Release: Crisis and new mining law pose challenges for the mining industry in Indonesia: PwC
Thursday, February 26 2009 - 12:36 PM WIB
PwC mining technical advisor Sacha Winzenried notes that ?consistent with previous years, while the Indonesian mining industry continued to show strong financial results during the strong commodity price environment of 2007, the exploration spending on new projects is still very low, considering the geological attractiveness of Indonesia.?
Mr. Winzenried also indicated ?Survey respondents still have concerns on the regulatory climate for the mining industry in Indonesia, despite the issuance of the new Law on Mineral and Coal Mining, which provides its own challenges for the industry.?
Surge in commodity prices continues to drive profitability in 2007, but falls off in 2008
For the Indonesian companies analysed in the PwC report, aggregate revenues have increased by 27% in 2007 over 2006 and net profits increased by a massive 65%. This is even more significant considering that 2006 net profits were already 17% above the prior year. 2008 is a stark contrast, with the results for the listed mining companies showing a decrease in revenues from 2007 of 3% and a much greater decrease in profitability of 33%. This reversal of fortunes was particularly dramatic for the minerals companies with a fall off in prices across the board, but most notably for nickel and copper. The coal miners however managed to show profit growth for both 2007 and 2008, given their annually negotiated sales prices were agreed in late 2007 and early 2008 in the high price environment.
During 2007, investor confidence in the mining sector was strong in Indonesia, and around the globe, as witnessed by a year of significant growth in the market capitalisation of mining companies on both international bourses and the Indonesian exchange. From mid-2008 commodity prices began to weaken, falling dramatically in the third quarter of 2008 when the full extent of the global economic difficulties became evident. This saw a massive sell-off of equities around the globe, across all sectors, with the mining sector heavily impacted. The aggregate market capitalisation of mining companies on the Indonesia Stock Exchange surged by more than 300% from 2006 to 2007, but by the end of November 2008, the market capitalisation had been slashed by 74%.
Mr. Winzenried stated that ?it is noteworthy that the sustained increase in profitability in the Indonesian mining sector from 2002 - 2007 stems largely from the commodities boom, rather than any significant expansion in activities.?
Mr. Winzenried also notes ?the improvements in profitability during the commodities boom masked substantial increases in operating costs which occurred due to supply side constraints. The industry now faces the challenge of significantly reducing operating costs built-up over this period, in order to lessen the effect of the downturn.?
There are significant challenges to increased investment in Indonesia?s mining sector. PwC?s report shows that there was a slight increase in total investment spending in the Indonesian mining industry in 2007 and 2008, however this mostly related to existing mines and particularly coal mines. The high commodity price environment during 2007 was not enough incentive to generate a significant boost in investment in the Indonesian mining sector. 2007 and previous years saw some growth in investment spending, but exploration spending is still very low considering the geological attractiveness of Indonesia compared with exploration spending globally. This condition will likely continue into the near term, especially given the current global economic difficulties.
Mr. Winzenried pointed out that ?the survey data for Indonesia, again, continues to show minimal investment in greenfields exploration, and that the other investment spending is mainly for replacement plant and equipment to maintain existing operations?.
Mr. Winzenried notes that ?this is a concern, as it indicates that existing players in the Indonesian mining sector are willing to spend to maintain current operations, but are not investing in new developments. Likewise the sector is not seeing significant investment from new participants?.
The PwC report shows that survey respondents still have concerns on the regulatory climate for the Indonesian mining industry, with the top issues noted being:
i) conflict between mining operations and forestry regulations;
ii) duplication and contradictions between central and regional government regulations;
iii) need for inclusion in the new mining law of a mining agreement similar to a contact of work system;
iv) lack of fairness in divestment of foreign mining interests and mine closures;
v) uncertainty in Contract of Work system and other mining regulations;
vi) taxation issues (tax incentives, VAT on gold and coal, corporate tax rate);
vii) illegal mining;
viii) delay in finalisation of the new mining law; and
ix) lack of coordination between new investment law and mining regulations.
Many of these issues are similar to those that have been raised in previous years, and the PwC report notes that survey respondents consider that only limited progress has been made in resolving these matters.
Mr. Winzenried highlighted that ?this situation has now been exacerbated by the change in the regulatory environment in Indonesia with the passing of the new Law on Mineral and Coal Mining. Unfortunately, Indonesia did not attract significant new investment during the global mining boom. Many projects slated for commencement in the last few years were delayed due to various regulatory hurdles, With the passing of the new mining law, the future of these projects may now be in doubt, as the contract of work system is no longer available. This is compounded by the onset of the global economic downturn, and the accompanying fall in commodity prices, which is forcing even the largest global mining companies to rethink their investment plans around the world.?
