Regional Report - Indonesia: clear as mud

Rick Beckmann and Richi Sheyoputra, Susandarini & Partners in association with Norton Rose Fulbright Australia, and Robert Milbourne, Norton Rose Fulbright Australia, discuss the legal minefield that is Indonesia’s mining industry.

Attention in Indonesia’s drama-ridden mining industry has most recently been focused on ore producers. The Government of Indonesia’s plan to ban exports of unprocessed mineral ore, and to require processing to be conducted onshore, came into effect in January – albeit in a watered-down form. An industry group immediately filed a challenge in the Constitutional Court. A mining powerhouse announced plans to launch arbitration proceedings against the government for breach of contract. Ore producers have already started laying off workers as a result of the ban. With an election – looming in April – and certain politicians playing to the increasing tide of resource nationalism, it is unclear where this will all end up.

Coal mining companies are not impacted by the export ban, but maybe not for long. A threat to ban export of low calorific value coal still hovers in the background, together with plans to increase export duties and royalties, while the government continues to try to renegotiate prestigious Coal Contracts of Work (CCOW).

Ban on low calorific value coal exports?

The proposed ban was initially announced three years ago. Multiple drafts of regulations were discussed, with a planned threshold for low calorific value coal oscillating between 5100 – 5700 kcal/kg – a stretch on the concept of "low”. When China proposed to ban low calorific value coal imports last year, the threshold was reportedly at a more realistic 4540 kcal/kg.

It is now rumoured that, if the proposed ban ultimately comes into effect, the threshold for low calorific value coal will be below 5100 kcal/kg. The government’s position is that prohibiting low calorific value coal exports is justifiable and economically viable for the following reasons:

• Indonesia has various optimistic coal-fired power plant plans on the table, while the country's existing coal-hungry power industry continues to need feeding. There is thus more than sufficient domestic demand for low calorific value coal.
• Indonesia must develop its local processing industry. Adding value to mining products should take place further up the domestic supply chain: ore has now been caught; coal should not be exempt.

Indonesia already has in place a system to satisfy its power needs. In 2010, the Domestic Market Obligation (DMO) was introduced, under which nominated coal producers are required to set aside coal for sale into the domestic market. The DMO requires that coal be sold at or above the coal reference price, which is a price set by the Ministry of Energy and Mineral Resources (MEMR) on a monthly basis. The mandatory sellers are matched with mandatory buyers under regulation. Of the companies subject to the DMO, nine are the larger-scale CCOW holders. By far, the biggest buyer is state-owned electricity company, PLN.

The Indonesian coal industry reacted with alarm to the proposed import ban by China, which is the country’s largest export market. But the government was rather nonchalant, again pointing to Indonesia’s power industry needs and the potential to boost exports to other countries, such as India. Meanwhile, the government started signing bilateral agreements with Vietnam with respect to co-operation in the coal sphere.

Ultimately, the Chinese Government abandoned its proposed ban on low calorific value coal imports and instead imposed a tax, which is set at 3%. In a similar vein to the ore industry, coal industry players have threatened a constitutional challenge to any prohibition that comes into effect.

Adding value to coal

As a taste of things to come, the president’s New Energy and Security Policy of February 2012 highlighted the need to value-add as a critical issue for the Indonesian mining industry, alongside excessive foreign influence and “unfair” concession contracts that were entered into with foreign-controlled companies. Indonesia’s new mining law of 2009 – which essentially restructured the entire mining industry – had also flagged the need for local value-add. No exemptions for coal.

In this context, any requirement to process coal goes beyond the usual drying and crushing activities to increasing the calorific value. But coal upgrade technology in Indonesia has often proven to be problematic. Some optimistic pilot plants have been abandoned in recent years, with one of the reasons cited being the difficulties of implementing coal upgrade technology in a tropical environment. Posing further difficulties, under regulation coal mining companies are required to process their own coal.

In the ore space, the idea that processing should take place not only in country but also by the mining companies themselves was heavily criticised as being unrealistic. Depending on the mineral, a smelter may cost up to US$ 1 billion, which would cripple the smaller players. Ultimately, the concept of “own processing” was watered down and a regulation last year provides that ore miners may use the smelters of others for processing purposes.

Coal upgrade technology will also involve huge investment, both in terms of funds and timing. If the plan comes into effect, this will be problematic for the small and medium-sized coal players. For the larger players, local technology is not yet available and co-operation will be required with foreign companies. If the MEMR ultimately waters down the requirements, so that the small and medium miners can use coal upgrade facilities of the large players, who have the funds available, the risk of monopolistic-style concentration of the coal processing industry into the hands of the elite miners looms.

Royalties and coal export tax

The ore industry was slammed with new export taxes in May 2012 of up to 20%. Meanwhile, the government continues to waver on whether to increase royalties or impose an export tax on coal.

Coal concessions in Indonesia come in two forms:

• Mining Business Permits (IUPs), which are granted at regional level, except where foreign investment is involved, in which case IUPs are granted by the MEMR.
• CCOWs, which were traditionally granted by central government.

Royalties on coal currently mostly stand at between 4 – 7% of net sales. Since September 2010, all coal sales must be at or above the coal reference price and, accordingly, the government is able to control the minimum level of royalties it receives. Early last year, it announced a plan to increase royalties on IUPs to 13.5% on the reported rationale that this is for the most part what the CCOW holders are required to pay.

