Indonesia's mining sector

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Indonesia's mining sector

indonesia mining minerals coal

Indonesia has significant coal and mineral deposits, with the majority of Indonesia's mining exports being thermal coal. Indonesia's close proximity to the large energy-consumption nations of China, India, Japan and Korea, coupled with low-cost production, have resulted in Indonesia becoming the world's largest exporter of thermal coal. The country scores very highly for its prospectivity. However, this attractiveness is tempered somewhat by Indonesia's regulatory uncertainty.

The investment climate in the mining sector has been challenging due to a major regulatory overhaul which commenced in 2009 with the passing of a new Mining Law to replace its 1967 predecessor. Since the passing of this general framework law by the Indonesian Parliament in January 2009, the Indonesian Government has over the past few years continued to develop the detail of the new mining regulatory regime, and continues to issue new regulations to implement the Mining Law. This has had the inevitable effect of causing uncertainty for investors -- as making investment decisions in a changing regulatory landscape is fraught with risk. However as things currently stand, the vast majority of the implementing regulations have been issued, and the focus around regulatory uncertainty has now shifted to the issue of whether the Government plans to go back and re-visit and amend some of these implementing regulations despite their relatively short life.

Indonesia, like a number of other jurisdictions around the world, is struggling to draw the correct balance in respect of the interests of mining companies vis-a-vis the interests of the Indonesian Government and Indonesia's people. Recent reforms in respect of imposition of obligations on mining companies to supply the domestic market, bans on the export of ore in order to have mining companies carry out value adding processing in Indonesia and requirements for foreign investors to divest majority control of their mining operations are all elements of the phenomenon of ``resources nationalism” which is affecting resource-rich jurisdictions around the world. How the Indonesian Government draws this final balance will have a major impact on Indonesia's ability to attract the foreign capital necessary to enable Indonesia to fully and sustainably exploit its natural resource wealth.

Mining is regulated under Law No 4 of 2009 on Mineral and Coal Mining (the Mining Law). The Mining Law replaced the previous law on mining, which had been in place since 1967. The current Mining Law sets out general requirements but leaves large aspects to further implementing Government Regulations and Ministerial Regulations. These have been progressively issued since the introduction of the Mining Law, and as things presently stand, the vast majority of the implementing regulations have already been issued.

Mining rights take two main forms in Indonesia:

* “IUPs” (Izin Usaha Pertambangan - Mining Business Licenses), which are in the form of a license with a set of standard license conditions (about five pages long); and

* “Contracts of Work”, which are in the form of an agreement between the government of the Republic of Indonesia and an Indonesia-incorporated mining company. A Contract of Work sets contractual requirements for each stage of the mining project from general survey to production, and also provide for other matters such as taxation. From the introduction of the current Mining Law, no more Contracts of Work will be issued and existing Contracts of Work will be phased out upon expiry of their current terms. Contracts of Work have traditionally been used for large mining projects often with foreign ownership.

Companies incorporated in foreign countries cannot hold an IUP or a Contract of Work directly. An Indonesia-incorporated company is needed to hold the IUP or Contract of Work. Foreign companies can hold shares in this Indonesia-incorporated company but subject to foreign ownership restrictions discussed below.

IUPs are issued by various levels of government based on the following rules (simplified somewhat here):

* If the IUP is to be issued to a company with foreign ownership, the IUP will be issued by the Central Government (the Director General of Minerals and Coal on behalf of the Minister of Energy and Mineral Resources).

* In all other cases:

(a) if the IUP area is within one regency (Local Government area), the IUP will be issued by the regent (the head of the local government);

(b) if the IUP area overlaps regencies, the IUP will be issued by the governor of the province; and

(c) if the IUP area overlaps provinces, the IUP will be issued by the Central Government (the Director General of Minerals and Coal on behalf of the Minister of Energy and Mineral Resources).

