Digging in: With a wealth of mineral resources the sector has much potential

Long a stalwart of Indonesia’s economic development, particularly in terms of exports, the country’s mining and quarrying industry maintains a steady presence despite fluctuations in both global commodity prices and domestic mining policies. Claiming some of the world’s most expansive reserves of valuable minerals and largest operational mines, the sector has seen some of the highest levels of investment of any industry in Indonesia’s economy in recent years.

RICH IN RESOURCES: According to the Ministry of Energy and Mineral Resources (MEMR), Indonesia’s total metallic mineral resources include 6060 tonnes of primary gold, 140 tonnes of alluvial gold, 825,480 tonnes of silver, 223.7m tonnes of bauxite, 13,030 tonnes of platinum, 1.4m tonnes of cobalt, 6m tonnes of manganese, 211,500 tonnes of molybdenum, 32.7m tonnes of nickel, 962.3m tonnes of iron (including sediment, laterite, primary and sand), 82.5m tonnes of copper and 2.06m tonnes of tin.

The country remains a premier destination for investment, attracting mining majors from across the globe, particularly with the copper, gold, tin and nickel commodities as well as thermal coal. In addition to hosting numerous international players, Indonesia has also developed a formidable complement of homegrown mining companies led by Aneka Tambang (Antam). The company, which is 65% held by the Indonesian government with the remainder floated on the Indonesian and Australian stock markets, posted net sales of Rp10.35trn ($1.03bn) in 2011, up 18% on the previous year, according to company reports. Antam’s unaudited net sales reached Rp7.1trn ($710m) in the first nine months of 2012. In 2011 the diversified, vertically integrated company derived 36% of net sales from ferronickel, followed by gold with 35% and nickel at 24% along with smaller contributions from silver (3%), coal and bauxite (1%) and precious metals refining (1%). However, unaudited results from the first nine months of 2012 showed gold moving to first with 35% and ferronickel falling back to 30%.

Sustained levels of high demand and subsequent buoyant international commodity prices have so far outweighed investor misgivings over the many uncertainties surrounding the implementation of the country’s 2009 mining law, specifically regarding a bevy of critical issues such as divestments of capital for foreign mining licence holders, processing requirements and domestic market obligations. But even as investment continues to flow into the sector, a variety of factors have conspired to reduce production of nearly all minerals in 2011, with the exception of coal.

DOING THE MATHS: Non-oil and gas mining contributed Rp393.76trn ($39.37bn) to the country’s GDP in 2011, with the quarrying sector kicking in an additional Rp109.21trn ($10.92bn), according to preliminary figures from the Indonesian Central Statistics Agency. These two sectors account for approximately 6.77% of the country’s total 2011 GDP of $846.8bn. These figures represent significant increases, with the non-oil and gas mining segment growing 18.26% over the Rp332.97trn ($33.29bn) recorded in 2010 and a more than 500% jump from the Rp65.12trn ($6.51bn) in 2004. Royalty rates for mineral sales range from 2. 5-5%, while coal royalties range from 2-6% for underground operations and 3-7% for open pit mines.

Although still relatively small, the mining and quarrying sector has also been expanding in its role within the national economy as the mining sector has nearly doubled its percentage of GDP contribution since 2004 from a 2.8% share to 5.3% in 2011, while quarrying has expanded from 0.9% to 1.5% over the same time period. Government revenues derived from the mining sector have also seen a marked increase in recent years, with 2011 accounting for the highest windfall to date at Rp79.7trn ($7.97bn) – Rp55trn ($5.5bn) in tax revenue and Rp24.7trn ($2.47bn) in non-tax – collected in the year, according to data from the MEMR. These figures have grown each year since 2007, rising from Rp38trn ($3.8bn) to Rp47.9trn ($4.79bn), Rp51.4trn ($5.14bn) and finally Rp66.9trn ($6.69bn) in 2010.

LAW OF THE LAND: Three years after the unveiling of the new comprehensive Law on Mineral and Coal Mining No. 4/2009, which replaced the Mining Law No. 11/1967, the jury is still out as to the impact of the sweeping legislation on the sector. The new law represented a significant departure from the past in terms of the structure of contract between the government and private mining companies as the state continues to wrestle with balancing the profits of its lucrative mineral wealth between private investors and national benefit. Prior to 2009 two separate contractual systems operated for Indonesian and foreign licence holders. The former was governed through a mining rights, or kuasa pertambangan (KP), while the latter utilised a CoW and Coal CoW system.

