Indonesian regulation responds to challenging commodity environment

Commodities exports are an important part of the Indonesian economy, and the country has been negatively affected by a slump in global prices, with export receipts contracting significantly since 2012. Although much of this is due to weakening demand in China, Europe and the US, the recent introduction of several protectionist policies – including restrictions on raw iron ore, nickel and copper concentrate exports – has also played a role. While these policies will help boost value-added production and support long-term industrial growth, they come at a time when global commodities prices are gradually recovering from earlier lows, with price gains expected to continue into 2018 on the back of rising Chinese demand.

The government has recognised the risks of lower commodity-export revenue streams to drive macroeconomic growth, and it rolled back some restrictions on nickel and copper exports during the first half of 2017. However, a recent dispute with US mining giant Freeport-McMoRan showed that while promotion of domestic industrialisation is a government priority, it is a potential liability for foreign mining investors.

Authorities need to decide whether to capitalise on the export of raw materials in the short term, or to continue with protectionist policies to support long-term industrial growth, which some industry officials believe could dampen commodity export revenues, employment and investor confidence.

COMMODITY RECOVERY: Global commodities prices have dropped significantly since their peak in 2011, although the World Bank reported in March 2017 that import and export activity from Indonesia’s major commodities – crude palm oil (CPO), oil and gas, rubber, coal and base metals – has pushed the country into an environment with positive terms of trade since July 2016, with prices forecast to continue climbing into 2017. Coal prices rose by 86% in 2016, palm oil prices increased by 20% over the same period, and metals prices are forecast to rise by 11% in 2017.

According to the Ministry of Trade, palm oil per tonne prices, which are set by the government, fell from $688 in January 2015 to a low of $566 in January 2016. Prices improved throughout 2016, however, reaching $805.75 in February 2017.

Base metal prices have also experienced fluctuations, with global iron ore prices rising from around $55 per tonne in October 2016 to reach nearly $90 in mid-March 2017, before falling again to around $65 per tonne in July. Nickel prices rose from $7600 per tonne in February 2016 to hit a high of $11,128 in late 2016, before moderating to around $9155 per tonne in May 2017. This came after the Philippines, which supplies 10% of the world’s nickel, rescinded the cancellation of several major nickel mining licences.

COPPER PRICE GAINS: Despite fewer unscheduled production losses, copper prices rose in 2016. HSBC attributed this to tax incentives for small cars in China, which led to an increase in Chinese auto sales during the year. Rising electrical grid and industrial investment demand, as well as growth in the consumer and transportation sectors, is supporting price gains, with HSBC upgrading its 2017 estimate for Chinese demand-driven growth to 2.7%, up from 1.7%. The International Copper Study Group forecast mine supply growth to drop from 4% in 2016 to 0% in 2017, further supporting a price recovery. Prices on the London Metal Exchange have also risen from around $4300 per tonne in January 2016 to $5900 in mid-2017.

GROWTH SUPPORT: A gradual recovery in global commodities prices supported macroeconomic growth in the first quarter of 2017, with Statistics Indonesia (BPS) reporting that GDP grew by 5.01% year-on-year (y-o-y) in the first two quarters of 2017, up from 4.94% in the fourth quarter in 2016.

Goods and services exports increased by over 8% during the first quarter of 2017, largely attributed to rising agricultural prices. Growth continued into the second quarter: BPS figures show total export receipts rose by 18.6% y-o-y between January and April 2017 to reach $53.9bn. This was driven by a 13.9% increase in oil and gas export revenues, which hit $4.7bn, and a 19.1% rise in non-oil and gas exports, which was $49bn. According to BPS, price recovery in primary exports – including palm oil and coal – boosted GDP growth to 5.02% in 2016, up from 4.88% in 2015.

PROTECTIONIST POLICIES: Although the country is benefiting from a gradual improvement in commodities prices, protectionist policies to improve value-added processing and reduce raw exports have affected economic growth. While commodities accounted for 60% of all exports in 2012, this figure fell to around 40% in 2017. They comprise just 6% of GDP, half as much as in 2012, which analysts attribute to trade restrictions, along with declining crude oil and gas output, with figures in early 2017 declining to their lowest levels since the early 1970s. Stricter environmental rules and other policies – which include import tariffs, more stringent visa requirements for foreign workers and a restriction on many raw exports – have affected investment in commodities production.

