The love-hate relationship in the mining sector

Achmad Syafriel, Analyst

An investor-focused environment is needed before Indonesia can make the most out of its natural resources.

A few weeks ago, I attended a panel discussion about the development of mining in emerging economies. The keynote speaker was a director of a major Brazilian mining company. He shared some interesting insights about CVRD, his company, in its journey to becoming a global commodities producer.

Established in 1942 by the Brazilian government, CVRD went public in 1997. The company's market capitalization has grown from only US$10 billion to over US$150 billion currently.

Now they are the second largest integrated diversified metals and mining company, and have operations in many locations around the world, including Indonesia.

The company is the world's largest producer of the iron ore and pellets needed for producing steel. It is also one of the largest producers of nickel, a raw material used in the production of stainless steel, and also produces other metals, such as copper, bauxite, and manganese.

CVRD's success story should serve as an example to Indonesian mining companies. Indonesia has abundant natural resources. But of the many domestic mining companies, none are anywhere near the size of Brazil's CVRD, or any other global mining company. Regulatory uncertainties may have been a key barrier in this regard.

The mining sector requires huge investment and is fraught with high risk. Geological data may show potential reserves in certain areas; however mining companies still need to perform further expensive tests to ensure the technical and economic feasibility of exploration before progressing to the exploitation stage.

Exploration and exploitation work is cost intensive and requires hi-tech expertise. All of these costs must be borne by the mining companies. So, many foreign companies have been invited to invest in tandem with local mining companies. These companies then sign agreements with the government to conduct exploration and production work under specific profit-sharing schemes and for specific periods of time.

But Indonesia has always had a love-hate relationship with the mining companies. On one hand, the present legislation and regulations are often criticized for being insufficiently in favor of Indonesia. The profit scheme is often more beneficial to the foreign companies than the state as the owner of the resources.

But on the other hand, the government must be able to provide more certainty to the mining companies. For example, there have been a number of instances whereby higher royalties and corporate taxes, in addition to what was initially agreed, have been demanded from the mining companies. This does not provide good publicity for the investment climate.

Another issue that needs tackling is the uncertainties regarding Contracts of Work (CoWs). Every mining company operates under a Contract of Work. This elaborates on the details of the agreement, such as the areas covered by the CoW and its duration. A company should not face any other obstacles to performing its work inside the areas covered by the CoW.

However, the reality is different. In many cases, forestry regulations conflict with valid CoWs. The areas covered by CoWs are frequently designated as protected forests by the Forestry Ministry. This prohibits exploitation work, and requires the company to obtain an additional permit from the Ministry, thus creating unnecessary uncertainty.

To better manage the mining sector, the government together with parliament, is preparing a new mining law. Unfortunately the bill as it currently stands is beset by various shortcomings that could further exacerbate the problems.

Before the rolling out of local autonomy, the central government was the only authority that could sign mining agreements and issue permits. Under the mining bill, companies will have to obtain a variety of permits from local governments. They will need one permit for exploration and another for exploitation.

This only serves to give rise to further uncertainty: mining companies have to spend huge sums to undertake exploration work. However, the exploitation permit could eventually be given to another company at the local government's discretion.

The term "permit" should also be reconsidered since it does not accord adequate legal status to mining companies, as opposed to contractual agreements that provide greater detail about the rights and obligations of each party (i.e., the government and the company). Permits can be revoked at any time, unlike an agreement.

A better share of profit for the Indonesian public is important. But companies must be willing to invest in the first place before any revenue can arise. The new mining law, when eventually enacted, should be able to provide certainty and encourage more investment. To achieve this, a lot still needs to be done.

- The writer is an analyst in the research department of PT Bahana Securities
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