SINGULAR SCHEME: The new system consolidated all contracts into a singular scheme for all mining outfits under the new mining business licence (IUP). In addition to the IUP general licence, the government may also issue special mining permits (IUPK) for conducting mining activities in specific areas and People’s Mining Licence (IPR) for smaller operations available only to Indonesian investors. Although existing CoW and potential extensions remain valid, new entrants to the market are now faced with much more limited options in terms of both scale and contract duration.

Exploration IUP contract lengths for rocks, non-metallic minerals, metallic minerals and coal are limited to three, three, eight and seven years, respectively, while production IUPs can range up to five, 10, 20 and 20 years. Rock and non-metallic mineral agreements may also be extended twice for a period of five years each, while coal and metallic mineral contracts may be extended twice for 10 years. In terms of concession size, coal exploration IUPs can range in size from 5000 to 50,000 ha, to be reduced to a maximum of 25,000 ha after three years, while production IUPs are limited to 15,000 ha. Metallic mineral exploration areas are also restricted to between 5000 ha and 100,000 ha (to be reduced to a maximum of 50,000 ha after three years) with a production area no larger than 25,000 ha. Non-metallic minerals encompass the widest possible range of size at 100-25,000 ha (reduced to 12,500 ha after two years), while the production areas max out at 5000 ha.

LEGAL LIMBO: Since the inception of the mining law, the government has made noticeable efforts to retain more of the benefits of country’s mineral wealth through a series of measures intended to bolster the state’s position in the sector. These include the imposition of minimum domestic market sales obligations, benchmark pricing framework for coal and mineral exports to set a minimum price for commodity transactions and discussions on an export ban on low-rank coal possessing with a calorific value of less than 5700 kcal.

The two big changes to hit the sector in 2012 include restrictions on the exportation of raw mineral material, which would require most minerals to be processed domestically by 2014 as well as increasing divestment requirements for IUP interests held by foreign investors from the current level of 20% to 51% upon reaching the end of the 10th year of production (see analysis).

The most recent change to divestment requirements is the latest in a slew of changes since 2009. Under the old CoW system, which was originally devised with the coal industry in mind, a 51% majority divestment was required. For other mineral projects, divestment requirements were written into some CoWs, depending on the generation of the contract.

The inception of the IUP system under the 2009 mining law essentially combined the old CoWs and KPs under one roof. Policymakers took a middle of the road approach by imposing a 20% divestment requirement. Shortly thereafter, popular support in parliament amended this regulation to its current state in an effort to boost divestment requirements of all mining operations to 51%. The result of this carousel of regulatory changes and alterations has meant a continuous state of uncertainty among investors as well as the lenders who are critical to financing new projects.

“All these sudden changes in the mining sector might be good for the country, but they are certainly not good for the investment climate,” Nischal Jain, the chairman of Apple Coal, told OBG. “Very often, these laws or regulations are announced prematurely and without any sort of debate with the industry players.”

Another long-running thorn in the side of investors is the decentralisation of the permit process to the local level, which lacks national uniformity in tendering, qualification and licensing procedures. This often leads to concession overlap, multiple industrial-use permits for the same territory and other uncertainties.

DOWN THE RANKS: The cumulative effect of these legislative vagaries has resulted in an exceptionally poor rating for Indonesia in the Fraser Institute’s “Survey of Mining Companies 2011/12”. After polling more than 5000 executives at exploration, development and mining consulting companies (802 of which responded) on 16 policy areas such as taxation, regulation, and land claims, the Canada-based institute formulated a composite policy potential index ranking each country on a scale of 0-100. Of the 93 jurisdictions included, Indonesia ranked 85th, between Vietnam and Ecuador. This marks the fourth consecutive year Indonesia languished in the bottom 10 after scoring 70 out of 79 in 2010/11, and 62 out of 72, and 62 out of 71 in years prior. More worrying is the downward trajectory of the country’s cumulative index score, which has declined over the past four years from 25.1 to 24.7 to 22.5 and finally bottoming out at 13.5 in 2011/12.

