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Energy | Indonesia’s Metal Mining Sector: Rewriting the Rules

On 11th January 2017, the Indonesian government issued abrupt and unexpected changes to its Mining Law that sent reverberations around the world for metal miners. In a bid to encourage the development of the country’s downstream mining industry, the government issued regulation GR Reg No. 1/2017 and MEMR Reg No. 5/2017 that permits miners to export low-grade mineral concentrates such as nickel and bauxite for a further five years, but in doing so, they will also have to convert their Contract of Work (CoW) permits to Special Mining Business Permit (Izin Usaha Pertambangan Khusus, or IUPK) and demonstrate sufficient progress with the construction of domestic processing and refining facilities. In 2009, the Indonesian government introduced the Mining Law (See The Question Of Indonesia’s Unprocessed Ore Export Ban – Updated) which required minerals to be processed domestically prior to any form of export. More regulations were passed in 2014 which effectively imposed a ban on certain unprocessed minerals in an effort to encourage the development of domestic smelting facilities — a subsequent three-year delay was announced before the ban was imposed as local processing facilities were still inadequate to undertake the task.

Indonesia’s metal Mining Sector: Rewriting the Rules
The lack of sustainability in the mining laws demonstrates the government’s lack of due diligence over a policy they fiercely fought for

With the release of the new regulations, it appears the government has taken a softer stance towards the export ban as the issuance of an IUPK license will allow miners to begin exporting unrefined minerals again. This has caused confusion and frustration amongst mining companies in Indonesia with mining giant Freeport-McMoran threatening to take the Indonesian government to an international arbitration tribunal in a high-profile dispute over the implementation of the new regulations. As such, this ultimately sheds light on ongoing inconsistencies facing investors seeking to enter or develop the sector.

The new regulations requires foreign miners — regardless if they were previously under a CoW or IUPK permit — to gradually divest a majority share in mining projects to Indonesian investors over a ten-year period; the previous requirements only affected mining companies who were IUPK holders with foreign shareholders that were required to divest 49% of their shares. The impact of these new regulations has been felt through dampened metal ore prices worldwide; in addition, the sudden change in policy is also demonstrative of the financial pressures and unpredictable legal landscape of Southeast Asia’s biggest economy which has become a major stumbling block for international investors within this highly lucrative sector.

As a country abundant in mineral deposits, Indonesia’s mining sector has been integral to economic growth as well as playing a prominent role in the global mining industry accounting for significant production in gold, nickel, and copper; Indonesia produces some 60% of global nickel exports and 70% for bauxite. As such, demand, particularly from China, has lent significant support to global metal prices and Indonesian metal producers. The 2009 Mining Law thus drew strong opposition from both domestic and foreign miners with reports of thousands of layoffs as well as losses in state revenue through lost taxes and royalties. This has been due to many smaller mining companies struggling to convert their existing permits to IUPKs because of backlogs in processing permits coupled with the lack of technical expertise to build smelters and other facilities; not an unexpected outcome given that often it is not their core business (See Indonesia's Smelting Plans – Moving Slowly, but Moving).

Moreover, the decline in global commodity prices combined with the effects of economic slowdowns in China (See What China’s Slowdown Means for Indonesia: A Trade Perspective) and Japan have contributed to a decline in mineral exports by 27% in the first half of 2014. Bauxite production fell by more than 95% since the ban to 2.6 million tonnes in 2014 and a further 1 million tonnes in 2015 (US Geological Survey) – the lack of downstream processing facilities and poor integration between bauxite mines and refineries also contributed to the decrease in production (See Metal Mining in Indonesia: Time to Face the Facts). Nickel production fell from 834,200 tonnes – a record high – in 2013 to 177,000 tonnes in 2014 with only 4.2 million tonnes of nickel 0re exported in that year compared to 64.8 million tonnes in 2013 (US Geological Survey). The recent regulations will add further fears of an oversupply of bauxite and nickel with the price of nickel falling 5% on the London Metal Exchange in January 2017.

