on global prices, though attempts by companies to use this to their advantage have been largely fruitless. Tin production is strongly concentrated on the Island of Bangka. Illegal mining and a lack of investment in new mines have been blamed for declining output. Government-backed PT Tambang Timah dominates the market, while PT Koba Tin, majority owned by Malaysia Smelting Corp, saw its production fall over the past few years, as the government kept it guessing whether or not its expiring mining contract would be renewed.

Copper: Copper deposits exist across the archipelago, but mine output and exports declined sharply after 2009. Nevertheless, the country remains a top-ten producer. The Grasberg mine in Papua, operated by PT Freeport Indonesia, is believed to hold the world’s largest recoverable reserves, while the Batu Hijau mine on Sumbawa Island, run by PT Newmont Nusa Tenggara, is another major asset. Both mines are undergoing expansion programmes to access deeper-lying deposits. Indonesia only has one copper smelter, owned by a consortium of Japanese companies and Freeport Indonesia’s US-based parent company. The government has said it may help fund new smelters.

Gold: The Grasberg mine is also thought to hold the largest reserves of gold and together with Batu Hijau accounts for more than half of Indonesia’s gold output. National production fluctuates strongly depending on conditions at these two mines. Hundreds of unlicensed mines employ tens of thousands of people across Indonesia. Authorities are clearly turning a blind eye on operations that lack health and safety standards and cause severe environmental damage. While many of these so called traditional mining activities are small in scale, their combined output is substantial.

Mine output (Thousand metric tons. Gold: metric tons)

Frequently changing regulations are cited as one of the main obstacles for mining in Indonesia. Law No. 4/2009 on Mineral and Coal Mining vastly altered the legal landscape, with some regulations welcomed by investors and others lamented. The law’s implementation caused concern among foreign mining licence (IUP) holders, mainly due to two aspects:

  • Ministerial Decree No. 7 of 2012 bans exports of most unprocessed metal minerals. The idea is to compel mining companies to invest in processing facilities to build a strong domestic downstream industry. Mining companies have the option to build their own refineries and smelters or cooperate with other companies to process their ores. The decree went into effect in May 2012, just three months after its announcement. However, companies are granted temporary metal ore export licences if they can produce a credible plan to arrange for domestic processing by 2014, when an all-out ban on raw exports is to be imposed. In the meantime, ore exports are subject to a 20% tax. The policy hit export volumes hard in summer 2012 as the short-term permits were being processed. The Supreme Court in November 2012 annulled four articles of Decree No. 7, but the government vowed to stick with the policy by issuing new regulations.
  • Government Regulation No. 24 of 2012 requires foreign IUP holders to divest 51% of a project to Indonesian interests within ten years after the start of production, much higher than the previous 20% requirement. Divestment kicks in stepwise five years into the production phase. Stakes are to be first offered to the national government, then to provincial and local governments, then to state or region-owned companies and finally to private Indonesian investors. Multiple holders of the “Indonesian” 51% may effectively gain control over operations if they work together.

Industry representatives have criticized recent regulatory changes as nationalistic-minded and raised concerns about alienating foreign investors. In a 2012/2013 global survey among mining companies, the Fraser Institute found Indonesia to be the “least attractive jurisdiction for investment” with regards to the political environment. Indonesia scored second-worst on the criterion of “Legal processes that are fair, transparent, non-corrupt, timely, and efficiently administered.” This impression was obviously influenced by a small number of prominent legal disputes in Indonesia of foreign companies wrestling with authorities or local interests over concessions and compliance. On the bright side, the country scored very highly in terms of its mineral potential and was seen as one of the countries with most room for improvement.

It is clear that Indonesia will fail to install the necessary capacity to process all its metal ore domestically by 2014, and some government representatives have hinted that the rules would not be enforced as uncompromisingly as they stand on paper. It is likely that the government will further soften its stance on the issue, given the fact that Indonesia can ill afford to massively curtail export volumes at a time when the country is running a severe trade deficit.

In the long run, however, there can be little doubt that the downstream will play a greater role in the mining sector. If implemented in an organized and predictable manner, this can unlock enormous business potential in refining and smelting. The Investment Coordinating Board (BKPM) has promised greater incentives in the sectors of bauxite, nickel and copper, in addition to existing tax holidays available for pioneer industries (See New Tax Incentives for Investors in Indonesia). However, many potential locations for smelters lack transport connectivity and reliable electricity; the construction of infrastructure and power plants needs to be factored into costs (See Indonesia’s Electricity and Power Generation Sector).

Indonesia’s metal mining sector continues to hold immense resource potential, and growing domestic demand means more metal will be processed within Indonesian borders. This provides attractive opportunities upstream and downstream. The recent economic slowdown and current account deficit make foreign investors in this process more necessary than ever.

Global Business Guide Indonesia - 2013

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