Commodities exchange: A ban on unprocessed ore exports should drive demand for onshore contracts

While attempts since 1999 to establish a dynamic commodity futures market have faced low liquidity and patchy trading, the single most significant stimulus has come from new government restrictions on the export of unprocessed mineral ores since 2013. The Trade Ministry, which oversees the Commodity Futures Trading Regulatory Agency (BAPPEBTI), has sought to build Indonesia’s commodity spot-trading capacity to support a ban on tin traded offshore. Although a full ban on exports of unprocessed ores from January 2014 onwards has been modified, providing exemptions to those planning smelters locally, it should also drive investor demand for onshore commodity contracts. As the market deepens, with new commodity futures contracts planned in the year ahead, onshore contracts are set to become more liquid and the number of active traders more diverse. As Asian platforms develop their own pricing benchmarks for key commodities, Indonesia will therefore be able to leverage its position as a leading producer of key commodities.

Export Bans

A key requirement of the 2009 Mining Law stipulates an increase in the local processing of mineral output and the development of onshore spot trading for such commodities. The first significant step in this direction was enacted in August 2013 when the government required all tin exports to be first traded through an Indonesian commodity exchange. While the policy initially only covers tin ingots, it will be expanded to other products including solder from 2015. In direct challenge to the dominant London Metals Exchange (LME), the tin contracts traded through the Indonesia Commodity and Derivatives Exchange (ICDX) were the only means through which tin could be secured. Although both producers and traders initially expected the ban to be diluted given previous mining policy reversals, the government held steady. “We have the chance to be a price setter for tin,” Trade Minister Gita Wirjawan told Reuters in December 2013. “If the ICDX succeeds in keeping prices up, we can make it the basis for other commodities.” The policy is also aimed at curbing illegal mining, given the requirement of accurate documentation for all ores traded through ICDX, and to improve the transparency of price discovery.

“With tin trading onshore there can now be more transparency in tin prices and in the way tin is traded,” Megain Widjaja, ICDX’s president director, told OBG. “We can also coordinate research into pricing and evaluate the efficiency of Indonesia’s tin mining industry.”

In January 2014 the president signed new rules implementing the ban on exports of other unprocessed ores, requiring minerals like bauxite, nickel, tin, chromium, gold and silver to be fully refined prior to export and those like copper, iron ore, lead and zinc concentrates to be purified or semi-processed. New export taxes were also passed to act as disincentives for semi-processed mineral exports. While the government was required by the 2009 law to enact the ban, it did move to dilute requirements somewhat. Purity requirements of the initial tin export ban were cut, with the minimum lead content raised to 300 parts per million, higher than initially planned. Despite the softening of the export ban, the government has viewed such policies as a blueprint for other commodities, both hard and soft.

Processing Commitments

Temporary exemptions on the total ban on unprocessed ore exports were extended until 2017 for 66 firms with plans to develop smelters locally. Given past policy reversals and excess global smelting capacity however, miners have lagged in developing domestic smelting capacity.

“The market may have taken a complacent stand on the law, taking a chance that it would not be implemented in its original writing,” Jens Nærvig Pedersen of Danske Research wrote in a January 2014 note. With over 4000 firms holding mining licenses, many smaller producers lack the financial capacity to develop their own smelters. Indeed, a 1m-tonne-per-year aluminium smelter requires a roughly $1.5bn investment, a high commitment amidst falling commodity prices in 2014.

Larger miners like Freeport McMoRan and Newmont Mining, which account for 97% of Indonesia’s copper output at the Grasberg and Batu Hijau mines, respectively, process roughly a third of their output through Indonesia’s only copper smelter. Amongst over 100 nickel miners, only Antam and Vale Indonesia process their ore locally. While China refined 565,000 tonnes of nickel in 2013, Indonesia refined only 16,000 of the 271,000 tonnes it produced, according to ICDX.

With larger miners arguing that the production of semi-processed copper concentrate accounts for the majority of value-added in the copper chain, the exemption of unprocessed exports until 2017 favours larger miners with local smelter plans. Smaller producers will be expected to either upgrade their facilities or sell their unprocessed ore to feed larger smelters. Of the 66 firms licensed to continue exporting unprocessed ore, the Energy and Mineral Resources Ministry (EMRM) reported in January 2014 that 25 had almost completed construction of their smelters, 10 were still in construction, 15 had just broken ground and 16 had submitted their environmental impact assessments to government for approval. These smelters are predominantly copper and nickel processing facilities, given Indonesia’s global production lead, while bauxite miners, predominantly Chinese, are developing mines in West Africa as alternatives to Indonesia.

