Attracting or retaining Foreign Direct Investment in minerals exploration and mining has not been a priority for Indonesia for over 15 years. The country's far-reaching Regional Autonomy Law in 2001 devolved permitting to municipalities, a level of government without authority to contract directly with foreigners. This anomaly was meant to be resolved by the 2009 Mining Law. However FDI was subsequently discouraged by onerous new regulations, including a process to unilaterally abolish Contracts of Work established as vehicles for foreign investment. Despite a high turnover of ministers responsible for the mining sector in its first two years, the national government of President Joko Widowo has made efforts to consult more thoroughly with the industry on the next Mining Law. Muhammad Karnova, Reggy Firmansyah, Luke Devine and Norman Bissett of Hadiputranto, Hadinoto & Partners, a member of Baker & McKenzie International, provide the following observations on some of the issues tackled by the latest draft of the proposed law.
FOLLOWING
THE APPOINTMENT of a new Minister and Deputy Minister to Indonesia's Ministry
of Energy and Mineral Resources (MEMR), revising the current legal and
regulatory regime for miners will be a key priority. We have recently
reviewed a discussion draft of a proposed new mining law circulated by
the MEMR (Draft Mining Law). The Draft Mining Law, if enacted, will
replace Indonesia's existing mining law, Law No 4 of 2009 on Minerals and Coal Mining (Current Mining Law). It is likely that the Draft Mining
Law will go through further iterations before reaching a final form;
however, it provides a useful insight into the current thinking of the
Government in respect of many issues of importance to investors in the
mining industry in Indonesia.
Contracts of Work
The
Government seems determined to drive a stake through Contract/Coal
Contract of Work holders once and for all. The proposed legislation
requires all COW/CCOW holders to be converted into IUPKs (see below)
within one year. The period of the IUPKs will be the same as the
remaining period under the COWs/CCOWs, with the rights and obligations
under the IUPK matching those under the contracts, as amended.
The
draft law is silent as to what happens if the COW/CCOW contractor does
not agree with this process. The proposed draft also seems to assume
that contractual rights and obligations under a COW/CCOW can be easily
converted into licences. Query whether this process will be so
straightforward. How, for example, will the IUPKs incorporate binding
arbitration provisions, or the attempts of some generations of
COWs/CCOWs to nail down tax rates, etc.?
In this connection,
the reference to the rights and obligations of the IUPKs matching those
of the amended COWs/CCOWs would seem to be an indirect attempt to
resuscitate the concept under the Current Mining Law, that effectively
the more disadvantageous fiscal terms should apply. On top of this, an
additional 10% royalty on net profits will be payable by IUPK holders.
Processing and refining
The
Draft Mining Law contains provisions requiring domestic processing and
refining of minerals and coal which are more detailed than in the
Current Mining Law but largely replicate existing regulations which have
been issued under the Current Mining Law. Domestic processing/refining
is a compulsory term to be included in each IUP and IUPK.
This
being said, the Draft Mining Law refers to the requirement for mining
companies to increase value through processing and/or refining. Both
terms are clearly defined, with processed minerals retaining their
original physical/chemical properties, and refined materials having
different properties from their constituent ores. If this distinction is
maintained, query whether, in fact, the Government is trying to move
away from requiring the construction of smelters to accepting that
beneficiation of ore is an equally significant "value add".
In
this connection, the amount of value adding which needs to be performed
is stated to be determined based on a consideration of the quantity of
mineral or coal reserves available and domestic industrial demand. On
one interpretation, this would appear to leave the door open for export
of raw ore without any processing or refining if there are sufficient
reserves and insufficient domestic demand.
Notwithstanding
this, it seems that there is still every likelihood that the Government
will seek to impose smelter construction requirements for most minerals,
while at the same time allowing itself some additional flexibility with
regard to others.
Another new aspect is that provisions have
been included which provide that fiscal incentives may be provided to
holders of mining licences who construct processing and/or refining
facilities. Unfortunately, it is not clear from the drafting whether
this means that new fiscal incentives may be provided under the Draft
Mining Law as new incentives or whether those incentives only consist of
the general incentives available under other prevailing laws and
regulations. Nor is it clear that these incentives would apply to
smelting companies, as opposed to companies holding mining concessions
and seeking, also, to build their own smelters.
Divestment
The
Draft Mining Law contains divestment provisions that are similar to
those contained in the implementing regulations of the Current Mining
Law. However, the ultimately permissible level of foreign ownership
before divestment will apply has been changed from 49% to become 51%.
This means that foreign shareholders will be able to have a controlling
interest in the mining company, rather than the situation under the
Current Mining Law, which requires that foreigners ultimately divest to a
level where their interest is a minority interest. This is an
improvement for foreign investors over the current situation but still
much worse than the originally permitted 80% foreign ownership, which
applied when the implementing regulations of the Current Mining Law were
issued in 2010.
