It’s no secret that Indonesia is a major player in the global mining industry. A country rich in natural resources, it has abundances of copper, gold, tin and nickel and is also one of the world’s largest exporters of thermal coal. Indonesia needs foreign investment to tap into its potential. However, and as is so often the case, an ever-changing and uncertain legal landscape has become a major obstacle for foreign investors looking to thrive.
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, which hit its lowest in the first quarter of 2016. Another major factors is 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 for Indonesia’s raw ores before shipping, which would be done through the growth of domestic refining and smelting facilities. This 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 ore types, 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, a 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.
According to an article published on environmental news portal Mongabay, many publicly listed multinational and Indonesian companies will engage in best practices because they are answerable to shareholders, the media and the laws of their home countries.
But big private Indonesian companies and foreign companies operating in Indonesia are not as well monitored. The article states: “Some of Indonesia’s biggest mining companies also have direct and personal connections to powerful political figures, which gives them a degree of immunity.”
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 the 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 1970s, 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 for 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.
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 to the current mandatory 30 percent (the miner has until now only divested 9.36 percent).
The dispute is ongoing, and as of February 10, Freeport stopped production, letting go of 10 percent of its expatriate workforce, those of who were 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 plans to lay off more workers if it continues to be unable to export. Local and foreign employees still employed are feeling the stress that an uncertain working future brings.
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 with substantial long-term risks. For this reason, it should offer incentives 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 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 and of itself. 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 – in line with the government’s new policy – that would be able to handle all output (the company’s existing smelter built in 1996 can only manage 40 percent).
The development is estimated to cost more than US$2 billion and will actually cost the company hundreds of millions of dollars each year. It seems nobody is certain how this story will pan out, but there is no doubt the Freeport saga has and will continue to affect the investment climate in this sector for years to come.