Considered a powerhouse in the realm of mineral production, Indonesia’s mining sector has long served as a key pillar of economic expansion, acting as a significant contributor to GDP by attracting much-needed export dollars, while also creating employment opportunities across the nation’s diverse landscape. However, soft commodity prices, declining demand from China and regulatory changes intended to promote the downstream industry have seen the sector’s contribution decline in recent years. Despite this trend, the country’s substantial mineral and coal reserves remain attractive assets. In order to further monetise these resources and create more viable investment opportunities, policymakers are addressing regulatory shortcomings, and reducing the perceived risk of investing in the country.
KEY INDICATORS: According to official statistics from the central bank, Bank Indonesia, the sector’s GDP contribution declined from 6.14% in 2011 to 4.23% in 2016, while its total contribution to exports has stagnated at 13% since 2014, a drop from 2011, when it accounted for 18% of export revenue. Despite these waning figures, Indonesia remains a major producer of coal, copper, gold, tin and nickel.
In addition, with major investments aimed at increasing mineral processing and refining capacity, coupled with the easing of the export ban on unprocessed minerals (see below), the sector’s overall contribution is set to increase over the long term.
While Indonesia is recognised for its considerable coal and mineral wealth, there has been a slowdown in foreign capital inflows and a lack of greenfield projects in recent years. Sacha Winzenried, energy, utilities and mining leader at PwC Indonesia, told OBG, “The number-one concern for investors is the uncertainty of regulation. The second concern is the lack of coordination between central and regional government.”
Indonesia is still highly attractive in terms of its mineral resources; however, recent regulations have lacked clarity, leading to some firms putting their investment decisions on hold. Winzenried told OBG, “The valuation methodology for foreign divestment requirements needs to be clearer and commercially sensible.”
In addition to a sliding scale for foreign divestment starting at 20% after six years and ending at 51% after 10 years, mining companies have also faced tender delays, uncertainty around the conversion of contracts of work (CoW) into special mining business licences (IUPKs), and higher royalties. Furthermore, all of this has taken place in an era of low commodity prices.
FRAMEWORK: In an effort to balance the interests of investors while also ensuring Indonesians are fairly compensated for the exploitation of national resources, the government adopted the Law on Mineral and Coal Mining No. 4 of 2009. The updated legislation replaced the previous Mining Law No. 11 of 1967, which had served as the legal framework for mining for more than 40 years, including for existing concessions under CoWs. Initially, the new bill, along with its accompanying regulations, was expected to usher in a wave of investments by increasing market certainty. However, a tug of war between mining companies and the government regarding various aspects of mining law over the last eight years has created an ambiguous regulatory environment. Some of the ongoing back-and-forth negotiations relate to divestment rules, domestic processing requirements, and the conversion of CoWs to IUPKs. For the most part, the CoW system, which was established under the 1967 law, has played a key role in the progress of Indonesian mining, and the requirement to have it replaced has created tension in an already uncertain market.
As it stands, the central government, via the Ministry of Energy and Mineral Resources (MEMR), determines which areas can be mined, with regional governments then having the authority to grant licences within allocated zones. While this process was initiated to improve conflicts over land use between various ministries and overlapping concessions, the mapping process has been complex and slow. The government’s One Map initiative is expected to rectify this confusion and solve this problem by clearly demarcating areas to be used for specific purposes, such as forestry, agriculture or mining (see Economy chapter).
While investors face a number of regulatory obstacles, some improvements have been made. Winzenried told OBG, “The Indonesia Investment Coordinating Board has effectively set up a one-stop shop system, which has reduced the running around between departments during the initial investment phase.”
CAPITAL FLOWS: Despite this, total investment in the Indonesian mining sector fell by around 31% from $7.4bn in 2014 to $5.2bn in 2015, according to MEMR figures. Ian Wollff, a geologist and independent consultant in Indonesia, told OBG, “Greenfield exploration has stagnated because of low commodity prices, some difficulties associated with the forestry law and varying levels of ease for land compensation. For many investors, the mining law is not conducive to investment. There is an effective moratorium on issuance of new tenements, as the Law No. 4 of 2009 is yet to implement the new bidding process. Measures are being taken to address these issues, but the process is slow.”
In recent years there has been increasing demand for new mining legislation to replace the 2009 law and to address many of the existing gaps. A draft regulation released in June 2016 suggests that both tax and non-tax incentives will be available for mining business licence (IUP) holders who pursue downstream activities. This is expected to be a more positive method than the export ban was, and should encourage further development. By late 2017 there was no further news regarding when the new law would be introduced, although a revamp of current regulation was expected to be released by the end of the year.
