On the surface, Indonesia seems an ideal destination for mining, combining an abundance of resources with the largest economy in South East Asia.

Yet a global survey in 2012/13 found that out of 96 countries, Indonesia was the least attractive investment destination for the mining industry. Digging deeper, a review of Indonesia's legal framework for mining reveals reasons why ...

Under Indonesia's legal framework, mining licences are available to foreign investors, albeit with certain significant restrictions.

Before a foreign investor can apply for a mining licence (Izin Usaha Pertambangan: IUP), it must first establish an Indonesian limited liability company (a PMA Company).1

Once the PMA Company is established, it can apply for an IUP. The PMA Company holding an IUP may be wholly foreign-owned.

Importantly, however, the PMA Company can only be 100% foreign-owned for the first five years of commercial production.

DIVESTMENT REQUIREMENTS

Once a PMA Company holds an IUP, its foreign investors must progressively divest their shareholding so that by the end of the tenth year of commercial production Indonesian investors hold at least 51% of the total shareholding.

Once this threshold is achieved, the Indonesian shareholding cannot be further diluted by any capital increases in the relevant PMA Company.

The divestment shares must first be offered to the national, provincial and regency governments. If these decline the offer, then the shares must be offered to a state or regional owned entity. If these decline, the shares can be offered to an Indonesian private entity by way of auction.

If the foreign shareholders decide to divest part of their shareholding before the statutory obligation arises, it is understood they can choose the Indonesian entity to which they wish to divest (without having to first offer shares to the relevant government or government owned entity).

EXPORT LIMITATIONS

As Indonesia has prioritised developing its downstream mining industry and ensuring the domestic availability of refined products, exports of unprocessed minerals and ores are restricted. Export quotas are currently in place, with miners paying a 20% export duty on exports of certain unprocessed materials.

A complete export ban on exports of unprocessed minerals and ores commences on 1 January 2014, although media reports have suggested the export quotas might be removed and the ban relaxed, at least for companies that have local smelting plant projects. To date, no formal policy documents or regulations have been released to give effect to this.

Miners must also sell a minimum percentage of their production to domestic users, principally power producers, complying with benchmark selling prices. In 2014, that minimum will be 25.9%. Miners that do not comply with the domestic market obligations can be penalised by a reduction of up to 50% in their annual production quota.

Against this background of divestment requirements and pending export bans, the legal framework for foreign investors presents something of a minefield.

And a new regulation appears to have only made matters worse.

TIMING OF DIVESTMENT

According to Ministry of Energy & Mineral Resources Regulation No.27 of 2013, if a domestic investment company holding an IUP wishes to convert into a PMA Company, or if a PMA Company applies for approval to change its shareholders (including as a result of a transfer to another foreign party), its foreign ownership must not exceed the following percentages:

Type of IUP Maximum Foreign Ownership
Exploration IUP 75%
Production Operation IUP 49%

Thus, this regulation appears to apply the divestment obligation immediately upon conversion or a change in shareholding, despite the previous legal framework contemplating progressive divestment after five years of commercial production.

The new regulation also provides:

  • the price for the divested shares is calculated using the so-called replacement cost valuation method, which may be less than the market price;
  • the divestment obligation cannot be satisfied through the capital markets; and
  • new prohibitions on loans to purchase, and the pledging of, shares required to be divested.

This highlights the regulatory volatility that foreign investors in Indonesia's mining industry must endure. It is particularly problematic for an industry which requires certainty for long term planning and investment and has lengthy return periods.

Reflecting this volatility and uncertainty, a Fraser Institute survey in 2012/13 found that out of 96 countries, Indonesia was the least attractive investment destination for the mining industry.

WHY IT MATTERS

These developments in Indonesia's mining sector have a broader context.

While resources may not dominate the Indonesian economy, they are a key part of economic stability. Palm oil, coal and oil and gas represent approximately 68% of Indonesian exports. The recent falls in resource demand and commodity prices have not only increased pressure on miners, they have also contributed to a negative terms of trade.

For over a decade, Indonesia has been a net oil importer. As reflected by Jakarta traffic, domestic consumption continues to increase. Oil is also subject to government subsidy. In June 2013, the government reduced the subsidy, resulting in a 44% increase in petrol prices and widespread public protests. Yet the revised subsidy still represents a cost of approximately US$20 billion a year.

The Indonesian currency continues to weaken, peaking at over 11,500 rupiah against the US dollar. While favourable for resource exporters, in the oil context the consequences are a growing budget deficit and a record current account deficit.

Facilitating mining is not the answer to these macroeconomic challenges. But the legal framework, and the extent to which it facilitates foreign investment, is not irrelevant either.

In order to avoid making a bad situation worse, a reconsideration of some of the recent regulatory developments – and a recognition of the positive contribution of, and continuing need for, foreign investment – would be welcome.

Footnote

1For more information on establishing a PMA Company in Indonesia, refer to the article available here.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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