TACKLING AMBIGUITY: With these uncertainties in mind, most of Indonesia’s premier foreign-held mining operations have already come to the bargaining table with the government to renegotiate the terms of their existing CoW deals before they expire. Large internationals including Freeport Indonesia, Newmont Nusa Tenggara (PTNNT) and Vale Indonesia are all in the process of renegotiation; however, in early January 2013 The Jakarta Post reported that only two out of 97 outstanding contracts had been squared away. Thamrin Sihite, the director-general for coal and mining affairs at MEMR, told the paper that the government was hoping to get all contracts wrapped up before the end of 2013, adding, “As for the adjustment of working areas, the government is willing to grant the firms’ wishes as long as they provide guarantees of long-term planning for their operations here.”

In October 2012, Nicolaas Kanter, the president director of Brazilian miner Vale, told The Jakarta Post that the firm was still discussing the working area adjustment, and that royalty payments were expected to increase gradually over the next five years, with the firm planning to spend as much as $2bn on smelter expansion. Meanwhile, Freeport has said it needs “assurance” regarding its contract extension, as the firm wants to invest around $17bn for the period from 2012-41.

With decades of valid extensions left (Vale’s contract is set to expire in 2025, while Freeport’s final extension would take the contract through the year 2041), there are numerous issues and concessions to be discussed by both sides. The most important issues being future royalty rates, concession sizes, length of contracts and divestment requirements. While any renegotiation will likely include significant horse-trading for both parties, it is unclear how any agreed upon concessions would be affected by the newly enforced regulatory scheme and if exceptions could be imposed.

RISKY BUSINESS: In addition to the fluid nature of regulation in the country, another challenge facing mining outfits is local opposition to mining operations. While opinions as to the root cause of unrest vary, the result is another level of uncertainty and risk that must be taken into account for any venture. In just the past year numerous protests have caused significant and costly production delays for a handful of operations.

The most high-profile of these occurred from September through December in 2011 at Freeport Indonesia’s Grasberg mine that forced a shutdown late in the year and resulted in production decrease from 284m pounds of copper in the first quarter of 2011 to 123m pounds in in the first quarter of 2012, according to the company. Gold output was similarly affected, plummeting to 229,000 ounces in the first quarter of 2012 compared to 441,000 ounces in the same period of 2011.

These lower production rates resulted directly in a loss of state revenues to the tune of approximately $6.7m per day as potential daily sales for the company were curtailed by $19m. Other similar incidents occurred in varying degrees over the past year at mines operated by Arc Exploration (Sumbawa), Hillgrove Resources (Sumba), Sihayo Gold (North Sumatra) and G-Resources (North Sumatra).

INVESTMENT: While many firms have expressed misgivings over the profitability of running smelting operations domestically, many appear to be playing along for the moment given the cavalcade of new smelter proposals submitted to MEMR in the wake of MEMR No 7/2012. Since the issuance of this regulation in February 2012, some 154 companies had tendered proposals to construct new smelters as of September 2012, compared to just 24 companies prior.

If each of these proposals were fully realised, this would represent a more than 25-fold increase over the current seven processing and refining facilities in operation around the country. The likelihood of all these multibillion-dollar investments coming to fruition is much less certain, of course, both in terms of the current legislation remaining unchanged as well as the financing capacity of the parent companies.

That being said, investment remained strong in 2012. In fact, mining led all industries in the third quarter of 2012 in attracting more than $3.2bn in foreign direct investment (FDI), which accounted for 17.3% of total FDI, according to the Investment Coordinating Board.

TIN: After peaking in 2005 at more than 137,600 tonnes of tin produced, Indonesian output has fallen off in recent years as global demand and market prices have curtailed to just under 96,000 tonnes by 2010. The cumulative tonnage in the 10 months ending in October 2012 is 82,181 tonnes, according to UK-based industry association the International Tin Research Institute, up by 4.5% compared to the previous year.

