Jakarta Post - February 2014
The Indonesian mining sector is at a cross roads as we enter 2014. The current downturn in commodity prices globally, combined with recent regulatory activity to implement key articles of the 2009 Mining Law are causing mining investors, domestic and foreign, to reassess their investment plans. Of particular note are the imminent ban on the export of unprocessed minerals, the requirement for divestment of foreign interests in mining concessions, and the ongoing renegotiation of existing Contracts of Work held by some of the largest mining producers. All this at a time when the Indonesian economy is being buffeted by the winds of global economic challenges, highlighted by outflows of foreign capital, with the resultant impacts on equity markets and the Rupiah.
There is no doubt that the mining sector has been one of the key sectors supporting Indonesia’s economic growth for a number of years. The sector makes a significant contribution to Indonesian GDP, exports, government revenues, employment and, perhaps most importantly, the economic development of the remote regions where mining operations are located. This has been true even during the ups and downs in commodity prices during the past five years – from the mining boom of 2007, through the global economic downturn of 2008 - 2009, moderate recovery in 2010 - 2011, and a return to downward pressures from 2012 to the present. Over this period, increases in production volumes for most mining products, driven by long-term positive views of the sector, have offset the negative impact on revenues. As we enter 2014 however, there is some doubt whether investors remain bullish on the long-term prospects of the industry in Indonesia.
It is clear that mining investors continue to rate Indonesia highly in terms of the abundance of its mineral resources – whether coal, copper, nickel or tin – and judged purely on this factor, Indonesia would be a highly attractive destination for mining investment. This is borne out in both PwC’s most recent survey of the Indonesian mining sector (released in May 2013) and the February 2013 report of the Fraser Institute. However, both these surveys conclude that the perceptions of the regulatory environment remain a key challenge. Even though we saw some increases in investment in the Indonesian mining sector after the global economic downturn of 2009 – 2010, expenditure on exploration activities, specifically in greenfield sites, is still disproportionately low. In fact, average expenditure on exploration in Indonesia over the past 10 years represented less than 2% of global exploration expenditure, while at the same time investor perceptions of Indonesia continued to deteriorate. The Fraser Institute survey ranked Indonesia lowest (96 out of 96 countries being analysed) in terms of its policy potential index, which gauges how friendly government policy is in the mining sector. This represents a significant drop from its ranking of 85 out of 93 countries in the previous year’s survey. This negative perception, together with the decrease in commodity prices, has contributed to the decline in the value of listed mining companies in Indonesia.
The global economy is also undergoing changes and two key developments should be of concern to stakeholders in Indonesia’s mining sector, including the Government of Indonesia. The expected tapering of the quantitative easing policy of the US Federal Reserve is likely to continue to see foreign capital outflows from Indonesia. At the same time, there is a general view that China will grow more slowly in the medium term. In Indonesia, these factors have contributed to foreign capital outflows, which have in turn pushed down equity prices and the value of the Rupiah, heightening inflationary pressure. The rate of growth of foreign direct investment has declined in recent quarters while the trade deficit has reached 4% of GDP. This is a significant concern if Indonesia cannot attract more long-term investment to fund its imports.
With the end of the period of easy money, now is the time for Indonesia to attract long-term foreign direct investment – the type of long-term capital that comes with large infrastructure and mining projects – which cannot be withdrawn with the same ease as investments in financial instruments, shares, property and the like. The question is whether the recent regulatory action around unprocessed ore exports, foreign divestment and contract renegotiation are of benefit in attracting such long-term investments, at such a critical time.
In line with the objectives set out in the 2009 Mining Law, the Indonesian government has issued several regulations, which have been perceived by some as nationalistic in nature. This has culminated in a higher level of uncertainty, which is impacting the investment plans of mining investors. The apparent objectives of the law, in particular the desire to create added-value to Indonesia’s mining activity through onshore processing of minerals, or to retain more of the benefits of the country’s mineral resources in Indonesian hands, are not unreasonable in themselves. However, the method of implementation is of concern, given the significant financial impact it has on mining projects in which investors have already made significant commitments.
The divestment rules as set out in a ministerial regulation issued in September 2013 are likely to discourage new mining investment in Indonesia, particularly in the large-scale, long-term projects that are so important. The requirement for foreign investors to divest at least 20% and 51% of their stakes by the fifth and tenth years of production, respectively, potentially result in many projects being economically unfeasible (other than projects with very short mine lives or payback periods). The arbitrary divestment dates which are applicable to all minerals, do not take into account the different nature, for example, of a coal development versus a copper mine. Neither is it consistent with the requirement for in-country mineral processing – while foreign investors are required to double or even triple their investment in order to build smelters, they are at the same time obliged to divest their controlling stake after 10 years. It also remains unclear whether the domestic financial markets have the significant equity and debt funding capacity needed to fill the gap left by a significant reduction in foreign equity interests, whether for mining exploration or building processing facilities and related infrastructure.
