BUSINESS
It’s no secret that Indonesia is a major player in the global mining industry. A country rich in natural resources, it has abundance in copper, gold, tin and nickel, and is also one of the world’s largest exporters of thermal coal. Indonesia needs foreign
Why is Investor Confidence Low in Indonesia's Mining Industry?
INDONESIA has seen a decline in the investment of mining in recent years, even though global mining companies rank the country highly in terms of coal and mineral prospects. Weary investor confidence comes down to several factors, namely a continued reaction to the global energy and raw material market price slump that hit its lowest in Q1 2016, as well as the Indonesian government’s flip-flopping of policies in this sector, which has stemmed from regulation changes made eight years ago.
The Not-So-New Law
Early in Jokowi’s administration, Law No. 4/2009 on Mineral and Coal Mining, known as the ‘New Mining Law’, was introduced. The idea was to boost export revenue to Indonesia’s raw ores before shipping, which would be done through the growth of domestic refining and smelting facilities that would keep the downstream processes within the nation, and add value to the industry. In a nutshell, the New Mining Law halted the old practice of exporting mineral ore. But it would seem the law came too little too late, and without much forethought, which has rendered it ineffective.
Since 2014, the government further tightened the law on the export of raw mineral ores, including copper, nickel, bauxite, gold, silver and tin, causing mineral export earnings to fall, which led to a significant tax shortfall. This export ban also caused a substantial reduction in the mining sector, with growth declining from 4.3 percent in 2011 to -3.4 percent in 2015.
A full- scale export ban on concentrates was set to take effect in January, but with companies lagging behind expectations on downstream and smelter developments, the restrictions on exports of nickel ore and bauxite have been relaxed. Companies who can now demonstrate that they are in the process of developing smelters are exempt and will be allowed to export ore.
Rife with Corruption
According to the Fraser Institute, Canada-based policy research and educational organization, Indonesia ranks lowest in the “state of the investment climate in the mining sector across the world”, with limited investment being made in recent years. To add to the range of challenges already evident in mining, this sector also lacks transparency and is perceived as a source of much of the country’s corruption.
Indonesia Versus Freeport
At the centre of disputes that test Indonesia’s ability to implement new industrial policies, and a story that has been making global headlines, is the case of Freeport versus the Indonesian government. Grasberg in Papua is the largest gold mine and third largest copper mine in the world, operated by PT Freeport Indonesia, a subsidiary of United States miner Freeport- McMoRan Inc.
Since it began operations in the ‘70s, PT Freeport Indonesia has paid more than US$16.5 billion in taxes. Plans to expand the mine over the next 25 years would produce a further US$ 40 billion to the government, but due to continuing changes in regulations, the future of the mine is very unclear.
In 1991, Freeport and the Indonesian Government signed a Contract of Work (CoW), granting the company the right to operate until 2021. The government, however, wants the old contract to be converted in line with the New Mining Law, requiring it to change its CoW to a special mining license, Izin Usaha Pertambangan Khusus (IUPK), to continue exporting copper concentrate.
PT Freeport Indonesia spokesperson Riza Pratama told Indonesia Expat, “Upon conversion to IUPK, the government requires the company to forfeit its CoW, which could jeopardize our stability and certainty of our operations.”
A switch to IUPK status would involve changes to taxes and other terms from which Freeport Indonesia is currently exempt. The miner would need to start paying a dividend tax, a 10 percent value-added tax (VAT) and an export duty of up to 7.5 percent on copper concentrate exports. It would also need to divest up to 51 percent of its Indonesian unit compared with the current mandatory 30 percent (the miner has up until now only divested 9.36 percent).
The dispute is ongoing, and as of 10 February, Freeport stopped production due to a labour strike, letting go of 10 percent of its expatriate workforce, those mainly working on an underground development project – the building of two large underground mines that would replace the open pit mine. The company employs around 32,000 people and would be forced to lay off more workers if it continues to be unable to export. “We will be left
with no other choice but to reduce our production capacity to 40 percent, which will then reduce our operations, domestic purchase, contractors and direct employees,” says Pratama.
Critics believe both parties need to work together to create a win-win solution. Some believe Freeport needs to get on board with the new mining practices, which will help to improve its negative reputation as a symbol of US economic imperialism in Indonesia. The government, on the other hand, should realize that building smelters is capital-intensive and has substantial long-term risks, and should offer incentive for miners to embark on such high-risk investments. The 51 percent divestment requirement will most likely hinder further investment in this already volatile sector.
Where’s the Infrastructure?
Another very serious concern miners have is inadequate supporting infrastructure and a skilled workforce in place to support downstream processing facilities. In order for a company to develop processing facilities such as a smelter, miners may also have to fund and develop much of the supporting infrastructure, including power, rail, roads, and ports. It would also need to hire foreign workers to train locals on the development and use of smelting facilities, which is an issue in itself, since in recent years the government seems to have developed a more nationalistic stance, making it harder to hire foreign workers, particularly in mining.
PT Freeport Indonesia can put into context how much of a financial strain the New Mining Law is on miners. The company is currently conducting preliminary engineering on a second smelter that that would be able to handle 100 percent of copper concentrate domestically – the company’s existing copper smelting plant, PT Smelting Gresik, built in 1996, can only manage 40 percent.
“We are still committed to developing an additional smelter facility as long as the government grants legal and fiscal certainty for the company’s longterm operating rights,” says Pratama. “To date, PT Freeport Indonesia has not obtained this assurance, as the government has not given approval for the contract’s extension beyond 2021.”
According to Pratama, during almost 20 years of its operation, the smelter in Gresik has not provided a reasonable return on investment. “Only 50 percent of the copper cathodes produced are sold in the country – the rest are exported,” he says. The development of a second smelter is estimated to cost more than US$2 billion, an investment particularly heavy due to power and infrastructure, and would actually lose the company hundreds of millions of dollars each year.
It seems nobody is certain how this story will pan out, but PT Freeport Indonesia somehow remains optimistic. Pratama is hopeful the company will “stay in Papua and sustain productive mining operations so that the mine continues to create benefits to the province's economy and drive 94 percent of the economy of Mimika.”
“The development of a second smelter is estimated to cost more than US$2 billion, an investment particularly heavy due to power and infrastructure, and would actually lose the company hundreds of millions of dollars each year.”