Trading Infrastructure

Mineral refiners have long sold their output through long-term supply contracts with end-users in the region, such as Singapore, Malaysia, China, South Korea, Taiwan and Japan, or through global commodity exchanges in London and New York. Although there are two commodity benchmark exchanges in Asia – Tokyo’s rubber futures and Malaysia’s palm oil futures markets – the vast majority of commodities are traded through Europe and the US. Asian consumers have increasingly established their own trading platforms however, with China launching an iron ore contract through the Dalian Commodity Exchange and a gold contract through the Shanghai Futures Exchange for instance. Since 2009, Indonesia has played host to two competing commodity exchanges: ICDX, founded by 11 gold and palm oil producers, and the older Jakarta Futures Exchange, established in 1999. Starting with gold and palm oil contracts, the two have struggled to attract significant liquidity until the 2013 tin ban (see analysis).

Trading Tins

After an aborted launch on ICDX in 2012, the tin contract of five-tonne lot sizes of 99.9% purity was re-launched in 2013. Volumes have grown significantly, from a low of 795 tonnes in September 2013 to 7440 tonnes in November and 8245 tonnes in December, according to Bloomberg. While this was still lower than the 929,105 tonnes of tin traded through the LME in October 2013, the rapid growth on ICDX reflected the government’s steadfastness in challenging the global benchmark.

Indeed, by December ICDX had attracted 31 tin traders, including 14 buyers and 17 sellers out of a total 47 domestic tin ingot producers. An additional 16 applications that were still under consideration by BAPPEBTI in January 2014.

Pricing Power

While the JFX had planned to launch its own tin contract, the Trade Ministry has maintained that contracts for a commodity would only be licensed through one exchange, in order to establish a single onshore benchmark, and refused to license the JFX contract. “It will be difficult to take a price reference if there are two exchanges or more that trade the same contract,” BAPPEBTI chairman Sutriono Edi told Reuters in December 2013. “ICDX will keep trading tin because it has been successful.” Although 22 tin smelters had backed the JFX contract, they have gradually shifted to trading through ICDX – the Serumpun Tin group of 18 smelters joined ICDX in October 2013 for instance. Global commodity traders are also taking note, with JP Morgan’s application for an ICDX license in late 2013 lending credence to the exchange’s challenge to LME. While ICDX plans to launch tin futures contracts, JFX, for whom gold accounts for an average 60% of trading, will launch new contracts of its own in an effort to drive 50% growth in turnover in 2014. The bourse is adding arabica and robusta coffee bean and rubber contracts from December 2013 and coal, soybeans and new gold futures in 2014 to add to its existing gold and olein contracts. In particular, JFX hopes to leverage Indonesia’s role as the world’s largest thermal coal producer to establish a local benchmark for coal prices. The exchange also plans to grow the share of multilateral trades, between numerous buyers and sellers, from 6.9% in October 2013 to 30% in the next two years in a bid to boost liquidity. ICDX launched a dollar-denominated palm oil contract in late 2013, hoping to create an alternative benchmark to Malaysia’s ringgit-denominated benchmark market. While the initial focus is on tin, coal and palm oil, Indonesia hopes to expand onshore spot trading to other commodities both hard and soft. “Indonesia is one of the major producers of crude palm oil, cacao beans, rubber and coffee beans. So why don’t we set the reference prices using the exchange prices?” Deputy Trade Minister Bayu Krisnamurthi remarked at a commodities conference in November 2013. While Indonesia holds pricing power in commodities like nickel, tin, coal and potentially palm oil, its sway on more common ores like bauxite faces challenges from other producers, particularly in West Africa. While gold and silver are already refined locally, the ban will only affect part of Indonesia’s coal output – that produced under mining business licenses, not contract of work.

Building Benchmarks

Confident that downstream processing capacity will come online soon, authorities hope to build local benchmarks for key commodities in a bid to place a floor under prices that have fallen throughout 2013. Efforts to develop price discovery mechanisms closer to the locus of production and consumption in Asia are part of a broader trend, however.

China alone launched futures contracts in coking and thermal coal, bitumen, iron ore, short-grain rice and eggs in 2013. While the pricing of commodities continues in dollars, the growing role of Asian platforms in global commodity markets reflects the evolution of global trading patterns. “Sooner or later there will be an Asian time-zone price because it's natural, all the consumers are here,” Michael Syn, head of derivatives at Singapore Exchange, told Reuters in December 2013.

Indeed, global exchanges are following suit and driving global integration of commodities markets, following the growth of trading in Asia. In November 2013, the Intercontinental Exchange Group announced its $150m takeover of Singapore Mercantile Exchange, while Hong Kong Exchanges & Clearing bought the LME for $2.2bn in 2012. In addition to this, the Tokyo Commodity Exchange has been engaged in discussions with CME Group since 2013 about the establishment of the first global liquefied natural gas futures market.

Of the utmost importance now will be for fledgling commodity exchanges like ICDX and JFX to create the links necessary to establish a liquid benchmark.

The management of Indonesia’s two exchanges have recognised this and, aside from denominating key contracts in dollars, are engaged in the pursuit of partnerships and linkages with foreign exchanges and traders.