Sales of the product plummeted in August 2012 as 24 of the 28 smelters located in the Bangka-Belitung province (roughly 70% of the nation’s smelting capacity) ceased production in response to freefalling prices for the commodity in July. The strategy paid off in short order as prices rebounded strongly in response to the supply constriction, with London tin futures increasing 17% from July lows by November. But while the price of tin trading on the London Metal Exchange has gained about 8% on the year, the $20,738 per tonne the commodity sold at in November is still a far cry from the $33,000 a tonne set in April 2011. According to Hidayat Arsani, the chairperson of the Tin Mining Association of Indonesia, the industry would like to see a price range of $21,000-22,000 per tonne.

The late-year rally could help soothe the stagnating export market, which has experienced a 27.62% year-on-year dip in exports through the first eight months of 2012 as the shipments have declined in value from $1.87bn from January to August of 2011 to $1.35bn in 2012. This downturn comes on the heels of a strong five-year period of growth in which the value of tin exports increased by 17.08% from 2007 to 2011.

REASON FOR OPTIMISM: Despite this trend of slow production erosion, the world’s largest exporter of refined tin (accounting for approximately 40% of the world’s trade) showed strong growth towards the end of 2012 after data from the Indonesian Trade Ministry recorded a month-on-month increase of 12% in October 2012. The 11,048.4 tonnes sold was the highest level of shipments since December 2011 (15,102.8 tonnes) and well above both the previous month’s 9874.5 tonnes and the previous year’s 5441.6 tonnes registered in October 2011. Singapore, Malaysia, Japan, China and South Korea are among the primary importers of Indonesian tin.

State-owned mining behemoth Tambang Timah (Timah) is the king of tin in Indonesia, with the 65% state-owned vertically integrated company churning out 38,132 tonnes of the metal in 2011 compared to 40,413 tonnes the previous year. The decreasing production in recent years has been attributed to a number of factors, including adverse weather conditions and more difficult to extract reserves, while declines in 2012 have been blamed on a reorganisation of the company due to the implementation of new mining regulations. Tin-in-concentrates production through the first three quarters of 2012 fell 14% to 24,357 tonnes compared to the same period in 2011, while refined tin from its two smelting plants in Bangka and Kundur dipped 18% to 23,255 tonnes, according to company statements.

The other major player on the Indonesian tin market, Koba Tin – with 25% held by Timah and 75% by the Malaysian Smelting Corporation – announced in November 2012 it was suspending all mining and smelting operations ahead of the expiration of its Contracts of Work (CoW) in March 2013. Majority owner Malaysian Smelting Corporation cited ongoing losses due to lower commodity prices as well as uncertainties over the contract renewal and changing mining laws as the reason for halting production. The sector is rounded out by dozens of other smaller independent players. The world’s 10th-largest tin producer, for example, produced 6332 tonnes of the commodity in 2011, down slightly from the 6644 tonnes the previous year.

COPPER & GOLD: In 2011 Indonesian gold mining operations produced a total of 104,536 kg of gold, of which 81,196 kg was exported, according to MEMR figures. Copper production amounted to 878,276 tonnes on the year, 612,208 tonnes of which was exported. This represents a significant decrease from production levels just a few years ago, with Indonesia’s Central Bureau of Statistics figures showing 2009 production levels of gold and copper at 127,716 kg and 998,530 tonnes, respectively.

A sparkling example of the scale of Indonesia’s vast mineral wealth, and all the profits and costs associated with it, is embodied in the world’s largest operating copper and gold mine. As of December 31, 2011 Freeport held reserves estimated at 31.6bn pounds of copper, 32.2m ounces of gold, 330.3m ounces of silver and 860,000 pounds of cobalt. Of these, 98% are located at its Grasberg mine located in Papua (with production split 75% from the open pit mine and 25% subterranean). Under the current shareholder structure the parent holding company Freeport-McMoRan holds 90.64% of the venture with the remaining 9.36% held by the Indonesian government. The firm also boasts a processing capacity of roughly 200,000 tonnes per day (tpd), which is set to be expanded to around 240,000 tpd through a five-year, $700m investment.