On the other hand, the domestic processing requirement faces many challenges of its own, such as the lack of infrastructure, energy and fiscal incentives. These factors mean that there will not be new downstream processing capability in place by the five-year deadline set out in the 2009 Mining Law, which falls on 12 January 2014. Government plans to relax the domestic processing deadline for mining companies that had a clear commitment to build a smelter in the future have not been realised at the time of writing, ostensibly due to opposition in the House of Representatives.
As of early December 2013, plans for around 100 smelter projects have reportedly been submitted to the Government, but only 28 have reached the groundbreaking stage and only one has reached commissioning (Aneka Tambang’s chemical grade alumina plant). As such, there will be no new smelters in full operation by January 2014 when the export ban should come into effect. This will result in an immediate and significant impact on the Indonesian economy through:
As reported recently, PT Freeport Indonesia alone, which operates Indonesia’s largest copper mine, has said that if the export ban is implemented, it will need to cut production by 60%, reducing government income from taxes, royalties and dividends by around US$1.6 billion per annum. It can be argued that in the long-term, the Indonesian economy will benefit from the ore export prohibition through more domestic processing. It may well lead to an increase in global commodity prices, more jobs, and increased investment in smelters. However, at this point in time, considering current global economic conditions, the current negative trade balance and unfavourable Rupiah exchange rate, there is little doubt that if the export ban comes into force it will adversely impact the Indonesian economy in the short to medium term. This is likely to mean that mineral production will fall in the next few years, but commodity prices may increase due to Indonesia’s reduced exports, ultimately resulting in a higher cost of imported processed materials for Indonesian consumers. Given the consequences, many in the mining investment community believe that there will be a last minute change in stance by the Government, delaying the full implementation of an export ban on unprocessed minerals – it seems we will have to wait to see what the new year brings.
It is worth noting that the coal mining business appears to be largely unaffected by this regulation. Supported by a number of positive factors, including increased demand from domestic power plants coming online and continued demand from other parts of Asia, Indonesia’s coal production is likely to continue to grow over the coming years. While a much talked about potential ban on the export of low-rank coal has not eventuated, investors will continue to watch Government plans around domestic market obligations for coal producers, and specific quotas for coal-fired power plants. The main challenge for coal producers is the lack of transport infrastructure in remote areas where much of the large reserves are now located – reserve replacement may be affected if such infrastructure is not prioritised.
The ongoing renegotiation process of the terms of existing Contracts of Work, in line with the requirements of the 2009 Mining Law, is also a significant challenge for the industry. After two years of negotiations, it has been reported that only two of 37 contractors have agreed to the amendments proposed by the Government, and that no revised contract has been signed to date. The main sticking points have been around the insertion of clauses requiring downstream processing of raw materials in Indonesia, divestment requirements and reductions in the size of mining areas. The Government’s commitment, in line with the principles of the 2009 Mining Law, is to fully respect the current contracts until expiry, or renegotiation – however the long process to conclude negotiations, and the Government’s attempts to impose obligations such as downstream processing on existing contracts, have caused uncertainty, and resulted in many large contractors delaying plans for expansion. This is of significant concern, as the majority of Indonesia’s production of coal and minerals continues to come from the large contract of work holders, rather than licences issued under the 2009 Mining Law.
The regulatory upheaval in recent years has cast Indonesia’s mining sector in a negative light. This is compounded by the political risks inherent in the lead up to an election year as policy-making takes on a populist flavour. This results in a “wait and see” approach by investors, the last thing that is needed given the current global economic environment, in which countries are competing for scarce investment funds.
It will be unfortunate if Indonesia cannot make the best use of its vast resources for the sustained wealth of its citizens. To be sure, the regulatory challenges in Indonesia, together with a lack of coordination amongst various government agencies, inadequate infrastructure and other risks, have hampered the entry of investors into the Indonesian mining sector, despite its great geological potential. Given the capital-intensive and long-term nature of the mining business, investment will be needed from the global market to fund the exploration and mine development required to boost government and export revenues, spur economic growth and expand regional prosperity. The Government should therefore prioritise clear, consistent, business-friendly measures and policies to demonstrate that the Indonesian mining sector is indeed a good place to invest.
Writers: Sacha Winzenried is the lead technical adviser, and Fandy Adhitya a director, in PwC Indonesia’s Energy, Utilities & Mining practice. They are responsible for the production of mineIndonesia, PwC Indonesia’s annual review of trends in the Indonesian mining sector, which can be obtained at www.pwc.com/id.