Stockpiles to impact global supplies

The loosening of the export policy is set to benefit miners that have large stockpiles such as state-owned diversified miner, PT Aneka Tambang, which is currently sitting on ore stockpiles of 20 million tonnes (Bloomberg); the company has the potential to ship as much as 70,000 tonnes a year of low-grade nickel ore in the coming years. The majority of this will likely be exported to Chinese nickel pig iron producers and compete with producers from the Philippines that had replaced Indonesian exports since the ban was introduced and resulted in low global commodity prices. A jump in shipments for mining firms that can export their mineral stockpiles would also provide much needed funds to implement smelter projects. However, the change in policy is likely to severely hit much smaller companies that are unable to invest in smelter construction as well as mining companies that have already invested heavily in building large-scale smelters in Indonesia.

Disadvantageous for some

According to data from the Processing and Smelting Companies Association (AP3I), as many as 27 smelters were constructed between 2012 and 2016 (The Jakarta Post) with Chinese companies having invested some $15 billion USD for smelters that are already in operation. It remains unclear, however, whether investments into new smelters will continue given the change in policy that places smelter developers at a disadvantage as many miners will choose to export their mineral ores. Data from the AP3I also showed that the export ban had attracted $20 billion USD in investment for 32 smelters nationwide in the past four years. Among the disadvantaged companies are Vale Indonesia, the country’s largest nickel producer and the local unit of Brazilian mining giant Vale, which had been against the lifting of the export ban due to fears of oversupply in the market in addition to its already significant investment in smelter facilities. Shares in Vale plunged more than 15% as nickel prices could drop to as much as $9,000 USD (Nikkei Magazine) – and Chinese firms PT Virtue Dragon Nickel Industry and PT Sulawesi Mining Investments who both have committed to developing nickel smelters in Indonesia to meet growing demand from China’s stainless steel sector could also suffer off the back of lower nickel prices (See What China’s Slowdown Means for Indonesia: An Investment Perspective).

Possible legal loopholes

As part of the regulations issued in January 2017, Contract of Work holders who produce mineral ores are forced to convert their Contract of Work into IUPKs, or else be prohibited from exporting mineral concentrates; Minister for Energy and Mineral Resources Mr Ignasius Jonan said this process would be done in a ‘maximum of 14 days’ with no requirement for a tender. Upon attaining an IUPK licence, miners are given an extra five years during which they are permitted to export approved concentrations of mineral ores, provided they are willing to develop domestic refining facilities.

The new regulations appear to conflict with the provisions of the 2009 Mining Law which stipulates that there is no requirement to convert CoW into IUPKs. Moreover, the Mining Law requires IUPKs granted to private entities on the basis of a tender. As such, with many mining companies having recently re-negotiated their CoW contracts, the new regulations will render these obsolete and many miners are now forced to seek to alter those terms because of regulatory intervention.

Infrastructure woes

Another contentious issue for metal miners is inadequate supporting infrastructure (See High Stakes for Indonesia's New Infrastructure Push) and the skilled human resources (See Indonesia’s Brain Drain Pains) needed to support downstream processing facilities. In order for a mining company to develop a smelter, miners also have to fund the development of roads, railways (See Indonesia’s Railways; Just the Ticket to Improve Logistics), ports (See Indonesia's Maritime Ambitions Require Massive Upgrade of Seaports), as well as maintain a large amount of electricity supply (See Investment in Indonesia’s Electricity Sector; Sparks of Life). Despite a doubling of total electricity generation in the past decade, Indonesia still only has a low electrification rate compared to that of its ASEAN neighbours. Given the challenges in getting infrastructure projects approved, such complementary investments may not materialise in time as the country aims to add value to its downstream metal mining sector.

The Freeport saga

The high-profile dispute involving Freeport Indonesia places into context the difficult situation major mining companies in Indonesia are facing. As the operator of the Grasberg Mine, Freeport’s existing Contract of Work was signed in 1991, granting the company the right to operate until 2021. With the introduction of the 2009 Mining Law, the Indonesian government deemed it fit for Freeport Indonesia to convert its old contracts to be in-line with the new law. According to Freeport, the company wants the same legal and fiscal certainty currently laid out under its CoW and is prepared to take the Indonesian government to an international arbitration tribunal to settle the dispute. Under the new regulations, Freeport Indonesia would be liable to a dividend tax, 10% value-added tax, and an export duty of up to 7.5%. Furthermore, the company would have to divest up to 51% of its Indonesian unit shares – compared to the current mandatory 30% (it currently has only divested 9.36%) — and construct a smelting plant. With Indonesia having relatively shallow financial markets, Freeport will find it difficult to find local partners with the necessary capital willing to invest in such a large stake in the company (See Indonesia’s Capital Market: Growing Beyond Expectations).

