Indonesia's larger mining firms developing processing and refining facilities

Nowhere else in Indonesia’s economy are the costs and benefits of government efforts to boost value-added industries more apparent than in the mining sector. In the past, the state was content to allow international and domestic outfits a degree of latitude in determining the most effective way to profit from the extraction of lucrative mineral deposits, as it reaped benefits from the various taxes, licences and royalties. However, the status quo changed dramatically when the Ministry of Energy and Mineral Resources (MEMR) implemented Ministerial Regulation No.7 of 2012 (referred to as PerMen7), which established new mineral processing requirements for mining firms, regardless of the terms of their existing contracts.

Code Of Conduct 

Applying to 32 metal- and non-metal-based minerals and rocks, the minimum requirements vary according to the product but generally require companies to refine ore to finished product stage, or close to it. The new obligations were phased in over four years, depending on the development status of operations, and a January 12, 2014 deadline was set for compliance by IUP holders already in the process of constructing downstream facilities.

The export ban officially came into effect on May 6, 2012, but transitional provisions allowed companies holding pre-existing mining permits a grace period in which to bring their mineral processing capabilities up to the new standard. Since the introduction of the ban, Indonesia has also permitted the export of concentrates (semi-finished ore products) until 2017, including copper, manganese, zinc, lead and iron, on the condition that firms develop facilities to process the minerals to a finished product stage. However, these companies were subsequently subjected to a progressively increasing export duty applicable to all unprocessed minerals and ores until January 12, 2017. Should any mining company operating under an IUP fail to comply with the law, it will forfeit the right to export unprocessed material.

Obstacles To Compliance 

For mining corporations, the tough implementation timeline and large capital expenditures needed to yield relatively small profit margins continue to make compliance with the law very challenging, and in many cases economically infeasible even in the long term. The wide-ranging implications of these laws have forced many involved in the industry to question whether the export requirements have gone too far, and if the regulations are doing more harm than good. One of the main arguments against the current legislation is that it lumps all minerals into the same category, even though the costs of refining different metals can vary substantially.

For minerals that Indonesia does not produce significant quantities of, such as silver, obtaining enough feedstock to justify a smelter is a significant challenge. Copper processing also generates very narrow profit margins – particularly in the current stage of the commodity cycle – and requires substantial economies of scale, leaving little wiggle room for other considerations such as power, labour and environmental compliance costs. Conversely, refining materials like nickel, for which Indonesia already has substantial smelting capacity, offer ample investment opportunities.

In addition, the country’s underdeveloped infrastructure has proven to be problematic for companies involved in smelter development. For example, Indonesia is currently suffering an electricity shortage, yet refineries require a large and consistent supply of power to operate.

In spite of these challenges, the law has managed to facilitate a flurry of interest in investment in smelting facilities, with hundreds of plans for new installations filed by companies seeking to avoid negative effects of the export ban. As of February 2016 there were 78 companies nationwide building smelters, according to MEMR data. Of these, roughly half had completed at least 40% of construction work on their respective projects. Many of these smelters are being developed by Chinese steel companies, which have been among the most active investors in the segment, though these outlays have primarily been in low-tech processing operations such as pig iron smelting. Brazilian multinational Vale and Indonesia-based firm Antam are also involved in developing nickel processing facilities. However, there has been little incentive recently for nickel producers to invest in new processing capabilities as of 2016, with much of the country’s capacity remaining idle due to low commodity prices. Furthermore, of 12 nickel smelters that were expected to be completed in 2015, only five were eventually finished.

Uncertain Future 

Due to the substantial reduction in mining-related revenue making its way into government coffers since the ore export ban was implemented and slowing overall economic growth, a parliamentary commission announced in 2016 that it was discussing making revisions to the PerMen7 regulation. Members of the commission revealed to the press that reforms could be announced as early as September 2016. One key revision being considered is moving back the January 2017 ban on concentrates by two years, so as to allow Freeport-McMoRoran and Newmont Nusa Tenggara, Indonesia’s top two copper producers, more time to build a $2bn smelter for which funds have already been allocated.

Commission members responsible for drafting the proposals noted that mining companies, particularly nickel producers, should be allowed to resume some ore and bauxite exports so that they can earn enough revenue to complete their smelter projects. “If they are not allowed to export, the economy could be destroyed,” commission member Erwan Kurtubi told local media. However, there is no guarantee that the law will be relaxed, as dissenting opinions were apparent within the commission itself. “We have seen the fact that some cannot provide [smelters] as required, but it does not mean we have to change regulations to follow them,” said Fadel Muhammad, the commission’s co-chairman, “If they cannot make it, then goodbye to them. Somebody else can make it.”

A Quest For Compromise 

Even if a more relaxed approach by the government were largely welcomed by the mining sector as a whole, it would also present a separate set of complications for a number of companies that have already committed significant resources to downstream investments. With some mining operators having built smelters, in the process of building facilities or at least adjusting their financing to accommodate the law, it could prove difficult for the state to roll back the legislation in a wholesale fashion.

Nevertheless, there remains plenty of wiggle room for negotiation in the implementing regulations, and the new, pro-business Joko Widodo administration could prove to be more accommodating. The most feasible options for this include creating legal provisions for companies to begin exporting materials once a certain threshold of investment or construction is achieved on smelter projects, which would satisfy the government’s aim of developing processing capacity in the long term, while also allowing mining companies to generate some much-needed revenue to conduct capital-intensive investments in the short term. A new mining law draft released in June 2016 also suggests tax and non-tax incentives will be implemented for IUP holders that pursue downstream activities, which in itself would be a more positive way of encouraging the segment’s development.

The Long View 

The drive to expand the scope of activities across the mineral extraction value chain cannot be dismissed out of hand, and it could set the country up as a major mineral processor. However, the timing of the legislation caught the industry in the midst of an ebb in the commodity price cycle. Furthermore, many mining operations in the country lack much of the infrastructure necessary to make the processing and refining facilities cost-competitive with those established elsewhere. The infrastructure requirements of downstream processing, including a reliable power supply, and modern roads, rail systems and ports to move heavy equipment in and finished products out, were all inadequate when the ban was introduced. This is still the case today, and while a renewed focus on infrastructure spending that started in 2015 could create a more favourable operating environment in the future, it might come too late for companies that have been hit hard by severely diminished export returns in recent years.

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The Report: Indonesia 2017

Mining chapter from The Report: Indonesia 2017

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