The reason why IUPs are issued at several levels of government is due to Indonesia's Regional Autonomy laws, which have the aim of giving regions more control over the wealth generated in their own regions. However, the Indonesian Regional Government Law that was recently issued indicates that the Regent is no longer entitled to issue the IUPs, and as the result if an IUP area is within one Regency (Local Government area), the IUP will be issued by the governor of the province. This new regulation causes an inconsistency with the Mining Law.

The Central Government has supervisory powers under the Mining Law and does exercise these. In essence, bureaucratic processing and evaluation of applications and compliance requirements under IUPs are done at the regional level. However, the rules and directions which govern compliance are set at the Central Government level.

Contracts of Work are all issued by the Central Government. Prior to the issuance of an exploration IUP for ferrous minerals and coal over a new area, a tender needs to be conducted.

The Mining Law also provides for “specific” IUPs which can be issued to companies wishing to undertake processing or transport and sales of minerals or coal but not having a mine. In addition, the Mining Law provides for some other types of mining rights such as “People's Mining Rights,” which are designed for small-scale (community) mining operations. These other types of rights are beyond the scope of this chapter.

The legal system

Indonesia has a civil law system inherited from Dutch colonial law. Contract law in Indonesia is governed by the Indonesian Civil Code, which derives from the nineteenth-century Dutch Civil Code which, in turn, derives from the French Civil Code. Since the end of the colonial period, most pre-existing Dutch colonial regulations (including some parts of the Civil Code) have been replaced by new Indonesian legislation.

Ownership of minerals and coal

Under Indonesia's constitution, the land, water and natural resources of Indonesia are under the control of the State and are to be used to the greatest benefit of the Indonesian people. The State is the ultimate owner of minerals and coal. Land titles (as opposed to mining rights) do not give the holders of the land any rights to minerals or coal located on or under the land.

The point at which a mining company obtains title to the minerals or coal mined varies. In the case of IUPs, the Mining Law provides that the mining company is entitled to own the minerals and coal “produced” provided that the necessary government duties have been paid, and for that purpose, the Indonesian Government requires the payment of government duties to be made before the minerals or coal is shipped or transported. From that point, the mining company will have good title to the minerals or coal which they can then transfer to offtakers. The time at which title passes can be different under Contracts of Work and depends on the precise terms in the particular Contract of Work, however, the earlier generations of Contracts of Work generally provide for title to pass at the point of export (for export sales) or domestic point of sale (for domestic sales).

Regulation of different minerals and coal

Indonesia only has one Mining Law which governs all mining activities (but not oil and gas or geothermal activities). In the Mining Law, distinctions are made between different minerals and coal in a number of areas, for example, in relation to the minimum and maximum size of concessions and the term of concessions. There are also some quite distinct and separate rules for radioactive materials.

Oil and gas

Oil and gas activities are regulated separately from mining under a quite different regulatory regime with different regulators, although both mining and oil and gas sectors are under the ultimate authority of the Ministry of Energy and Mineral Resources.

Restrictions on foreign investment in mining

Foreign shareholders in Indonesian mining companies holding IUPs may initially own 100% of the shares but must progressively divest shares to Indonesians (or Indonesian-owned entities) from the end of the fifth year of production moving from a maximum foreign ownership of 80% in the sixth year of production to a maximum of 49% in the tenth year of production. The recent change that was introduced by the Government is that foreign shareholders are permitted to maintain their ownership in an Indonesian mining company holding a Production Operation IUP up to 60% if the company carries out its own processing or refining activities, and up to 70% if the company carries out underground mining. In that case, they are given 15 years to achieve the sell-down. The change also provides that for holders of IUPs whose shares are listed on the Indonesian Stock Exchange (IDX), a maximum of 20% of those shares are recognized as being held by “Indonesian participants”, irrespective of whether those shares are in fact held by Indonesians or foreigners. However, it does not apply to an IDX-listed shareholder of an IUP company.

The shares for a sell down are required to be offered to the Government and Governmentowned entities ahead of Indonesian private entities, at cost basis (not market value). If the foreigners divest prior to the time the relevant divestment requirement applies, they may choose who they divest to as the divestment requirement will not need to apply.