Freeport Indonesia and Rio Tinto (Freeport’s partner in the Grasberg mine) are also planning to convert the mine to underground operations; the companies have plans to transition to underground mining in late 2018 as they plan to cease open pit mining operations. This is because an estimated 94% of the mine’s reserves can only be recovered underground. The current turmoil with the Indonesian government can jeopardise this multi-billion dollar expansion and therefore lead the company to reduce its workforce and suspend investments on future smelter projects. The impact of this ongoing dispute will only deter international investors and mining companies and further smear the image of Indonesia’s metal mining sector as a lucrative investment channel.

Under the new amendments to the Mining Law, foreign ownership of mining projects are now limited to 49%; this must be done by the tenth year of production, except when the company is engaged in underground mining activities. As such, the shares for divestment must be offered to (i) the Central Government, (ii) Regional Government, (iii) State-owned Enterprises or Regionally-owned Enterprises, and (iv) Private Entities. Additionally, there is no time limit for responding to an offer of shares, which means that the divestment process can be delayed for an indefinite time. The latest divestment scheme will impact the expected investment returns of foreign investors and may discourage much needed investment into the metal mining sector. Furthermore, foreign companies will have difficulty in finding local partners with the necessary finances to take onboard a majority stake in mining projects.

A misguided policy?

For decades, Indonesia has been relying on its natural resources as a key source of government revenues. The country’s fourth revision to its mineral mining laws sent ripples through the global metal mining industry with the price of nickel, copper, and bauxite fluctuating since the implementation of the new regulations. The Indonesian government should get a boost from the resumption of mineral exports and greater control over foreign mining projects appeals to national sentiment. With the Indonesian government’s prioritising other infrastructure projects outside of the mining industry, allowing miners to export in return for investment in downstream smelting facilities should generate thousands of jobs, boost local economies, and meet domestic demand for infrastructure development (See Indonesian Infrastructure: Tremendous PPP Opportunities).

Yet among mining companies and investors in Indonesia, there is growing concern over the sudden change of heart in the country’s mining policies. As CoW contract holders produce the majority of Indonesian minerals, efforts to add value to its metal mining sector have created uncertainty around the rights to the extension of existing contracts as long-term miners may not be able to commit to exploration, development, and downstream processing projects. The new regulations may negatively affect companies that have heavily invested in smelters but will benefit companies with large stockpiles. It is inevitable that the relaxation on ore exports will boost Indonesia’s trade, however, the recent revisions will no doubt lead to more complexity in a country already ranked 91 out of 131 by the World Bank on Ease of Doing Business (See Indonesia’s Economic Outlook in 2017: Remain Cautiously Optimistic).

The lack of sustainability in the mining laws demonstrates the government’s lack of due diligence over a policy they fiercely fought for. Coupled with a high-profile legal case and low commodity prices, it is still unclear which direction Indonesia aims to take its downstream mining processing industry as it continues to deliberate on how this important sector can play a bigger role in the country’s economic development.

Global Business Guide Indonesia - 2017

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Indonesia Energy Snapshot

Contribution to GDP: 3.44% (2016) Oil & Gas Imports: $1.22 billion USD (Jan 2016)
Proven Oil Reserves: 3.69 billion barrels (2016)
Proven Gas Reserves: 2.85 trillion cubic metre (2016)
Proven Coal Reserves: 28 billion tonnes total reserves (2015)
Proven Potential in Geothermal Energy: 27 GW
Proven Potential in Hydropower: 75 GW
Other Energy Sources: Coal Bed Methane, Biomass, Waste, Ocean Current, Solar, Wind.
Current Energy Mix: Petroleum 41%, Coal 30%, Natural Gas 23%, Renewables 6% (2014).