PALM OIL: Indonesia is the world’s top producer of palm oil, while animal and fat oil, including palm oil, was the largest single export category between January and August 2017 with $15.23bn of exports, or 15% of total export receipts. Palm oil alone accounts for roughly 10% of total exports. Production has risen significantly in recent years: according to the Indonesian Palm Oil Association (GAPKI), production rose from 19.2m tonnes in 2008 to reach 23.5m tonnes in 2011, before increasing again to 31.5m tonnes in 2016.

Exports have also risen from 15.1m tonnes in 2008 to 25.1m in 2016. However, falling global palm oil prices have constrained the sector, with export revenues falling from a nine-year high of $21.6bn in 2012 to $16.5bn in 2015. Palm oil production and exports both declined in 2016, although export revenues rose to $17.8bn on the back of an increase in palm oil prices.

CPO TAXES: Rising prices could adversely affect CPO exports, however, and in January 2017 the government announced it had set its CPO export tax for February at $18 per tonne, up from $3 per tonne in the previous month. The sharp increase was due to a rise in CPO prices, which had surpassed $800 per tonne – a threshold mandating higher export taxes. This rise is designed to encourage planters to increase domestic sales, reducing the need for palm oil exports and supporting domestic biodiesel production.

The Vegetable Oil Industry Association said that exporters already pay a $50 per tonne levy on CPO exports, with the latest tax increase expected to dampen export growth and damage the country’s competitiveness. The export taxes have also been criticised by US biodiesel lobby groups during an investigation into biofuel dumping in the US market, launched in May 2017. Nonetheless, some industry officials believe the tax will have only a limited impact on CPO exports due to supply disruptions in Malaysia, which have dampened the global production outlook.

ORE EXPORT BAN: In January 2014 the Indonesian government announced that it would halt the export of mineral ore products to encourage the construction of local smelters and the development of a domestic smelting industry. Former President Susilo Bambang Yudhoyono implemented the ban, which prohibited raw ore exports and only permitted the shipment of processed or refined minerals if they met specific purity requirements. Authorities later clarified that although the ban would cut nickel supplies, copper concentrate exports would not be affected.

The Philippines replaced Indonesia as the world’s top nickel producer in 2014, and the country lost around $2bn in monthly raw mineral export revenues. The crackdown also influenced two major foreign resource companies – Newmont Mining and BHP Billiton – to exit the country in 2016 (see Mining chapter).

An abrupt policy shift came in January 2017 when Indonesia rolled out new rules permitting nickel ore and bauxite concentrate exports under certain conditions. The decision was partially attributed to revenue shortfalls, with the government missing its 2016 revenue target by $17.6bn. New rules include changes to mining permit extensions, although nickel miners must also dedicate at least 30% of their smelter capacity to processing low-grade ore. Bauxite with aluminium oxide content of at least 42% is also now permitted for export, with industry officials predicting the country could export up to 15m tonnes of nickel ore in 2017, representing 25% of 2013 production levels.

COPPER REGULATIONS: The copper industry was more deeply affected by protectionist policies in 2017. Although it moved to relax raw ore export restrictions for nickel and bauxite in January 2017, the government simultaneously introduced new rules restricting copper concentrate exports, again with the aim of supporting the domestic smelting industry.

Under the regulations, mining companies such as Freeport-McMoRan, which owns the world’s second-largest copper mine in Grasberg on Papua, can continue exporting semi-processed ores and concentrates, provided the company obtains special mining permits in place of the current “contracts of work”. The changes would force companies to pay higher taxes and royalties, divest a 51% stake in operations to the government and relinquish arbitration rights.

OPERATIONS: Freeport described the conditions as a form of expropriation, announcing in February 2017 that it had begun to send its Grasberg workers home, subsequently slashing output by 70m pounds of copper each month. The announcement came during a stoppage at the world’s largest copper mine, located in Chile, pushing copper prices to a 20-month high in mid-February. A concurrent strike at Freeport’s sole domestic copper concentrate offtaker, PT Smelting, significantly constrained its output options.

By April 2017 the company reported it lost an estimated $1bn in revenues since copper concentrate exports had been halted, with 10% of its 32,000-person domestic workforce “demobilised”. After a 15-week stoppage, Freeport reached a temporary deal to resume exports. However, labour unrest at the Grasberg site – stemming from Freeport’s announcement that it could cut another 5000 jobs to stem losses – prevented the facility from returning to full operations. The strike continued into mid-2017, highlighting the challenges facing the Indonesian government as it seeks to make long-term investments in industrialisation while avoiding near-term losses of revenues, employment and investor confidence.