?Unless Indonesia can demonstrate a competitive advantage over other mineral rich countries, it will miss out on the allocation of the scarce investment funds available in this tight economic environment. It is not clear that the contents of the new mining law will provide the necessary stimulus? he continued.
The PwC report lists the Top12 issues and challenges from this new Law as ranked by the survey respondents:
1. Contradictory transitional provisions for existing Contracts of Work and Coal Contracts of Work - to what extent will the terms of existing CoWs and CCoWs be grandfathered?
2. Requirement for existing producing CoWs to conduct onshore processing of ore within five years of enactment of the new Law.
3. Requirement for existing CoW/CCoW holders to submit a mining activity plan for the entire contract area, within one year of enactment of the new Law, or face relinquishment of parts of the contract area.
4. Lack of clarity in process for conversion of existing Kuasa Pertambangan (KPs or Mining Rights) to Izin Usaha Pertambangan (IUPs) under the new Law IUPs) under the law
5. Potential delays in issuing implementing regulations to regulate provisions of the new Law.
6. Divestment requirement for foreign interests in IUPs within five years of production commencing.
7. In-country processing requirement for all IUP holders.
8. Restrictions on IUP holders using affiliates to provide mining support services.
9. Dealing with regional/local government officials to obtain IUPs.
10. Restricted size of exploration and exploitation lUPs, which may hamper large-scale projects.
11. Reduced legal certainty compared to provisions of existing CoWs/CCoWs.
12. Absence of a form of agreement/contract for large projects above a certain investment threshold.
Mr. Winzenried noted that ?given the reported concerns of many mining industry participants, the new law may not have entirely eradicated the uncertainty that has been hanging over the mining industry in Indonesia for some time. The terms of the law may be adequate to encourage some investors, both foreign and domestic, to take direct equity stakes in relatively small-scale projects. This will have a positive impact on investment. However, there is likely to be greater uncertainty around large-scale capital intensive projects, as the new law does not offer the long-term protections of the contract of work system.?
Mr. Winzenried also notes that ?the mining industry in Indonesia is now eagerly awaiting the implementing regulations for the new law, hoping that they will provide clear guidance for the future growth of the industry.?
The mining industry is an important contributor to the Indonesian economy
The PwC report states that the impact of the mining industry on the Indonesian economy continues to be significant, representing approximately 4% of Indonesian GDP and more than 20% of export revenues.
Total government revenue from all sources reached US$4.8 billion, a record for the last decade. Income taxes and royalties made up 72% of this amount.
The industry also continues to make significant contributions to regional and community development - Rp 1.7 trillion in 2007 based on survey respondents, or an increase of 70% from the previous year, on top of a 26% increase in 2006. The industry continues to be a major employer, with the total number of employees reported by survey respondents increasing 1 % to 38,500. Employee compensation has however increased significantly (by approximately 12% overall, on top of a 49%? increase in 2006) due to increased benefits received as a result of increased profits and production.
The PwC report notes that the total economic benefit to Indonesia is significantly greater than the direct benefits captured by the survey. This is because of the indirect multiplier effect that the mining industry?s direct contribution has on other economic activity, which is particularly noteworthy in the regional and remote areas where the industry operates.
Outlook
?2007 was another spectacular year for the global mining industry, as illustrated by the record results for the sector as a whole in Indonesia. This growth has tapered off in 2008 with the impact of the global economic downturn beginning to take hold. Recent years saw unprecedented demand, primarily driven by Asia, and new supply coming on stream for many commodities. This bullishness has dissipated and the next few years are likely to see less investment in the sector from the global players? Mr. Winzenried said.
Mr. Winzenried also noted that ?this leaves the Indonesian mining industry in a precarious position, as it grapples with the terms of the new mining law. It is unfortunate that the issuance of this law has coincided with the global economic downturn and the accompanying fall in commodity prices. While these are challenging times, Indonesia has a great opportunity to set itself up for the upturn in the sector, which many analysts expect to begin as early as 2010. Key to this is bedding down the implementation of the new mining law through swift issuance of comprehensive and unambiguous implementing regulations, which address the main areas of uncertainty for investors.?
?Only time will tell whether investors will overcome their concerns and invest in the large projects which are the lifeblood of a strong mining sector. What is clear is that it would be best for all concerned if the implementing regulations for the new law are issued as quickly as possible and cover all potential issues, as uncertainty is the enemy of increased investment? Mr. Winzenried stated.