Minimum sales pricing, domestic market obligation and onshore processing

Indonesia has a coal “benchmark pricing system” under which a reference price is determined based on an average of a number of international and Indonesian published coal indices. This reference price is then split (using a formula) into a number of different reference prices for different brands of Indonesian coal based on differences in calorific value, sulfur, moisture and ash content. Sales contracts for coal are required to “refer” to the benchmark price, and royalties on the sale will be calculated on the higher of the benchmark price and the sale price. It is not clear from the regulations as to whether the sale price can be below the benchmark price (regardless of whether royalties are paid at the benchmark price). However, the Government takes the view that sales below the benchmark price should not be permitted. A failure to adhere to the benchmark pricing regime can ultimately lead to a revocation of the IUP. The benchmark prices are issued monthly by the Directorate General of Minerals and Coal. For “spot” contracts (contracts with a term of less than a year), the applicable benchmark price is the benchmark price at the time of delivery, whereas for “term” contracts (contracts with a term of more than a year) the applicable benchmark price is the weighted average of the benchmark price over the three months prior to the beginning of the term (reset after each year of the term). A similar benchmark system is contemplated for other minerals.

Indonesia also has a “domestic market obligation” in relation to coal sales. In summary, the Government obtains forecasts from the larger coal producers of their expected output in the following year and from major coal consumers (mainly power stations) of the expected coal requirements for the following year and then stipulates a percentage of production which the major coal producers must sell to the major coal consumers. A producer who has exceeded its domestic market obligation may sell quota to a producer which has not been able to achieve its domestic market obligation. The domestic market obligation for 2015 is 23.4071% of production, which has been applied to 82 coal producers. The list of producers who have a domestic market obligation imposed on them can change from time to time.

The Mining Law requires domestic processing of minerals to begin by 12 January 2014. Consequently, the Indonesian Government has now implemented a ban on the export of mineral ores. However, the Indonesian Government has also taken a temporary and transitional measure which gives a case-by-case exception for export of an amount of semiprocessed minerals (typically in the form of concentrate meeting minimum mineral content levels). This exception is only available until 11 January 2017 at the latest, subject to hefty and progressively increasing new export duties. Further, the temporary exception is only available to mining companies who can demonstrate concrete plans for construction of refining facilities or cooperation with those who are constructing such facilities. In January 2014, the Ministry of Finance issued a regulation increasing export duties for the mineral ores which are exported in the interim period until 11 January 2017. The export duty begins at 20% or 25% in 2014 (depending on the mineral) and progressively escalates to 60% for exports from 1 July 2016 to 31 December 2016. The export can be conducted after the relevant mining company obtains an export recommendation from the Directorate General of Minerals and Coal and an export approval from the Ministry of Trade.

The Government has also now required any export of coal and minerals to use a letter of credit instrument. However, exporters can apply for an suspension of the use of the letter of credit to the Minister of Trade provided that they can fulfill certain requirements (e.g. existing contracts that provide the terms of payment other than letter of credit was entered before 5 January 2015).

Environmental considerations

A Production Operation IUP cannot be granted unless an Environmental Impact Assessment (known as an AMDAL) or a less onerous Environmental Management Efforts/ Environmental Monitoring Efforts (known as UKL-UPL) has been completed and approved by the Government, and an environmental permit has been obtained. Whether a mine requires an AMDAL or an UKL-UPL depends on the size of the mining project. The AMDAL includes an ongoing monitoring and reporting plan which also needs to be complied with.

There are a variety of smaller licenses which are also needed for particular activities. The following are the typical environmental licenses which may be needed:

* a license to use groundwater;

* a license to use surface water;

* a license to dispose of wastewater to water courses;

* a license to operate wastewater treatment facilities;

* a nuisance act permit; and

* a license to dispose of hazardous and toxic waste.

