Domestic Obligations

Indonesia

Economic News

22 Jul 2010
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Indonesia's Ministry of Energy and Mineral Resources has announced the finalisation of a domestic pricing mechanism scheme for coal that will come into effect next year.



The country is the world's top producer of thermal coal, which is the leading contributor to the country's mining-related export revenues. Coal production is also of significant domestic importance, as the country is seeking to decrease its dependency on fossil fuel energy sources, with much of its newly built power capacity coming in the form of coal-fired plants.



For a number of years, the country has strived to achieve the right balance between maximising export revenue from coal while also ensuring that domestic requirements are met. It is hoped that with the new domestic market obligation (DMO) scheme, both government and producers will find a fair solution.



Under the proposed policy, rather than paying cash royalties, coal producers will be required to allocate 35-40% of their production to fulfilling domestic needs. An independent agency will be established to oversee the management and implementation of the scheme. This new agency will also act as a clearinghouse, trading the coal obtained from the miners' supply set aside for domestic obligations.



The government will also publish the price at which coal will be purchased and traded domestically, using a newly established Indonesian coal reference price as a basis to calculate state revenues from royalties. The price will be determined based on an index that takes into account the coal's calorific value and moisture content. Higher calorific value and lower moisture content will translate into higher prices. In the past, the domestic purchasing price of different grades of coal was often considered arbitrary, which acted as a disincentive for some producers to produce and sell higher-quality coal to the government.



According to the Ministry of Energy and Mineral Resources, coal production in the first quarter of this year was 30m tonnes, well below the initial target of 50m. The ministry has attributed the drop to adverse weather conditions and intentional slowdowns by coal producers due to a fall in the global selling price. According to a recent study by consultants Wood Mackenzie, coal typically needs to trade at above $55 per tonne to encourage output. The Indonesian Coal Association remains optimistic that the country will reach the production target of 240m tonnes by year-end, which is below the initial forecast of 265m but still just above the 238m tonnes produced last year.



Overall, despite the global recession and the reduced demand for resources brought about by the economic slowdown, the country's coal producers have been faring quite well. Reported net profits in 2008 for all publicly listed Indonesian coal companies reached $1.2bn, up from the $1bn recorded in 2007. One reason for this sanguine performance is that despite regional demand having fallen, especially from Japan, China's strong appetite for coal remains. Analysts believe that demand from China will recover, as its economy is expected to grow by 7% this year. The recent rebound in global oil prices to a seven-month high above $65 per barrel is also boosting producers' optimism, as fluctuations in coal prices tend to move in the same direction as oil.



Most of the domestic demand for coal comes from PLN, the country's state electricity provider, which plans to construct more coal-fired power plants as part of its aggressive capacity expansion programme. Fahmi Mochtar, the president director of PLN, told OBG, "For environmental as well as cost issues, we must decrease our dependency on oil. Most of the recently installed capacity and planned capacity for 2009 will be coal-powered." While borrowing costs and access to funding led many of PLN's new plant constructions to be delayed in the latter part of last year and early this year, with the economy showing signs of recovery it is expected that many will be back on track soon.



With demand and prices both on the rise, coal producers are predicting expansion years ahead. Bukit Asam, the country's third-largest coal miner by market value, has announced that it expects its revenue to grow by 20% this year. Meanwhile, Berau Coal has announced its intention to launch an IPO in September, after delaying the decision last year due to unattractive market conditions.



While producers are expressing relief that a firm DMO policy and pricing scheme appears to be in place, some are still awaiting clarification as to which types of coal will be affected, and how it will be enforced. Priyo Pribadi Soemarno, the executive director of the Indonesian Mining Association, told OBG, "DMO is difficult to implement, especially with the smaller regional miners, as it is hard to exactly ascertain how much they produce."



Some also cite the 35-40% allocation to the domestic market as too high a commitment, arguing that while they take their domestic obligations seriously, they would like the option to pay cash as a royalty instead, to enable them to commit more production for exports if they can fetch significantly higher prices abroad.



Purnomo Yusgiantoro, Indonesia's minister of energy and mineral resources, justified the importance of DMO, telling OBG, "We will never jeopardise our export obligations. However, the country has domestic needs, especially in the case of coal to fire our power stations. Greater domestic transportation of minerals creates infrastructure and jobs. We need to maximise both exports and domestic supply, which is why we are working persistently to create a conducive environment for the country to increase production."

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