DOWNSTREAM: In an effort to bolster the downstream industry by promoting the development of processing facilities, the government imposed a ban on the export of unprocessed ore in 2014. From January 12 of that year to January 11, 2017 the export of concentrates was only permitted if a mining company was able to meet requirements to build processing facilities while also paying increased export duties. These requirements were updated in January 2017, when the government issued Government Regulation No. 1 of 2017 and Ministerial Regulation (PerMen) No. 5 of 2017, which relaxed the export ban. As such, holders of operations production IUPKs (IUPK-OP) are allowed to export certain approved quantities of unprocessed and semi-processed product for a period of five years, ending in January 2022. During this period the firm must pay export duties and meet minimum domestic processing and refining requirements.
The easing of the embargo has been met with both positive and negative responses. Representatives from Indonesia’s domestic smelting industry were strongly against the end of the ban. Jonatan Handojo, executive director of the Processing and Smelting Companies Association, told international media in January 2017 that the new policy “damages Indonesia’s image” and that it makes it seem as if the country’s “laws and regulations can be changed just like that”. Handojo added that investors that had spent large sums on building processing and smelter facilities believed the ban should have been held in place in order to gain a competitive advantage over other nickel-producing heavyweights, such as the Philippines. He said, “Chinese companies will be most unhappy because they have invested something like $15bn in developing smelters that are already in operation.” However, other industry players believe the relaxation of the ban was necessary to boost export revenue that can then be channelled into downstream development initiatives. Tedy Badrujaman, former CEO of state-controlled mining firm Antam, told local press in March 2017 that revenues in the sector were threatened by the export ban and that the law had prevented growth in certain local economies, such as Kalimantan and Sumatra. The firm resumed exports of 20m tonnes of stockpiled low-grade ore over 2017.
EXPORT RULES: Under the new regulations, nickel and bauxite miners must reserve at least 30% of smelter capacity to process low-grade ore of less than 1.7% nickel content. If the installed capacity cannot absorb a miner’s production, then low-grade ore can be sold abroad. Likewise, bauxite with an aluminium oxide content of at least 42% may also be exported, though the amount that can be sold abroad remains unclear.
While the government’s decision to end the export ban has been met with a combination of criticism and applause, it has also had major repercussions for global minerals companies, with the price of nickel falling 5% to a four-month low on the London Metal Exchange when the new rules were announced.
“Regulatory certainty is important for investment. The initial decision to impose an export ban was based on the noble aim to promote downstream initiatives – which it did to an extent, as some investors came in to develop smelters. The supporting facilities that you need for a smelter are substantial, considering mines are located in areas with minimal infrastructure,” Frederico Gil Sander, lead economist at World Bank Indonesia, told OBG. “Therefore, the recent easing of the ban has made a number of those investors who spent large sums in developing smelters and surrounding facilities somewhat nervous, and this could potentially deter future investors in the mining sector.”
CONTRACTS: Despite continued debates within the private sector over the commercial viability of processing requirements in areas with inadequate infrastructure and the impact of export duties on profitability, the Indonesian government remains committed to enforcing the requirements stipulated under PerMen No. 5 of 2017 and PerMen No. 28 of 2017. Under the former, CoW holders must meet a variety of requirements before being allowed to export approved quantities of processed products. The mining company must first convert its existing CoW into an IUPK-OP by submitting a licence-change application to the MEMR, which will be either approved or rejected within 14 working days. In accordance with amendments made to both PerMens in 2017, a CoW that is converted into an IUPK-OP prior to the expiration of the contract will be changed to a IUPK for the remainder of the initial CoW agreement, and thereafter any further extension will be granted as an IUPK-OP.
In the first half of 2017 a number of CoWs were still under renegotiation. “The successful renegotiation for CoWs is very important,” Winzenried told OBG. “One of the most significant risks to the mining sector is the continuation of mines which are nearing their expiry date. A vast majority of activity is still under CoWs. Failure to address investor concerns could have a dramatic impact on the total contribution of mining to GDP and the sector’s long-term development.”
MARKET TRENDS: Softening demand from China also played a key role in the decline of coal prices, which fell by roughly 15% per annum between 2012 and mid-2016. Following a sharp decline in output from the Asian giant in the second half of 2016 after the Chinese government imposed a 276-day annual production limit – down from 330 days – coal passed the $100-per-tonne mark at the end of the year. However, according to a May 2017 report from international advisory firm PwC, the high price in late 2016 was unsustainable. This forecast proved to be correct, as the easing of the 276-day rule in China saw coal fall to around $80 per tonne by the second quarter of 2017. Indonesia’s coal-centric 35-GW power development programme (see Energy chapter), as well as increasing demand from India, should drive coal mining initiatives and support prices over the medium term.