NEXT IN LINE: The second major gold and copper producer in the country is Newmont Mining Corporation affiliate PTNNT, which operates the Batu Hijau mine. Together the two companies are responsible for the majority of the country’s copper output as well as nearly three-quarters of its gold production. Recent output for both companies, however, has dropped off substantially for a variety of reasons. Annual copper production for Freeport dropped from 2010 levels of 1330m pounds to 882m pounds in 2011, while gold output was curtailed by one-third from 2.1m ounces to 1.4m ounces. As a result, sales tailed off to 846m pounds of copper (compared with 1.2bn pounds in 2010) and 1.3m ounces of gold (compared with 1.8m ounces in 2010), while operating income fell 32% from $4.1bn to $2.8bn. Hurt by lower throughput, grade and recovery, as well as mill downtime, copper production from PTNNT’s Batu Hijau mine also plummeted from some 542m pounds in 2010 to 283m pounds in 2011, while gold output dropped from 737,000 ounces to just 318,000 ounces in the same period.

The long-awaited Martabe mine located in the Batang Toru of the North Sumatra province also produced its first gold and silver ingots in July 2012, marking the first extraction of the project’s estimated reserves of 7.86m ounces of gold and 73.48m ounces of silver. Developed by Hong Kong-based G-Resources Group, which has pumped an estimated $700m into the venture, the mine has an annual production capacity of 250,000 ounces of gold and 2m-3m ounces of silver. The project is operated under a sixth-generation CoW signed in April 1997, encompassing a total area of 1639 sq km.

NICKEL: Indonesia is the world’s largest producer of nickel, with output hitting 7.52m tonnes in 2011, of which 6.39m tonnes was exported, according to data from MEMR. Two nickel operations – state majority-owned Antam and Vale Indonesia (formerly Inco Indonesia) – are responsible for the bulk of domestic production. Vasily Tsarev, the president director of proprietary investment firm Bantry Corporation, told OBG, “There are still vast opportunities in Indonesia’s nickel mining sector. It is estimated that there are approximately 2bn wet tonnes of nickel on Indonesian soil. Although easy to reach, most of the ore is located under Indonesian forests. Therefore, this becomes a challenge.”

RECORD PRODUCTION: Antam achieved record levels of ferronickel production in 2011 with 19,690 tonnes, a 5% increase over the previous year. Nickel ore production also rose 13% over 2010 levels to 7.96m tonnes. The company, which is 65% held by the Indonesian government with the remainder floated on the Indonesian and Australian stock markets, operates three ferronickel smelters in Pomalaa, south-east Sulawesi.

High-grade nickel ore and low-grade nickel ore are procured from two mines in Pomalaa and Tapunopaka in south-east Sulawesi as well as a third mine in Buli, north Maluku. In 2012 the company also invested $1.6bn into a ferronickel project in East Halmahera as well as a new $450m chemical grade aluminium oxide ( alumina) plant in Tayan. Antam also owns a 10% stake in the Weda Bay Nickel project to exploit one of the world’s largest undeveloped nickel deposits located on Halmahera Island. The remaining 90% of the shares are held by special purpose firm Strand Minerals, which is composed of a consortium of international companies that includes the Mitsubishi Corporation (30% share), Pacific Metals Company (3.4%) and Eramet (66%). As of 2011 the combined ore resources for the Weda Bay project were estimated at 7.01m tonnes of nickel ore with the project targeting a top-end capacity of 65,000 tonnes of nickel per annum.

Majority owned by Brazil’s Vale (59.5%) and Japan’s Sumitomo Metal Mining Company (20%) with the outstanding 20.5% publicly held, Vale Indonesia produced 66,900 tonnes of nickel in matte in 2011. This output was down from the previous year’s 75,989 tonnes, which the company attributed to production disruptions from an earthquake and lightening storms in February 2011 as well as a scheduled shutdown of one of its electric furnaces in November. As a result of these production decreases the company’s earnings dipped 24% in 2011 to $333.8m compared to the $437.4m recorded in 2010.

OUTLOOK: Three years into the implementation of the 2009 mining law, investors are still awaiting the promise of regulatory certainty as recent changes on divestment and domestic refining requirements have raised as many questions as they have answers. Due to the changes in the regulatory climate there is scant chance of major international mining companies making any substantial new investments in the Indonesian mining sector in the short term.

Uncertainties regarding legislation, along with the implausibility of the full implementation will likely remain until after Indonesian elections in 2014 as the politically and socially sensitive ramifications of these issues give politicians little incentive to reform policies ahead of a campaign. However, the country’s vast mineral reserves combined with an expected rebound in global demand and commodity prices should help to ensure that the current production downturn proves to be little more than a temporary blip.