Endowed with ample mineral and coal resources that have yielded some of the most productive mines in the world, Indonesia’s mining sector continues to exert substantial influence on both the domestic economy and global markets. The world’s largest coal exporter, Indonesia continues to lead the seaborne market despite several leaner years due to weaker demand and softer prices. Local demand is also projected to expand significantly through the end of the decade with a new wave of coal-fired power plants slated for construction over the next five years.
At the same time, new regulations on mining are causing profound changes in the sector. A 2009 ban on exports of raw materials, intended to stimulate growth in the smelting industry and boost value-added exports, came into effect in January 2014 after a five-year transition period in which some mining companies were allowed to export limited commodities if they met certain criteria. New tax regulations were also instituted. As a result, exports of a number of commodities dwindled in 2014, including bauxite, nickel, copper and gold. To maintain a degree of raw-ore production during the transition to higher value, a clutch of bilateral agreements between the government and certain of the larger mining companies have allowed some major mines to keep producing.
Key Role for Coal
Coal is a cheap and abundant commodity in Indonesia, responsible for powering half of the country’s electricity. Bob Kamandanu, the chief of the Indonesian Coal Mining Association, is confident that coal has a key role to play in Indonesia’s modernisation, telling OBG that upgrading the quality of coal and increasing the focus on conversion technologies is one way forward. “If a developing country like Indonesia wants to achieve a higher electrification rate, which is now around 70%, we will need to continue looking at coal, but from a different and cleaner perspective,” he said. There are two good ways in which Indonesia can achieve this, he added. “The first is by upgrading the coal quality, which essentially means reducing the amount of water and impurities in the coal,” he said. “The second is by increasing our focus on coal conversion technologies. Coal to liquid or coal to gas are options that will significantly reduce the amount of CO ronment.” By adding value to mining products, such as coal upgrading and coal conversion into gas, both of which are widely acknowledged as key to improving the industry’s prospects, the government has thrown its weight behind in-country processing.
Striking a Balance
On January 4, 2014, five years to the day since the Mining Law of 2009 was passed, a number of divisive regulations came into force and continue to reverberate through the mining industry more than a year later. The crux of the issue remains much the same as when the much-debated law was made public in 2009: how can one balance inclusive economic growth and employment against the need for a sustainable business environment that is conducive to long-term investment? Taken as a whole, these new policies lean towards the recent global trend of resource nationalisation sweeping through many developing economies. In Indonesia’s case, the primary mechanisms include the accelerated divestment of majority ownership of mining tenements held by foreign companies; a restructuring of the tax scheme, contract size and contract duration in favour of the state; and the requirement for all minerals to undergo value-added processing prior to export.
The provision with the most significant short-term impact by far is the Ministerial Regulation No. 7/2012 (referred to as PerMen7), issued by the Ministry of Energy and Mineral Resources (MEMR) to establish new mineral processing requirements for all mining operations in the country. Applying to 32 metal- and non-metal-based minerals and rocks, the minimum processing requirements vary by product but generally require companies to refine ore to – or close to – finished product stage. The new requirements were phased in over four years depending on the developmental status of operations, with final implementation for mining business permits (izin usaha pertambangan, IUPs) starting January 12, 2014.
The export ban, passed in 2009, officially came into effect on May 6, 2012, though transitional provisions have allowed firms holding pre-existing mining licences a grace period in which to bring their mineral processing capabilities up to the new standard. However, these companies were also subjected to additional export taxes applicable to all unprocessed minerals and ores, equalling out to roughly a 20% tax. Should any mining company operating under an IUP mining licence fail to comply with the law, it will forfeit the right to export unprocessed material.
Weighing the Consequences
The profound implications of these laws have left many industry players to question the benefits of the new export requirements. Proponents say they stimulate value-added processing, but critics say the consequences of compliance could damage the mining sector, cost the country huge revenues and deter investment.
Among the chief objections to the law is that it lumps all minerals into the same category, even though the costs and benefits of refining differ widely for various metals. Processing copper, for instance, produces thin profit margins that require substantial economies of scale while leaving little margin of error for other considerations such as power – currently in short supply, especially in the remote areas where mines are likely to be located – labour and environmental compliance costs. Conversely, refinement of other metals such as nickel, for which Indonesia already has considerable smelting capacity, already offers higher added-value margins; for aluminium, refining and smelting add 94% of the final value. To reap such gains would require significant investment in smelters as well as huge upgrades to supporting infrastructure.