Furthermore, in line with the 35-GW plan, 60% of which is expected to come from coal, the Indonesian government set a thermal coal production target of 419m tonnes in 2016. Due to significant thermal coal price increases in the latter half of 2016, this target was surpassed, with total output estimated at 434m tonnes for the year. In addition, coal supplied to the domestic market amounted to 91m tonnes on the back of growing demand, up from 80m tonnes in 2015. At the start of 2017 Indonesia was expected to produce approximately 489m tonnes by the end of the year Considering market dynamics and increased local consumption, the coal mining segment holds significant potential and is arguably Indonesia’s best mineral asset. “Indonesia has improved its coal mining capabilities. In the past, the wet season was a low-production period due to technical issues and infrastructure limitations; however, these shortcomings have been improved,” Wollff told OBG. “More competition for offshore barge loading and cheap freight forwarding conditions bode well for the coal industry.”
TIN: China’s decision to escalate major infrastructure projects was key in the uptick of certain base mineral prices in 2016, which continued into the first quarter of 2017. Likewise, government intervention in both China and Indonesia to combat environmental and illegal mining issues within the tin industry has seen the global supply drop significantly. The state clampdown saw the closure of major mines in China, while Indonesia – the world’s top exporter of tin – has taken significant steps to block illegal mining and prevent reserve depletion by employing export caps. According to PwC’s 2017 report, Indonesia’s tin production fell by 63% in 2016. As a result, prices increased by 29% between the second and fourth quarter of 2016, hitting a high of $9.95 per pound in the last quarter of the year, up from a low of $7.70 in the second quarter.
NICKEL: Likewise, nickel prices throughout 2016 were affected by government intervention that led to a reduction in supply, resulting from Indonesia’s restriction on the export of unprocessed ore, as well as the Philippines’ decision to suspend activity at 23 nickel mines after an environmental audit. These measures saw the price of nickel rise by 34.6% between the second and fourth quarters of 2016, hitting a high of $5.32 per pound in the last quarter of the year, up from a low of $3.95 in the second quarter.
In early 2017 the price of nickel came under major pressure, a trend which is likely to continue through the better part of 2018. With its value falling by around 9% in the first few months of 2017, nickel was the lowest-performing metal in the opening quarter of that year. The dramatic boost in supply was the result of policy U-turns in both Indonesia and the Philippines. The former relaxed the export ban on unprocessed ores in January 2017, releasing stockpiles into the market, while the latter replaced the head of the its Department of Environment and Natural Resources, which led to the reversal of a number of mine suspensions. As a result, US finance company Goldman Sachs expects global nickel oversupply to reach 37,000 tonnes by the end 2017 and 100,000 tonnes in 2018. Given these figures, nickel prices will struggle to surpass $9000 per tonne, with the price possibly falling to $8000 per tonne on the back of lower Chinese demand.
COPPER & GOLD: Copper prices, however, reached a 21-month high of $6204 per tonne in the first quarter of 2017, after concerns over the global supply for the metal were escalated by a strike at BHP Billiton’s Escondida mine, the world’s largest active copper mine in Chile. Meanwhile, on the home front, continued negotiations between US-based Freeport-McMoRan’s and the Indonesian government have slowed output at the Grasberg mine in the eastern province of Papua. While the strike in Chile ended in late March 2017, a resolution over Grasberg was still unclear at the time of publishing. It is expected that the requirement for copper producers in Indonesia to convert their CoWs into IUPK-OPs will continue to negatively affect production and export numbers for the remainder of 2017.
Improved price conditions were also at work in gold mining, with overall production, up 20% in 2016 on the back of improved price conditions fuelled by an uncertain global political landscape.
GRASBERG: The most notable ongoing negotiations concerns Grasberg mine, the world’s second-biggest copper deposit, currently under the management of Freeport-McMoRan. In January 2017 the government imposed an export ban on the mine that lasted four months, and was lifted only when Freeport threatened to suspend development works at Grasberg. After lengthy talks, it appeared both the Indonesian authorities and Freeport were nearing a solution in the second quarter of 2017. “We have work to do, issues to discuss, but we’re going into this with goodwill and optimism about reaching a win-win situation,” Richard Adkerson, CEO and vice-chairman of Freeport-McMoRan, told media after a meeting with Ignasius Jonan, the minister of energy and mineral resources. Negotiations were centred on new taxes and royalties from which the operator had previously been exempt. In August 2017 the company tentatively agreed to transfer a 51% share to Jakarta amid the months-long worker strike, instead of 30% as set out in the initial arrangement.
A successful negotiation process is critical for both the operator and the government. According to a May 2017 report in the Financial Times, the mine produced more than 453,600 tonnes of copper in 2016, approximately 3% of global supply. Grasberg has also been a significant employer in the region, though it reduced staffing by 10% during the negotiation phase.