It is a condition under a Production Operation IUP and the related regulations that the mining company deposits a “mine closure guarantee” and a “reclamation guarantee” with the Government prior to commencing any production activities. The amount of the deposit is determined by the Government as part of the review of the reclamation and post-mining plan submitted with the application for the Production Operation IUP. At the end of a mining project, the mining company must perform reclamation on the land affected, to restore the land to a natural state. A reclamation guarantee is also required for reclaiming land damaged by exploration activities.

In order to conduct any activities in a forest area, a license from the Ministry of Forestry known as a “Borrow and Use” license (in Indonesian, an “Izin Pinjam Pakai”) is required. The concept is that in some areas of Indonesia where there is insufficient forest cover, in addition to reforesting the land used for mining activities when completed, additional land must also be provided and reforested by the mining company prior to mining activities being conducted. In other areas, where there is sufficient forest cover, only an additional government levy is paid. There are numerous requirements in relation to obtaining a “Borrow and Use” license. Open-cut mining is prohibited in areas of forest designated as “Protected Forest” (most of the coal mining in Indonesia is open-cut) so a “Borrow and Use” license cannot be obtained for these areas. There was also a two-year moratorium on the issuance of “Borrow and Use” licenses in certain areas of “peat land” and “primary natural forest” which was initially due to end on 13 May 2015, but has since been extended to 13 May 2017.

Indigenous people considerations

Indonesia has a system of registered land titles and a system of traditional unregistered land ownership. A mining concession is not a land title and does not remove the rights of those who have land titles or traditional ownership over land (the mining concession and the land titles co-exist). A mining company needs to negotiate and reach compensation agreements with local landowners in relation to the disruption of their enjoyment of the surface rights to the land (compensate for lost crops, for example). This can be done progressively as various areas of land are needed for mining activities or facilities within the mining concession area. It is not necessary for the mining company to actually purchase the land titles to the land, although sometimes a mining company may do this for strategic reasons.

Holders of IUPs are required to formulate plans for the development and empowerment of communities around the IUP area in consultation with the Local Government and local communities. These plans are submitted each year to the issuer of the IUP as part of the IUP holder's work plan and budget. The plans must be implemented and paid for by the holder of the IUP. IUP holders are also required to report on their progress in achieving the requirements of these plans. These plans often include things such as building (or contributing to) schools, roads and medical clinics.

Exploration

Tenements / rights available

There are two forms of IUPs: an IUP for Exploration and an IUP for Production Operation.

The IUP for Exploration covers the phases of General Survey, Exploration and Feasibility Study.

Terms of rights

The maximum term of an IUP will be between three and eight years depending on the mining commodity in question (see the table inrelation to Regulation of different minerals). An Exploration IUP has only one term and cannot be renewed. If exploration is not completed during the term of the Exploration IUP, the mining company will need to seek a new Exploration IUP (which will involve a tender process if it relates to ferrous minerals or coal).

The initial maximum exploration area also depends on the mining commodity. The maximum area for a Production Operation IUP is smaller than for an Exploration IUP so there may need to be relinquishment of areas which are not needed (depending on the size of the Exploration IUP) when moving to a Production Operation IUP. An IUP holder can also relinquish an area which is not needed voluntarily.

Holders of Exploration IUPs are required to pay “dead rent” to the Government, which is a flat fee per hectare covered by the IUP.

Steps to acquire an exploration right

At the time of writing, all existing IUPs are conversions of pre-existing mining rights which were issued under the previous Mining Law. The process for awarding new acreage is either by grant or by tender depending on the mineral commodities involved. New IUPs for ferrous minerals and coal require a tender process. The regulation on the tender process provides the required timeframes for almost all of every phase of the tender process which mainly consists announcement re proposed tender, pre-qualification announcement, determination of qualified tender participant and determination of tender winner. In determining the winner of the tender, the weighting applied is 40% to the evaluation of the prequalification materials, and 60% to the financial bid.

