Testing times for Indonesian mining
A controversial policy on mineral exports has sparked turmoil in Indonesia's mining industry. Michael Schwartz looks at the challenging times ahead.
There is no question that Indonesia is a key player in international mining. The country’s resources include gold, copper, molybdenum and coal, where it is a major exporter of thermal coal. The downside of Indonesian mining lies in its mining policy structure and consequently an investment climate that is not considered as positive. In its Mining in Indonesia Survey 2016, PricewaterhouseCoopers (PwC) notes that there has been limited investment in mining in recent years, particularly in greenfield projects.
Proof of the complex situation in which Indonesian mining finds itself is revealed in the Fraser Institute annual survey of mining companies 2016 – 350 responses were received from senior executives, covering 104 administrations – down from 109 in 2015 and 122 in 2014. Within these 104, Indonesia slumped 10 places to 99th in the Fraser Institute’s Policy Perception Index and 78th for investment attractiveness. Investment is being deterred, borne out by substantial disapproval of Indonesia’s regulatory duplications and inconsistencies, as well as uncertainty concerning protected areas and disputed land claims.
Government intervention is best known because in 2014 the Government banned mineral exports of unprocessed ores including copper, nickel, zinc and aluminium by Indonesian and Indonesian-based companies. PwC points out that while investment, particularly in greenfield projects, has been limited, some construction activity has actually started on downstream processing facilities.
A sympathetic market?
Finding company representatives willing to discuss the problems confronting Indonesian mining proved difficult – responses ranges from: a broken promise to answer questions use of websites and press releases rather than direct answers to questions an initial enthusiasm to reply to questions, but in the end a referral to a legal practice a set of answers requiring corporate anonymity
Regarding the latter, Materials World interviewed Claus Andrup who was involved with two companies based in Indonesia. The first company is TSXV-listed and closed a transaction comprising three coal licences in Indonesia in 2014. Things have not gone smoothly and the asset will, if all goes well, be sold back to a local Indonesian player at a loss in 2017. The second, another TSXV company, is said to have closed its qualifying transaction on a former Newmont gold licence. It was a complex deal. The senior executive advised on it and as a consequence it was discovered that the licences on the former Newmont licence and the drill holes as stated in the report did not exactly match. The transaction never completed.
Long-lasting and problematic negotiations
Demonstrating the complexity and sensitivity of Indonesian mining at present, Freeport-McMoRan was contacted by Materials World, and was directed to its website and press releases, which contain substantial information regarding the status of PT Freeport Indonesia’s (PT-FI) operations and its discussions with the Government of Indonesia.
Headquartered in Phoenix, Arizona, and quoted under NYSE as FCX, Freeport-McMoRan operates major proven and probable reserves of copper, gold, and molybdenum. It is the world’s largest publicly traded copper producer, and the world’s largest producer of molybdenum, as well as a significant gold producer. As of the latter half of 2016, Freeport-McMoRan's estimated consolidated recoverable proven and probable mineral reserves totalled 86.8bln lb of copper, 26.1Moz of gold, and 2.95bln lb of molybdenum.
Regarding its Indonesian operations, the Grasberg minerals district has one open pit and two underground mines features within the Freeport-McMoRan site via the latter’s subsidiary PT-FI. In September 2015, PT-FI initiated pre-commercial production at the deep mill level zone (DMLZ) underground mine. PT-FI also has several projects in progress in the Grasberg minerals district related to the development of the large-scale, long-lived, high-grade underground ore bodies located beneath and nearby the Grasberg open pit, including the Grasberg Block Cave underground mine. At Grasberg, copper, gold and silver are present from exploration to milling, with a total capacity of 240,000 tonnes per day of ore.
PT-FI operates Grasberg under a contract of work (COW) with the Indonesian Government, which owns 9.36% of PT-FI. On 20 February, PT-FI updated the status of its negotiations with the Indonesian Government on concentrate exports and other COW matters. It pointed out that five years of discussions in good faith with the Indonesian Government have passed in the hope of the two parties being responsive both to Jakarta’s aspirations and to protect the rights of PT-FI’s stakeholders.