In addition to supporting employment numbers, the company estimated that the government will receive more than $40bn in taxes, royalties and dividends from the mine between 2017 and 2041, assuming an agreement can be reached. In order for this to happen, the company will need key legal and fiscal safeguards contained in its initial CoW to be included in the new licence. To allow some time to negotiate, the government extended a six-month export licence to Freeport-McMoRan ending in October 2017.
DIVESTMENT: Broadly speaking, amendments for divestment requirements are vague and can lead to multiple interpretations. Under the original CoW framework, a foreign entity was allowed to hold a 100% stake in a mining venture, which was then subject to divestment requirements at a later stage. Under Government Regulation No. 77 of 2014, the foreign ownership share of a mining company that has been awarded an IUP or IUPK must be reduced after five years, with the reduction based on the type of licence.
Maximum foreign ownership under these conditions is: 75% for exploration IUPs or IUPKs after five years; 49% for operating licences that do not including processing or refining activities, such IUPK-OPs, over the same period; 60% for an IUP operating licence (IUP-OP) or an IUPK-OP which includes a requirement to process or refine products; and 70% for an IUP-OP for underground mining, again after five years. However, after the introduction of Government Regulation No. 1 of 2017, these rates are no longer applicable and divestment is required to take place on a sliding scale: 20% at the beginning of the sixth year; 30% from the seventh year; 37% for the eighth year; 44% in the ninth year; and 51% by the 10th year. This leaves the foreign company with a minority share of 49% after 10 years.
With regards to the divestment of shares, previously the foreign entity could offer shares to central and regional governments simultaneously. Now, following the introduction of Government Regulation No. 9 of 2017, the central government is given priority, followed by the regional government and then state-owned or regionally owned entities. Any remaining shares may then be offered to private players by way of auction.
FINANCE: On the back of an uptick in commodity prices, financing options from local banks to mining companies have improved, with a noticeable increase in appetite among finance firms involved in the development of coal mines. According to local media reports, a number of Indonesian banks are set to raise lending to the mining sector to a total of 9% of their loan books for the remainder of 2017, a more than six-percentage-point increase on 2016, when banks averaged 2.86%. According to data from the Financial Services Authority, non-performing loans from the mining industry reached a high of 7.4% in November 2016, compared to less than 1% during commodity price highs in 2012. Given a major rise in local coal consumption, backed by government power production initiatives, banks are confident in the ability of the sector to perform well.
While the increased lending exposure for mining may indicate a positive outlook, some banks are taking a less aggressive approach. In February 2017 Achmad Baiquni, president director of Bank Negara Indonesia, told Reuters, “We are more selective towards companies, not necessarily the sector. If one is in coal mining, but its contract has good long-term prospects, we can give a loan. But so far our exposure has been limited.” However, Bank Mandiri, Indonesia’s biggest lender, has a different stance, with 6% of its Rp434.8trn ($32.8bn) unconsolidated outstanding loans attributable to the mining sector in the third quarter of 2016.
Although banks have expanded funding options, operators still have to contend with varying royalty rates. As it stands, all IUP/IUPK holders are required to pay production royalties that change according to the scale, production level and the commodity mined. Holders of an IUPK are required to pay an additional royalty of 10% of their net profit.
According to PwC’s 2017 “Mining in Indonesia: Investment and Taxation Guide”, royalty rates are as follows: 3-7% for open-pit coal; 2-6% for underground coal; 4-5% for nickel; 3% for zinc, tin and iron; 3.75% for gold, silver, iron sand and bauxite; and 4% for copper.
OUTLOOK: Regulatory uncertainties coupled with the current fiscal regime will continue to create a challenging investment climate, particularly in a low commodity price environment. In addition, limited capital spending from mining companies will persist until commodities fully rebound. Indonesia has a significant opportunity to adjust its regulatory regime prior to the next cyclical upturn, and thus be a more attractive investment proposition for global mining firms. The ability of policymakers to establish a competitive investment framework will decide long-term development. Likewise, a new mining policy that provides a mixture of incentives while encouraging long-term development of downstream industries is critical. Fewer exploration hurdles, clarified divestment rules, improved coordination between central and regional governments, and a simplified permitting process will stimulate investment once commodity prices recover.
Over the near to medium term, revenue generated from tin and copper will continue to slow in line with efforts to combat illegal tin mining and moves by large copper producers to convert their CoWs into IUPK-OPs. The production and demand for coal will continue to reach new heights, given a significant boost by the coal-centric 35-GW power initiative, while new nickel smelters coming on-line should also increase nickel ore output. Processed nickel and bauxite are also expected to bolster mining’s contribution to GDP. Outside of Indonesia, Chinese demand will continue to strongly influence global bulk and base metal prices. Filling the demand gap left by China as its growth slows will be a priority not only for Indonesia but most mining nations.
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