IUPs for non-metallic minerals and rocks (e.g. for quarries) do not require a tender, and can be directly granted to interested investors

Obligations of holder - Exploration

Exploration IUP holders are required to deposit a “seriousness guarantee” of USD100,000 in a government bank appointed by the issuer of the IUP. Holders of IUPs are also required to submit annual work plans and budgets to the issuer of the IUP and to provide quarterly reports on their activities conducted in accordance with the annual work plans and budgets.

The more significant license conditions under an Exploration IUP are to:

* deposit the “seriousness guarantee” mentioned above;

* submit an annual work plan and budget;

* submit quarterly activity reports;

* submit a plan for community development and empowerment and report on it;

* pay dead rent;

* prepare their AMDAL or UKL-UPL;

* prepare and eventually submit a feasibility study (for progressing to the production operation stage);

* prepare a reclamation and mine-closure plan based on feasibility documents;

* prioritize the use of local manpower and domestic goods and services;

* prioritize the use of local and Indonesian-owned mining services providers;

* submit exploration data, including exploration activity reports, to the Government;

* compensate holders of land titles who have had their use of the land disturbed;

* prepare plans for domestic processing and refining;

* relinquish areas of the IUP area which are not needed; and

* apply good mining norms.

Development / Production tenements

When the mining company has completed its exploration activities, feasibility study and AMDAL or UKL-UPL, it applies for a Production Operation IUP. A Production Operation IUP covers the phases of construction and mining, and also allows the holder to undertake processing and transportation and sales of the minerals or coal produced. An Exploration IUP holder is guaranteed to receive a Production Operation IUP provided that it has been in compliance with the terms of the Exploration IUP and applied correctly for the Production Operation IUP during the period required prior to the expiry of the Exploration IUP.

Terms of rights

The term and area available for Production Operation IUPs are set out in the table in section 1.4. Two extensions to the initial term of a Production Operation IUP are available (but may be rejected if there has not been good performance). Each extension must be applied for at least six months (but not more than two years) before the end of the current period of the IUP.

Steps to acquire a right - Development / Production tenements

The holder of an Exploration IUP who wishes to obtain a Production Operation IUP must apply for a Production Operation IUP at least three months prior to the expiry of the Exploration IUP. The holder is “guaranteed” to receive a Production Operation IUP provided that their application is satisfactory and they have been in compliance with the terms of the Exploration IUP. A number of documents are required to be submitted at the time of the application, including: * a map containing the boundaries and coordinates of the area in question (produced to the Government's standards);

* a complete exploration report;

* the feasibility study for development of the mine;

* the reclamation and post-mining plan in respect of the mine

; * the proposed work program and budget;

* details of the availability of mining specialists and geologists having at least three years' experience

There is no legislated time frame during which a Production Operation IUP must be issued. However, because the application must be submitted at least three months prior to the expiry of the Exploration IUP, the concept is that the Production Operation IUP should be issued before the Exploration IUP expires (i.e., within three months). In many cases, a Production Operation IUP is applied for considerably before the end of the Exploration IUP as exploration activities have already been completed.

Obligations of holder - Development / Production tenement

Holders of Production Operation IUPs are required to pay a royalty which is a percentage of the sales price. The royalty amount depends on the type of mineral or coal and other factors (for example, with coal there are different royalties applicable to different calorific values). Indonesia has a benchmark pricing system for coal (based on a number of indexes) and the royalty on the sale price will be calculated on the higher of the sales price and the applicable benchmark price.

The more significant license conditions under a Production Operation IUP are to:

* deposit mine closure and reclamation guarantee monies;

* submit an annual work plan and budget;

* submit quarterly activity reports;

* submit production reports;

* submit a plan for community development and empowerment and report on it;

* pay dead rent and royalties;

* prioritize the use of local manpower and domestic goods and services;

* prioritize the use of local and Indonesian-owned mining services providers;

* submit geological data to the Government;

* compensate holders of land titles who have had their use of the land disturbed;

* obtain approval for long-term sales contracts (three years or more);

* perform processing domestically;

* construct the necessary mining facilities; and

* apply good mining norms

Indonesia's mining sector

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