The two parties have failed to reach an agreement – Indonesian regulations passed in January and February 2017 dictate that PT-FI must terminate its COW and turn to the Izin Usaha Pertambangan – IUPK – special mining business permit. Under the IUPK, copper concentrates can be exported for five years to January 2022, with export duties to be paid at a rate to be fixed by the Indonesian Ministry of Finance. A smelter must also be completed in five years and, after 10 years, 51% of holdings must be divested to Indonesian interests.
These developments have led PT-FI to inform the Government that the COW has been breached, and that PT-FI will only abandon the COW contract with its substitution by a mutually acceptable agreement, resulting in legal and fiscal assurances to support PT-FI’s long-term investment plans for Grasberg.
The outcomes of this disagreement are PT-FI’s current inability to export concentrates, suspension of investments on Papua, a 60% cut in production and significant reductions in both workforce and local supplier levels. In addition, PT-FI’s first-quarter production has been hindered by a temporary outage since 19 January 2017 at PT Smelting (PT-FI’s 25%-owned copper smelter and refinery in Gresik, Indonesia). PT Smelting advised PT-FI that it expected to resume operations in March 2017.
Richard Adkerson, President and CEO of Freeport-McMoRan, issued a document on 20 February stating that ‘Despite extensive efforts to reach an agreement with the Government, we have been unsuccessful in achieving a resolution that would avoid the negative impacts for all stakeholders, especially for our workforce and the local economy. We are simply asking the Government to honour our legally binding contract. We urge the Government to honour the contract and demonstrate that the country remains open for foreign investment. This would be in the best interests of all stakeholders, including the Government of Indonesia, our large workforce, the local community, local suppliers and Freeport’s shareholders.’
As things stand, even with the resumption of PT Smelting’s operations (under discussion as this article is being written) Freeport-McMoRan sales for Q117 were projected to fall by 17% for copper and 59% for gold. For each month the company fails to win approval for export, PT-FI’s share of production is projected to decline by approximately 70Mlb of copper and 70,000oz of gold. It is unclear how this situation will resolve itself.
Casting a legal eye
Jakarta-based Christian Teo and Partners is a legal practice that has frequently helped clients to establish a business presence in Indonesia before carrying out their corporate actions and mandatory corporate compliance. Bill Sullivan, the practice’s senior foreign counsel, summarised the implications of some recent far-reaching developments in Indonesian mining. One such regulation has changed the pricing regime for coal supplied to mine-mouth power plants (MMPPs). It reflects Indonesia’s dilemma as to how to reconcile low coal prices with long-term dependency on coal-powered electricity. A balancing act is in progress.
Indonesia cannot afford disruption at any stage of a hugely ambitious 35,000MW expansion programme, but the very act of reducing coal-selling prices may deter exploration for new coal deposits and may also mean depletion of existing reserves. There is a great difference between Indonesian data, namely 32.2bln tonnes or sufficient coal for decades to come, and PwC/Indonesian Coal Mining Association figures, namely 7.3–8.3bln tonnes or substantial exhaustion by 2030. Indonesia may well face the need to import coal.
In this respect, domestic coal producers are subject to quotas, which may reduce the pressure on the Government to find the necessary reserves. One tactic could be retrospectively changing existing signed contracts, but then there is the possibility of MMPPs being regarded as too risky. Coal is just one mineral drawn into Indonesia’s complex and controversial industries and only lack of space prevents more of Bill Sullivan’s work being summarised.
Hope for Indonesia
Andrup also commented on Indonesia’s 2014 ban on exporting unprocessed ores. ‘Personally, I believe the 2014 ban is a sideshow. One sees similar bans in other jurisdictions, most frequently in Africa. Banning the shipment of raw commodities makes sense if the exporting country has refining plants within its own borders. South Africa comes the closest when it comes to hosting its own refining plants,' he said.
‘Indonesia comes nowhere close. There are frequent calls for Canada to build its own refineries for producing gasoline, diesel and other upstream products. If Canada, for political, financial or environmental reasons is unable to build beneficiating plants – what hope is there for Indonesia?
‘The hope is that the majors will build plants within Indonesia. The risk in the boardrooms of Glencore, Newmont, Barrick and others is probably thought of as too high. Endure the bans – bans come and go.’
There are special circumstances influencing the content of this article, and how these challenges play out is, as yet, uncertain.