As with the Current Mining Law, shares which
are to be divested must first be offered to State-owned enterprises (at
the Central, Provincial and Regional levels). However, in contrast to
the Current Mining Law, if these entities do not wish to take up the
shares, the mining company is required to divest by offering new shares
on the Indonesian stock exchange, rather than directly to private
entities. The shares that are offered on the stock exchange may only be
taken up by Indonesian entities (not foreigners or foreign-owned
entities). Query, however, how on-sales will be restricted.
Longer production periods for integrated projects
The
Draft Mining law provides an additional 10 years to the initial
production period of a minerals IUP provided that the project is
integrated with processing and refining facilities. Similarly, an IUP
for coal mining will obtain an additional 10 years for its initial
production period if the project is integrated with a thermal coal power
plant (a mine-mouth project). Presumably this is to allow a greater
time for return on investment given the additional capital costs
involved in also establishing the processing or power facilities. The
extended time periods also apply in relation to IUPK projects that are
similarly integrated.
For IUP projects, applications for
extension of the production period must be filed no earlier than four
years before expiry and no later than one year before expiry. For IUPKs,
applications must be filed no earlier than five years before expiry and
no later than one year before expiry. So IUPK holders are given a minor
degree of additional flexibility as to when they can apply.
IUPKs
The
concept of an IUPK is defined under the Current Mining Law as a mining
area with strategic value to the State. That said, their precise purpose
was never clear under the Current Mining Law and no IUPKs have ever
been issued, although in the intervening years since the introduction of
the Current Mining Law, the Government has come to the view that IUPKs
should be used to replace existing Contracts of Work.
The
Draft Mining Law defines the area over which an IUPK may be granted as
being an area to be used for mining operations "in light of national
strategic interests", not too dissimilar from the Current Mining Law. A
new development though is that the detailed provisions in respect of
IUPK areas provide that the areas must be areas "to be used for the sake
of national interests in fulfilling domestic industrial raw materials
and energy needs". This contrasts with the provisions on determination
of areas for IUPs, which merely require that the areas must be "used for
sustainable mining activities". This contrast suggests that coal and
minerals derived from an IUPK area may need to be used domestically and
may not be able to be exported. The result is that IUPK areas are
effectively national strategic reserves. This concept seems to sit
uncomfortably with the concept of COWs/CCOWs being converted into IUPKs.
As
with the Current Mining Law, the Draft Mining Law gives priority to
receive an IUPK to national State-owned enterprises (BUMN) and Regional
Government-owned enterprises (BUMD). IUPKs may be granted directly by
the Government to BUMN and BUMD based upon an application from the
relevant BUMN/BUMD. They may only be granted to private business
entities if there is no interest from BUMN and BUMD, in which case the
grant will occur after a public auction in which the private business
entities are requested to bid for the relevant IUPK area.
As
mentioned above, IUPK holders may apply for an extension five years
before the expiry (but no later than one year before the expiry) of the
IUPK. The concern with this is that where the extension of a
COW/CCOW/IUPK requires more than 10 years to be viable, it is not at all
clear that it will be possible to request the second extension until
half-way through the first extension. Given depressed commodity prices,
and the extra burdens being heaped onto mining companies, the absence of
any clear certainty on the second extension of any mining concessions
may prove fatal to raising finance, and to these projects.
Bidding directly for Production Operation IUPs
Consistent
with the Current Mining Law, holders of Exploration IUPs are entitled
to upgrade to Production Operation IUPs provided they perform their
obligations under the IUP and continue to comply with the various
requirements under the law and regulations. However, the Current Mining
Law does not provide any method for the Government to issue a Production
Operation IUP to a mining company without first issuing that mining
company with an Exploration IUP. This does not work in circumstances
where, for example, an Exploration IUP holder may have fully explored
the area and then chosen not to upgrade to Production Operation
(relinquish their IUP) or has otherwise failed to comply with its
obligations.
The Draft Mining Law allows existing IUP areas
that have previously reached the feasibility stage (meaning that the
Government already has sufficient data on the reserves in the area) to
be auctioned to interested mining companies. The price that is being bid
upon is the price that will be used to compensate the Government for
the resource information that will be handed over to the successful
bidder. The successful bidder can then be directly issued with a
Production Operation IUP without needing to go through the Exploration
IUP stage. The provisions in the Draft Mining Law that relate to IUPKs
also implement the same concept.
Project financing difficulties not addressed
Sadly,
the Current Mining Law does not address one of the main difficulties in
respect of project financing involving mine-mouth power plants and
mineral smelters: the fact that the foreign ownership requirements for
mining companies are different from those for power plants and smelters.
This currently complicates project financing as the differing foreign
ownership requirements (and divestment regime under the Current Mining
Law and Draft Mining Law) mean that there will be different sponsors
(with different proportions of equity) in the mine part of the project
compared to the power or smelting part of the project.
The
Draft Mining Law seeks to address this to some extent by giving a longer
period to divest for integrated projects; however, this does not
necessarily solve the issue as it still means that a change in sponsors
could be required at a point in the project lifecycle that may not be
the most desirable. Settlement of surface rights with other land users
Unfortunately,
the Draft Mining Law does little to ease the ability of mining
companies to settle the compensation payable to owners of surface rights
over land or to institute a system for settling disputes in this area.
