Indonesia’s imposition of export taxes and foreign ownership limits in the mining sector earlier this year sends a clear signal that the government is determined to upgrade its economy, even if it means enduring short-term pain.

By any stretch of the imagination, 2012 has been an eventful year for Indonesia’s mining industry. In March this year, the mining ministry announced new rules requiring foreign companies to sell down stakes in mines, and increase domestic ownership to at least 51 per cent by the 10th year of production, at a time when the government was renegotiating existing royalty contracts with major foreign investors such as Freeport-McMoRan Copper & Gold Inc and Newmont Mining Corp. Then in May, the country announced that it would ban exports of 14 raw metals from 2014, and would ask all miners to submit plans to build smelters to add value to the country's mineral sector. “Our aim is so that we can add value, open new jobs and if (the products) become semi-finished, then they can be exported,” mining minister Jero Wacik said at the time.

Unsurprisingly, the industry did not react particularly well. In June, mine exports to key customers Japan and China slumped as firms halted operations, and laid off hundreds of thousands of workers, Reuters reported. However, Indonesia, the world's top exporter of coal for power stations and of nickel and tin, as well as a major supplier of bauxite, iron ore, gold and silver, announced in no uncertain terms that it was prepared to suffer a drop in mining exports as it sought to force firms to invest in processing ores into refined metals as part of the government's long-term strategy to upgrade Southeast Asia's largest economy.

In an interview with Reuters, Indonesian trade minister Gita Wirjawan said that the country wanted to refine the ore domestically, and then either ship finished metals overseas for much higher prices or profit further by manufacturing them at home into steel or iPads - just as its Asian peers do. “These policies are part of Indonesia’s goal to transform itself into a more industrialised country set at least a decade ago, but not many people are aware of this,” says Arfidea Saraswati, partner at AKSET Law.

Firm intentions

According to Saraswati, the reason for the export duty on unprocessed or semi-processed minerals is to ensure that a portion of the financial benefits of mining exploitation go to the Indonesian people while at the same time, preserving the sustainability of natural resources by requiring mining companies to either process the mined ores domestically or sell them to others for domestic processing. She adds that a similar set of regulations and policies had been in place even before the issuance of the New Mining Law in January 2009, and the regulations earlier this year. “Many of us were uneasy with the new policy when it was first issued in the New Mining Law, and then as implemented at first stage since May 2012,” says Saraswati. But following extensive research and analysis, “many now believe that the goal to build more smelting and refinery and processing plants in the near future would be more feasibly implemented in stages. These discussions and negotiations between the businessmen and regulators are ongoing, with a view to finding the most suitable framework to both support the mining and the processing industry while still benefitting the people of Indonesia,” she adds.

With regard to the requirement to limit the percentage of foreign ownership in companies holding mining business licences, or IUP companies through divestment over 10 years, Saraswati notes that this divestment scheme is not totally new for the mining industry. “The divestment requirement is new for holders of mining concessions, or KPs, which later become IUPs, but is not new for companies with contracts of work signed with the government of Indonesia,” she says. “From the perspective of the Indonesian government, this 'new’ policy balances the opportunity that is given to foreign investors to own 100 percent shares in IUP companies,” which, she says, hold mining business licences, but not contracts of work. 

Short-term pain

Following the announcement of the policies, Indonesia’s mining industry has been bleeding an estimated $164 million a month in lost sales of nickel and bauxite. In August, the country announced that it had awarded an increasing number of mineral export permits; however, to obtain export permits under the new rules, miners would now have to be certified “clear and clean”, and provide plans to process ores they dig up.

Muhammad Karnova, partner at Hadiputranto, Hadinoto & Partners, says that while the ban on ore exports have been loosened by the introduction of a series of regulations which permit ore exports with certain requirements, the net result would be to make investors reassess their business model for Indonesian minerals. “As with any transitional matter, those who are adversely affected will raise their voices, such as mineral exporters and their related stakeholders,” he says. “The current position from the central government is clear, namely, to promote onshore mineral processing so that mineral mining activities in Indonesia can give better multiplier effect for the longer term benefit of the people and the country as a whole, and they may do what is necessary to discourage ore exports.”

Saraswati says that the short-term pain will be the drop in State revenues from royalties on mineral exports and corporate income tax as the majority of exporters take a step back, and hold their position pending the fulfillment of set of requirements under the various regulations. “Also, given the 20 percent export duty, the mining companies may consider selling their products domestically,” she says. “The production of ores and raw materials would significantly be reduced when existing plants in Indonesia (if any) cannot absorb such raw materials, and at the same time the ores producer or the mining ministry is incapable of finding a solution for cooperation with another processing company.” She adds that from the buyer’s perspective, offshore buyers that rely heavily on Indonesia’s supply would have to absorb the additional charges in order to maintain supply, at least until December 2013 or January 2014, when the export of unprocessed minerals must discontinue permanently.