Coal miners were not immune to the new mining law. At the end of 2014, the industry was hit with a major royalty hike intended to help the government meet the revised 2015 state budget’s non-tax mineral revenue target of Rp31.7trn ($2.62bn). The move was deemed necessary to compensate for the 28.9% increase in the non-tax mineral revenue target from the previous budget due to a reduced oil and gas non-tax revenue target, which includes a sharp reduction of 63.7% in oil and gas non-tax revenue, amounting to Rp81.4trn ($6.72bn) itself due to other reductions in the oil price assumption (to $60 per barrel) and the oil-lifting target (to 825,000 barrels per day).
Under the proposed royalty rise, which affects holders of IUPs coal with a calorific content between 5100 kilocalories per kilogram (kcal/kg) and 6100 kcal/kg will see a 9% royalty fee, up from 5% at present. Coal with more than 6100 kcal/kg calorific content will be charged a 13.5% royalty fee, up from 7%. Although the royalty hike was first proposed under the previous presidency, implementation was initially delayed due to low coal prices and was then scheduled to be implemented by the first quarter of 2015, although as of April 2015 no official policy change had been announced by the Indonesian government.
Digging Deep
After the regulations came into effect in 2014, production and exports of ore and other materials fell substantially. Although coal exports, which are not subject to the same export restrictions, have disguised the impact of the restrictions because of their dominance in the export market, shipments of valuable minerals such as copper, gold, bauxite, nickel, tin, and others slowed dramatically in 2014.
After loading up the last shipments of ore in the first two weeks of January, mineral production has been curtailed and the output stockpiled for future export or processing as Indonesian smelting capabilities currently remain inadequate for processing the majority of raw minerals available. Copper exports, for instance, fell to 714,000 tonnes in 2014 – or less than half the average of 1.62m tonnes for the 2010-13 period – after shipments were restricted for the first six months of the year, according to Bank Indonesia (BI) data. Bauxite showed an even greater drop-off, to just 2.08m tonnes shipped in 2014 (all of it in January), compared to an annual average of 37.73m tonnes over the previous four years, while nickel exports totalled 4.28m tonnes in 2014, in contrast to a fouryear average of 41.67m tonnes per annum.
Ripple Effect
The ramifications of this dramatic drop in supply of these commodities on the global market have affected not only the Indonesian economy, but also the economies of import-dependent nations. In 2014 global bauxite production decreased 17% from 2013 levels, mainly due to lower production in Indonesia. This in turn resulted in large importers – namely China – taking measures to secure new supplies and stockpile inputs for its aluminium industry.
In anticipation of the export ban, many refineries in China stockpiled imported bauxite in 2013, which contributed to the surge in Indonesian exports the same year, while bauxite production in China also increased in 2014. Stockpiling by alumina refineries in China contributed heavily to a surge in Indonesian production – to 55.7m tonnes in 2013, from 31.4m tonnes the previous year.
Shortly thereafter imports of bauxite to China from January to August 2014 were 46% lower than in the same period in 2013, while alumina production through August was 5% higher year-on-year (y-o-y).
Production of nickel, for which Indonesia is also one of the world’s primary producers and exporters, also tumbled, from 440,000 tonnes in 2013 to an estimated 240,000 tonnes in 2014, according to a 2015 report from the US Geological Survey. Although Indonesia’s output decline had a minimal impact on global commodity prices due to an oversupplied market in 2014, it directly reduced global production by about 230,000 tonnes.
The reduction of Indonesia’s contribution to the global tin market, like its cutbacks from the nickel market, had a minimal impact on total output, even in spite of it being the second-largest tin producer in 2013, having produced 95,200 tonnes of tin that year. Global tin output actually increased between 2013 and 2014, from 294,000 tonnes to 296,000 tonnes in spite of a decrease in Indonesian output. As a result, prices remained flat throughout the year after temporarily spiking in April on fear of an impending supply shortage that then failed to materialise. With some incountry copper and gold processing capability already online and two producers able to resume operations mid-year, the decrease in production of those two minerals was less pronounced.
On the Home Front
Apart from the smelting requirements, other major policy changes which have yet to show up on the ledger include accelerating divestment requirements for foreign operators as well as curtailing the duration and plot size of mining contracts. This includes a second major policy change affecting the mining sector: bolstering divestment requirements for foreign-owned mining companies in Indonesia through the passage of Government Regulation No.24 (GR24) in February 2012.
Usurping the short-lived GR23 instituted in 2010 which required only a 20% divestment of foreign ownership, GR24 ups this figure all the way to a majority 51% requirement which must be achieved after the 10th year of production from the company.
The process is to be implemented on a sliding scale over a five-year period, starting with a 20% divestment requirement after the sixth year of production and then increasing in each subsequent year, ultimately reaching the required 51%.
