Moths to the flame

Indonesia may be one of Asia’s most vibrant economies and democracies, but it also a relatively young country in terms of its institutions and laws. And with legal uncertainty comes heightened risk. Nevertheless, investment in the coal sector continues to go from strength to strength despite the obstacles that must often be overcome before a return is earned. The reason for this, of course, is that the potential rewards are worth the leap of faith companies must often make to secure a stake in the archipelago’s raw materials wealth.

Investment in Indonesia’s thermal coal mining sector is expected to reach a record of almost US$ 2 billion this year before slowing gradually through to 2014, according to figures from analysts Wood Mackenzie.

This continued ability to attract investment has underpinned Indonesia’s emergence as the world’s largest exporter of thermal coal. Production is forecast to reach around 354 million t this year, of which 270 – 280 million t will be exported, largely in line with last year. According to the Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES), exports will climb to 294 million t in 2012, although some analysts predict more rapid expansion.

Certainly, Indonesia is in no danger of losing its status as the world’s largest thermal coal exporter. But despite recent growth in Indonesia’s coal production and export capacity, the country’s exports of thermal coal in Q1 2011 remained at about 62 million t, largely unchanged from Q1 2010, due to above-average summer rainfall, according to ABARES. Indonesia’s thermal coal supplies will be supplemented by planned expansions to production at PT Bumi’s subsidiaries.

Speaking to World Coal on the sidelines of Coaltrans Asia 2011 in Bali in June, Rudi Vann, a coal market analyst at Wood Mackenzie, predicted that between 2010 and 2020 Indonesia would account for 39% of the increase in global export supplies, assuming its miners succeeded in bringing proposed greenfield projects to market.

Indonesia’s tax system offers producers a sizeable advantage compared to Australian miners, where the Government take is set to rise when planned new taxes are introduced. Vann expects producers such as Adaro Energy and Bumi Resources to emerge as world leaders. He predicted both would be ranked among the world’s biggest five producers by 2015 alongside giants such as Anglo American, BHP Billiton and Xstrata.

The abolition of the Contract of Work (CoW) system in 2009 has helped boost investment by removing some of the regulatory doubt that had clouded the calculations of financiers while reform was being debated. Indian investors have been the most eye-catching newcomers in the last two years, but finance houses from the Middle East and as far afield as the UK have also been drawn by higher commodity prices and excellent long-term demand prospects.

“With opportunities for thermal seaborne exports, Indonesia needs to continue to attract new investors to sustain production increases ahead of its largest competitor, Australia,” said Vann. “By 2020, 60% of the 133 million tpa of new production from greenfield projects will be used for export supply. What will best attract investors to Indonesia instead of Australia will be competitive cash costs as well as attractive and stable fiscal terms.”

Indonesia has relatively attractive fiscal terms compared to Australia, with a lower Government take and less risk of fiscal instability, according to Vann. “At the moment, Australia faces higher risks of increased taxes from the potential Minerals Resource Rent Tax (MRRT) and carbon tax,” he continued. “This instability could discourage new projects, driving investments towards Indonesia instead.”

However, Indonesia also has its own obstacles to overcome if it is to continue attracting investors. Most relate to Government regulations, not least the implementing regulations for the new Law on Mineral and Coal Mining No. 4 of 2009 (MCM), which are still being developed.

Government regulation

The MCM replaced the CoW system as the main legal reference point for foreign investors. It introduced an area-based system of licensing and transparent tendering procedures, with local Government given more input. However, a guide to Indonesian taxation produced by PricewaterhouseCoopers (PwC) argues that, although the new law provides more certainty for investors, Indonesia has found it hard to balance the interests of foreign investors against those of Indonesian nationals. It also still remains unclear which areas of the country are protected and which can be mined, a central Government task under the MCM.

Furthermore, there is still a lack of clarity in relation to some of the recently issued regulations such as the price benchmark and domestic market obligation rules, according to PwC. At present, there still appears to be some reluctance on the part of investors due to these outstanding regulations.

There is also confusion about exactly how minimum coal pricing will be enforced in terms of royalty payments, and how the impasse over the issuing of mining licences introduced as part of a moratorium on forestry permits – which includes an audit of the 8000 mining permits already issued to check they are in according with environmental law – will be enforced, audited and resolved.

Export demand

Demand for Indonesian coal will remain strong in the coming years as coal quality and proximity to surging import markets give miners in Kalimantan and Sumatra a strong negotiating position in international markets.

David Bull, an analyst at Lloyd’s List Intelligence, believes the fundamental quality of Indonesia’s thermal coal output stands it in good stead. “[It] is of a high quality, with an average gross calorific value between 5000 – 6500 kcal/kg.” Indian coal, by comparison, is only 3000 – 4500 kcal/kg, he explained. “The expansion of coal production in Indonesia will continue in the future, with companies such as PT Indika Energy increasing production from 29 million t from its five mines last year to over 50 million t by 2012.”

Over the remainder of 2011, growth in Indonesia’s thermal coal exports are expected to be supported by increased import demand from India and China, according to analysis from ABARES.

China’s thermal coal imports are forecast to total 117 million t in 2011 and will rise next year to 119 million t, underpinned by continued growth in coal-fired electricity generation.

India, meanwhile, is now the world’s fastest growing importer of thermal coal. ABARES indicates that the country’s imports are forecast to increase by 28% to 77 million t in 2011. In addition, coal-fired electricity generation in India is expected to expand significantly – 18 GW of capacity is scheduled to be brought online over 2010/11.

The scheduled expansion of coal-fired electricity generation is expected to markedly increase import demand, as growth in domestic production will not be sufficient to meet consumption needs. These developments are expected to continue in 2012, supporting thermal coal import growth of 19% to 92 million t.

Infrastructure is a major challenge for Indonesian exporters. This is reflected in the shipping markets where, despite the huge volumes loaded in Indonesia, the biggest capesize vessels remain largely absent. During 2005, there were 967 panamax calls at the country’s ports. By 2008, the figure had passed 1400 and, in 2010, it reached 2200, according to Bull. By comparison, calls by larger, more cost-efficient capesize ships represented only a tiny proportion of overall port calls.

This article is adapted from September’s regional report. Subscribers can log in here to read the full article.

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