Karnova says that there are an increasing number of proposals to construct onshore mineral processing and refining activities. “Whether these proposals are genuinely put forward to be implemented or as some interim arrangements – for example, to allow certain exports of ore be able to continue until a full ban is implemented – this remains to be seen,” he says. “To a certain extent, the government will also need to see the readiness of all infrastructure and supporting facilities for an onshore mineral processing facility… so that the economics of an onshore mineral processing facility can be met and reasonable to be implemented.” In respect of certain other minerals, he says that the government should also take into account the demand of international market of certain unprocessed products, and not solely rely on technical matters when determining what can be exported as a raw material and what cannot. “Some minerals will have a huge market if those minerals are sold or otherwise exported as raw materials or half-processed materials, as opposed to full-scale processed materials or minerals with a very small-scale market,” he says. “There has to be some balance between implementing a good policy and commercial reality.”

Learning to adapt

According to Saraswati, because the domestic processing and export restriction was not expected until January 2014, foreign-owned companies and local companies that have not prepared for domestic processing are still waiting to see what options that may be available for them. “Those with small reserves cannot continue operating unless there is certainty that they can sell their ores,” she says. “One widely discussed scenario is that the government may establish a state-owned smelting company which would buy raw materials from small mining companies in the proximity of its smelter. It is under discussion where the plant would be constructed, depending on the availability of the raw materials, and other factors.  It will be interesting to see what the government decides to do.”

She adds that companies with abundant reserves and the potential to develop a processing plant are initiating discussions with industrial companies and researchers, and closely monitoring the progress of discussions and negotiations between the regulators and other business players. “But only if the processing business is considered commercially and technically feasible, and supported with the guarantee of sufficient supply of raw materials and the necessary infrastructure, will companies seek alliances for financing and technical and marketing support,” she says.

Karnova says that there are two kinds of foreign investors: Those who have been operating in Indonesia through a hybrid investment structure (such as a cooperation agreement, a tiered private company structure, mining services, and the like) and those who do not. For those who have been operating through hybrid investment structures, the new regime allows them to convert these structures such that they can directly hold shares in a mining company which was otherwise prohibited. “Winding up or restructuring these structures will certainly allow them to get better ’title and ownership’ compared to those hybrid structures. But there are tax costs associated to this restructuring, and a host of government approvals which need to be secure prior to making it happen, including converting the relevant KP into an IUP,” he says. “Those who have been investing directly, mostly in contract-based concessions, may see that there is no immediate concerns as contract-based concessions are still upheld until their expiry dates.”

The issues, he says, are starting to come we discuss about divestment requirement, having to relinquish some existing concession areas, amendment to the contract-based concessions, bigger statutory payments to government, and the like. “While these may be factored into as some changes to the business and to a certain extent financial model of said investors, finding some durable solutions to each of the problems faced by each of investor is key,” he adds.

Advice for clients 

Saraswati says that for clients considering acquiring a mining company, her firm suggests either maintaining the minimum local shareholder ownership or immediately find a strategic local shareholder. “This is for two reasons,” she says. “First, in anticipation of the divestment realisation, the local partner may be able take up more shares under first right of refusal and preemptive right exercise (if mutually agreed), or other means that can be structured between the shareholders.  Second, having a local shareholder who knows how to keep the business and licences in good standing with the local community and regional governments would be very useful.”

Karnova says that clients first need to determine what business model they may want to have in Indonesia. “Is there any idea to do listing overseas in established mining exchanges such as Canada or Australia?” he asks. Then clients need to determine how the initial operation is going to be undertaken, whether by partnering with more established local players, or going solo first and then partnering with others. “Different types of investors have different risk appetite and drivers, and cannot be generalised,” he adds. “As regards divestment, we ask them to pay attention to the upcoming implementing divestment regulation, and allow investment structure to be as reasonable as possible when dealing with the need for a local listing for various reasons.”

What the future holds

Saraswati says that after learning from the other companies who have been in recent disputes or failed in their investments for different reasons, investors in mining sector would be more cautious and prudent. “Both in the short term and long term, we expect that there will be more direct ownership in structuring of mining and/or processing investments to ascertain control over the investments,” she says. She adds that in order to ensure that the processing business will be owned 100 percent, or more than 49 percent by foreigners the business must be set up separately from the mining unit. “Under current policy, the divestment obligation only applies to mining companies holding production operation IUPs (for exploitation) and not companies holding industrial processing licences or IUPs especially for processing and refinery,” Saraswati says.

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