It does, however, clearly state that a grant of an IUP or of an IUPK
does not include surface rights. The Draft Mining Law also says that
settlement with surface rights holders can be reached through consensus
by way of purchase, exchange, proper compensation, acknowledgment and
other forms of compensation (including the mining companies guaranteeing
that they will reach a settlement - having reached agreement - but not
yet (presumably) implementing it in full).
Tax incentives
In
addition to the fiscal incentives which may apply in respect of
processing and refining facilities, the Draft Mining Law also separately
provides that tax relief and incentives may be provided to increase
investment in the mining sector generally (without any linkage to
construction of processing and refining facilities).
Non-tax levies
A
welcome addition included in the Draft Mining Law is a prohibition on
the Central, Provincial and Regional Government imposing non-tax levies
which would add to the burden of financial obligations on holders of
IUPs, IUPKs and Special IUPs for Processing and Refining without first
obtaining Ministerial approval.
Mining services companies
The
Draft Mining Law contains provisions in respect of mining services
companies that change the regime applying at the moment. Consistent with
the current regime, ministerial approval is required to appoint an
affiliated company to provide mining services (in order to cut down on
transfer pricing issues). However, in contrast to the current regime,
the Draft Mining Law anticipates that mining services companies will be
permitted to conduct actual extraction of mineral ores (not just removal
of overburden). This will be a welcome change for mining services
companies and mining companies who contract out services.
IUPs for Transportation and Sales
As
with the Current Mining Law, companies that do not engage in mining but
wish to conduct transportation of mine ores or trading of mine ores
need to obtain a licence for this purpose (a Special IUP for
Transportation and Sales). As referred to above, the Draft Mining Law
contains provisions that suggest that holders of such an IUP may only
trade minerals and coal domestically. There will also be an additional
royalty applied to trading activities.
Public participation
The
Draft Mining Law bolsters the rights of groups that are affected by
mining activities with specific provisions that provide that the public
is entitled to: • information regarding the implementation of mining
activities; • benefits from mining activities through the corporate
social responsibility obligations of mining companies; and • obtain
redress due to failures to implement mining activities in accordance
with legislation.
The Draft Mining Law provides rights for
the public to file lawsuits in Indonesian courts to obtain damages as a
result of any mining activity that violates laws or regulations. The
relationship between these rights and those given to local communities
under the Environmental Law and related regulations is unclear.
Centralisation
When
the Current Mining Law was introduced, it implemented regional autonomy
principles by allowing most decisions in respect of the vast majority
of mining licences (IUPs) to be made at the Regional Government level.
Unfortunately, lack of capacity at the Regional Government level
resulted in many invalidly issued licences, necessitating the Central
Government to step in and perform a verification process in relation to
the thousands of licences that were issued at the Regional Government
level. Seven years after the Current Mining Law was introduced, that
verification process (colloquially known as the "Clean and Clear"
process) is still ongoing.
The Draft Mining Law addresses
this by pushing authority over the majority of mining licences one level
up the hierarchy, to the Provincial Government level (consistent with
changes introduced by the Regional Administration Law). Further,
authority moves another level up to the Central Government in respect of
mining licences where the level of foreign ownership is 34% or greater.
The
34% mark appears to be arbitrary, roughly equal to one-third foreign
ownership. Recent regulations under the Current Mining Law, intended to
address lack of capacity at the Regional Government level, had moved
authority in respect of companies holding mining licences with any level
of foreign ownership up to the Central Government level. Consequently,
the situation envisaged in the Draft Mining Law is a compromise: the
Regional Government level loses authority in respect of the vast bulk of
mining licences, while the Provincial Government level gains that
authority (so it is not the case that everything is re-centralized to
the Central Government) but the Central Government level retains
authority if there is a significant degree of foreign ownership.
The
same delegations of authority are reflected in respect of authority to
issue licences for processing and refining facilities (Special IUP for
Processing and/or Refining), for issuing licences for mining services
companies (IUJP) and licences for transportation and sales businesses
(Izin Pengangkutan dan Penjualan).
The Central Government
retains the right to set national policies in respect of minerals and
coal mining (including domestic market obligations and export quotas)
and also retains the exclusive right to issue special mining licences
(IUPKs).
Conclusion
The Draft Mining Law is merely
a draft and may be subject to further iterations. Interpretations of
these new provisions may also differ. While considering the Government's
approach in the Draft Mining Law is a useful endeavor for those
interested in lobbying the Government, investors should wait for a final
version of the legislation before considering any impact on their
investments.
This being said, while the Draft Mining Law makes a number
of welcome concessions to investors (e.g., by relaxing the divestment
requirement), the overall effect of these proposals - given the current
stresses being put on the industry - may do little to revitalize
Indonesian mining for the time being.
See also: Indonesia and Philippines mining companies face increased uncertainty & compliance risks (31 July 2016);
New government policy breakthrough for Indonesia's minerals exploration industry? (1 Feb 2016);
Global downturn in commodity prices and domestic regulatory challenges dampen investment interest in Indonesian mining (13 Jan 2016);
Observations on Indonesian Exploration (17 Sep 2010)