With most of Indonesia’s large coal mines already in the hands of local ownership, this regulation primarily impacts the minerals sector. The first right of refusal to take on ownership of these divestments is initially offered to the Indonesian government. If refused, then provincial and regional governments are offered the chance, followed by state-owned or regionally owned enterprises and, finally, privately owned Indonesian companies.
Done Deals
While the sector as a whole remains in flux as mining companies await a decision by the government on future regulation, the state has also patched together deals with two of Indonesia’s largest mining operations to resume exports on a limited scale. Faced with the unappealing alternative of forgoing mining revenue from its 9.84% stake in – and assorted taxes and levies on – the nation’s largest mine, Grasberg, the Indonesian government and operator Freeport-McMoRan negotiated a settlement allowing the resumption of exports in July 2014.
Although the Indonesian government published regulations in January 2014 indicating that holders of contracts-of-work (CoW) permits with existing processing facilities would be permitted to export product through January 2017, the new regulations duly established new requirements for the continued export of copper concentrates, including the imposition of a progressive export duty on copper concentrates. This last caveat contradicted conditions in Freeport Indonesia’s valid CoW, resulting in the company being unable to secure government approval to export concentrates for half of the operation’s capacity in the first half of 2014.
Standoff
The ensuing stalemate resulted in substantial losses for both Freeport and the government. One of the largest copper and gold mines in the world, the Grasberg mine represents a significant source of income for the national and local governments both now and in the future.
Copper output at the mine ranged from 695m pounds in 2010 to 928m pounds in 2013, before being curtailed to 651m pounds in 2014, according to Freeport-McMoRan figures. This was augmented by gold production, which was not affected by the law, which reached 1.13m ounces in 2014, down slightly from 1.14m ounces the year before.
With both sides eager to resolve the impasse and get copper and gold flowing again, the two parties concluded negotiations in July 2014 by entering into a new memorandum of understanding (MoU). The MoU amended terms within the existing CoW including changes to the size of Freeport’s concession area, royalties and taxes, domestic processing and refining, divestment, local content, and continuation of operations after the original CoW is set to expire in 2021. These terms include increased royalties to 4.0% for copper and 3.75% for gold from the previous rates of 3.5% for copper and 1.0% for gold, as well as a commitment to pay export duties as set forth in a new regulation. Also included in the terms of the MoU is a stipulation that Freeport-McMoRan must also develop a new $2.3bn smelter by 2017 and immediately post a $115m “assurance bond” and a sign of its commitment. The government went a step further and has asked the company to build a second $1.5bn smelter by 2020, although this caveat involves separate negotiations which were still ongoing as of April 2015.
As a result of the agreement, which is valid through July 25, 2015, the company was able to resume full exports in August, though both parties continue to negotiate terms of the mine’s long-term future. Some key points of discussion include fair value divestment of Freeport Indonesia’s holdings to the Indonesian government and Indonesian nationals of up to a 30% interest (a rise of 20.64% from current levels) and the need to re-establish legal and fiscal terms after 2021. The latter step is required to ensure the company continues with its large-scale investment programme to develop underground reserves, which are necessary to ensure it continues operations from 2022 through to 2041. As a result of the standoff and negotiations, production at the Grasberg mine for 2014 totalled 664m pounds of copper and 1.13m ounces of gold, down considerably from the 928m pounds of copper and 1.14m ounces of gold produced 2013.
The country’s second major mining operation, Newmont’s Batu Hijau copper mine, was also idled in June 2014 until another bilateral agreement was reached with the government in September. Prior to the MoU deal Newmont declared a force majeure on deliveries from the mine and put 80% of its workforce on leave with reduced salaries. Similar to the arrangement struck with Freeport, the agreement allowing Newmont to resume shipping copper concentrates was also contingent upon reworking many of the provisions within its CoW, which was first established in 1986. As part of the six-month deal, Newmont agreed to pay higher royalties and to certain export duties.
Negotiations are ongoing to bring the two sides closer together on other outstanding issues as well, one of the largest being requirements for in-country smelting and refining and continued export of copper concentrate. Former MEMR minister Jero Wacik laid out the government’s position to the local press in June 2014, stipulating that one of the conditions for Newmont to resume exports was to agree to a written declaration to built a new copper smelter accompanied by a $25m deposit. In the meantime, the government renewed Newmont’s export permit in March 2015 for another six months, through September 2015.
In October 2014, Vale signed a contract amendment with the government that included adjustments to its work area, a royalty rate of 2% (rising to 3% for nickel), divestment of 20% of its shares to Indonesian holders and the option to extend its operating licence for two additional 10-year periods, which are subject to government approval.