The rationale is a little difficult to follow if the reports are correct. CCOWs were granted to the larger -scale miners and considered to be a more prestigious form of coal concession right. IUPs and their predecessors, Mining Rights (KPs), were granted to smaller-scale players and, before the 2009 new mining law, were limited to Indonesian ownership only. As a result, the IUP holders, where the IUP is a conversion from a KP, are unlikely to be as deep-pocketed as the CCOW holders.

Increasing royalties thus has the potential to make a huge dent in IUP holders’ revenue and lead to employee lay-offs. Again, in turn, this could potentially impact on mining services companies and coal trading companies, which rely on the existence of the IUP holders. In June 2012, the government announced that it was considering introducing a coal export tax, which immediately pushed shares in Indonesia’s leading coal miners down by 13%. For the most part, the potential coal export tax and the potential royalty hike have been presented as an either/or scenario – but there may be a sliver of a possibility that both may be enacted. Any export tax will likely push up coal prices and force China and India, Indonesia’s top coal buyers, to look elsewhere.

No sacred CCOWs

CCOWs are slowly becoming history. The new mining law of 2009 collapsed the existing regime of Contracts of Work (COWs) – which were for non-coal minerals and reserved for foreign investment only – CCOWs and KPs into a single form of mining right: the IUP. Rather strangely, the new law said that existing COWs would continue to be honoured, although at the same time would also need to “adjust” to comply with the new law. In 2012, the president established a top-level team to renegotiate existing mining contracts. The key provisions on the renegotiation list include divestment obligations in favour of Indonesian interests, the amount of royalties and in-country processing requirements.

However, COWs and CCOWs are, as the names suggest, legally binding agreements that cannot be unilaterally amended. According to the MEMR, of the remaining 74 holders, about 15 have renegotiated with the government with amendments agreed last year. But is appears that some of the CCOW holders are holding out, particularly the larger players.

Jitters over the spectre of export bans, export taxes, royalty hikes and upgrade technology are not the only woes facing the Indonesian coal mining industry, particularly where foreign investors are involved. After foreign investor elation that the new IUP system allowed access to quick-and-easy concessions for ultimate foreign holding, the government has since cracked down on foreign ownership, with the latest move being a maximum permitted foreign shareholding of 75% for exploration IUPs and 49% for production IUPs, where the IUPs were previously held by 100% Indonesian interests.

The problem of overlapping concessions also continues, although there have been some steps towards resolving this. The MEMR’s Clean & Clear List programme now requires all IUPs to be registered with the ministry, which is possible only where the IUP concession area has been cleared of overlap. Disputes over land remain one of the most litigated matters in the Indonesian mining industry. Forestry classifications, which (at least in the past) have tended to change, still cause problems: the classification could prohibit all opencast mining in the concession area or require the interested mining company to obtain a special licence from the Ministry of Forestry – which may take up to two years, sometimes longer.

A September 2009 regulation requires all concession owners to give preference to locally-owned mining services companies, before a foreign-owned mining services company may be retained.

The 2009 mining law has already been subject to four challenges in the Constitutional Court – in each case the court siding with the small-scale miners over the big players, or local community over the central government. Regulations issued by MEMR – including the raw ore export ban – have been tinkered with or totally struck down, by the court on three occasions. This has resulted in a wait-and-see approach by some potential investors in the Indonesian coal industry, particularly in the lead-up to the April parliamentary elections, with the presidential election currently expected to follow in July.

No longer just a national issue

The Indonesian courts are also not the only ones resolving issues with respect to the new Indonesian mining law regime. After the new mining law came into effect, Indonesian coal miner, Arutmin, and the Indonesian subsidiary of Thiess, an Australian mining services contractor, signed agreements under which mining services were to be provided by Thiess to Arutmin. Under the arrangement, Thiess was to provide, among others, coal mining services.

However, Arutmin did not provide any opportunity for locally-owned mining services companies to tender for the work and has since challenged the validity of the agreements, on the basis that they had been “frustrated” – in other words, because the activities under the agreements were not lawfully possible and that no tender process for local companies had been followed.

Last December, the Queensland Supreme Court rejected Arutmin’s challenge. The court said that it was Arutmin’s obligation – not Thiess’s – to conduct the tender process and, therefore, Arutmin could not rely on its failure to do so as a basis for having the agreements struck down.

What’s next for Indonesia’s coal sector?

Both Arutmin and Thiess were the victims of legal uncertainty in Indonesia and changing government policy. To avoid a repeat, further regulatory clarity is needed. In the lead-up to the elections, there is a rising feeling of resource nationalism, during which political points are hardly likely to be scored in advocating for foreign investment in mining. A new president may very well have a different agenda. Given that there is little certainty as to who will succeed Susilo Bambang Yudhoyono, it is difficult to predict what mining companies will face in Indonesia once the elections are over. But, the last-minute backtracking by the government on the mineral ore export ban leaves some hope for the coal industry that not all of the changes now being mooted will be implemented.

Written by Rick Beckmann, Richi Sheyoputra and Robert Milbourne. Edited by Jonathan Rowland

Read the article online at: https://www.worldcoal.com/special-reports/25062014/regional_report_indonesia_coal_industry_clear_as_mud_coal1019/