The election effect on Indonesia's mining law

Bruce Gale Straits Times 10 Sep 12;

INDONESIA'S handling of the mining industry has come in for some trenchant criticism from foreign investors recently.

New regulations, say the mining companies, could sharply increase the cost of doing business. They are also designed, insist the critics, to benefit well- connected businessmen at the expense of the industry as a whole.

Meanwhile, British coal mining company Churchill Mining has caused a stir by taking its dispute with the East Kutai district administration in East Kalimantan to the International Centre for Settlement of Investment Disputes in Washington DC.

Churchill accuses the local government of illegally withdrawing its mining licences and seizing its assets without compensation. Similar complaints from other foreign mining firms are in the works.

So what is going on?

"It's all about the 2014 elections," explained Mr Bill Sullivan, a legal adviser to many large mining companies, when I met him at the Jakarta law offices of Christian Teo Purwono and Partners last month. Parliamentary elections are due in April 2014, while the first round of the presidential election is scheduled for July.

Indonesia has a history of coming down hard on foreign mining companies ahead of major elections. The last time was in 2009, when a new law sought to restrict a foreign mining company's ability to sub-contract work to foreign rather than local companies. It also introduced a divestiture requirement obliging foreign mining firms to sell at least 20 per cent of the shares to a local company after five years of production.

Among the even tougher rules introduced this year is one that requires foreign companies to divest majority control of their mining projects within 10 years of starting production. Another imposes a 20 per cent tax on exports of 65 unprocessed minerals and metals, including nickel, tin and gold.

The government says it wants to add value to the mining sector by forcing companies to process locally. But critics point out that no such requirement has been imposed on coal. Bumi Resources, by far the nation's largest coal exporter, is controlled by the influential Bakrie family.

Local processing of coal could improve its calorific content and thereby its value-added when sold on international markets. The problem is the heavily indebted Bakrie conglomerate would be unable to afford the investment.

Industry observers note that the rules on divestment could significantly reduce foreign investor interest. One concern is the price at which shares would be sold to Indonesian interests. The rules state that if a foreign mining company does not sell the shares to a local buyer within the stipulated period, then the government has the right to acquire them at cost (capital plus operating expenses).

In effect, this allows Indonesian companies wishing to obtain the shares to drive a hard bargain as the deadline approaches.

Based on the experience of previous years, Mr Sullivan speculates that not all of the new rules will be implemented according to current formulations.

After the 2009 elections, for example, Jakarta announced implementing regulations that effectively "watered down the conditions by giving the mine owner wider discretion (when choosing sub-contractors)" than the new legislation seemed to imply.

The same may ultimately prove true of the demand that metal and non-metal minerals be processed locally. After all, Indonesia does not have the electrical generating capacity to run the expensive smelting and refining plants that would need to be built. In the meantime, however, a 20 per cent tax on unrefined produce - except coal, of course - threatens to make local mining companies globally uncompetitive.

It is well to remember, however, that not all developments in recent years have been negative.

Indeed, such backtracking often follows major advances. The big leap forward in the 2009 legislation was the decision to allow foreigners to hold mining licences directly.

Previously, foreigners had to enter into contractual agreements with Indonesian companies, many of which had no real intention of using the licences themselves. The participation of the latter merely added to business costs while doing nothing to encourage local participation in the mining industry.

That said, another provision in the 2009 mining law transferring the authority to issue mining permits to local governments has not worked as intended.

A combination of greed and contradictory legislation has resulted in abuses of power that have produced thousands of overlapping mining permits, creating yet more legal uncertainties.

In the case of Churchill, the local regent (district head) said he revoked the company's mining permits because they overlapped with forest conservation areas.

Many in the industry, however, believe the entire thing is a charade designed to pave the way for the Nusantara Group, run by ex-army general Prabowo Subianto, who heads opposition political party Gerindra, to take control.

Foreign mining companies, it seems, will have to wait until after the 2014 elections to know their true fate.