In spite of the setbacks that occurred with the midyear mine stoppage, gold production in 2014 at the Batu Hijau mine increased 58%, to 76,000 ounces – up from 48,000 ounces in 2013 – on the strength of higher ore grade and higher recovery. Copper production decreased 3%, to 156m pounds, from 161m pounds the previous year due to lower mill throughput associated with the period of care and maintenance, which was partially offset by higher ore grade and recovery. As of December 31, 2014, Newmont reported 3.15bn attributable pounds of copper reserves and 3.3m attributable ounces of gold reserves.
Firm Foundations
In spite of the recent turmoil surrounding the country’s mining sector, the vast amount of mineral wealth remaining in the country ready to be exploited continues to attract investment from world-class mining companies from around the world. Foreign investment in the country has been on the rise in recent years, primarily from Singapore and Malaysia. After recording $186m in investment for the mining and quarrying sector in 2010, spending ballooned to $452m and $445m in 2011 and 2012, respectively, before spiking to $712m in 2013 and $817m in 2014, according to data from BI.
Boasting some of the largest single copper and gold mines in the world, mining operators have long accepted the challenges of labour strife, protests, regulatory uncertainty and even violent attacks at mining sites as a trade-off for access to the country’s vast mineral deposits. Indonesia produced approximately 504,000 tonnes of copper in 2013, dipping to an estimated 400,000 tonnes in 2014. The country also boasts another 25m tonnes of reserves, easily among the top 10 in the world.
Gold production also shows no sign of slowing down, having increased from 61 tonnes in 2013 to an estimated 65 tonnes in 2014. With reserves of around 3000 tonnes, the country is well placed for continued production well into the future, on par with the US, though it trailed leaders Australia (9800 tonnes), South Africa (6000 tonnes), Russia (5000 tonnes) and Chile (3900 tonnes).
Prior to the export ban, Indonesia was the second-largest producer of bauxite in the world with 55.7m dry tonnes produced in 2013, up from 31.4m tonnes in 2012, according to US Geological Survey data. This placed it behind only Australia and its 81.1m tonnes and well ahead of China, in third place with 46m tonnes, and Brazil with 32.5m tonnes. With reserves of approximately 1bn tonnes remaining, Indonesia still has ample bauxite resources for exploitation – the sixth-largest such deposit in the world – though the new regulations are causing a decline in production.
Tin Trade
Another high-demand industrial metal with a strong Indonesian presence, tin, exhibited a much less precipitous drop-off in 2014 production. Output tailed off to 84,000 tonnes for the year after tallying some 95,200 tonnes the previous year, ranking the country as the second-largest producer in the world, as well as the leading exporter.
Domestic tin reserves are likewise estimated to be the second-largest in the world at 800,000 tonnes, around half of first-place China’s 1.5m tonnes.
Indeed, Indonesia’s strong position in the global tin trade led policymakers to bring some of the market transaction operations for the trading of the commodity onshore through the creation of the Indonesian Tin Market (Inatin) on the Indonesian Commodities and Derivatives Exchange in 2012. By reducing the country’s reliance on foreign trading houses for pricing information, Indonesia hopes to provide competition with the London Metal Exchange, which still remains the largest market for tin options and futures and continues to exert influence on global tin prices.
In 2014 new modifications to rules governing tin exports involved in the Inatin included restricting tin content in solder to a maximum of 99.9% tin, preventing pure tin ingots being sold as solder. The move was made to boost transparency in the sector by ensuring that the correct taxes and fees are applied to tin exports from Indonesia and the Inatin.
The impact of the new regulations had the dual effect of raising tin solder prices, as well as improving tracking of exports from Indonesia.
Outlook
Indonesia’s mining sector looks likely to remain in flux over the next few years as policymakers continue to hash out tough compromises in implementing the country’s evolving mining regulations. In spite of the apparent ban on unprocessed minerals, questions still remain on how strongly the government will hold its ground on the issue, leaving an ad hoc collection of agreements between individual mineral mining companies and the government as the sector’s main regulatory structure until a more permanent solution can be achieved.
Similar questions remain to be resolved in the coal sector, particularly regarding the implementation of new higher royalties, the future of domestic market obligations and value-added processing requirements. These regulatory hurdles are compounded in the coal industry due to the ongoing stagnation of market prices, although projected increases in domestic demand as a result of a bevy of new planned thermal power plants should help alleviate the demand situation over the medium term (see Energy chapter).
Because of these and other issues, mining companies looking to open up new ventures in Indonesia will be forced to consider if it will be economically feasible to do so, as well as whether the government will be able or willing to offer additional incentives.
The market for mineral commodities, however, provides for ample investment opportunities in light of positive economic projections for the Asia-Pacific region, which will likely boost both demand and prices of minerals including iron, copper and zinc, while demand for gold also continues to remain strong.
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