Will Rathvon: Let me give a brief overview from our perspective at ANZ with one of the largest teams of bankers in the natural resources sector. It is an area we take very seriously and we also have a substantial research team devoted to it, covering base metals, including coal, as well as precious metals, supported too by a highly regarded China economist.
Sity Leo Samudera
Really, there are three main factors that are going to impact commodity prices: the state of the US economy, China and the other Asian economies. The US economy is returning to an upward trajectory and [monetary policy] tapering will be deferred which will be good news for exporters such as China. The priorities for Chinese policy makers will be urbanisation [and] economic reform, exemplified by the implementation of the Shanghai Free Trade Zone — a mini-Hong Kong — and we expect GDP growth around 7% per year. Meanwhile the prospects for other Asian economies are positive, supported by strong foreign exchange reserves and generally healthy current account balances.
In the minerals and mining space the outlook is stable but coal is a soft spot for the time-being. Longer term there will be plenty of demand for coal, buoyed by consumption in China, Indonesia and eventually India. Oil and gas, and LNG in particular, are also very important to [Indonesia's] export potential.
Sandiaga Uno: In this environment of low commodity prices it is necessary to concentrate on what you can control. Cost reductions are a priority, which is something we have achieved at Adaro. Some other companies that have been late implementing cost-reduction programmes might struggle, so there could well be consolidation or aggregation in the coal mining sector.
Bhagyesh Dash: There are plenty of deals being transacted by the Chinese, especially out of Hong Kong, and there have been listings by Canadian mining firms for instance; although worldwide there has been a sharp fall in the amount of capital available for mining projects. Chinese companies, too, are now much more selective about the projects they will get involved in and about pricing.
What is the appeal of Indonesia’s natural resources sector?
Sandiaga Uno: The outlook is certainly positive in Indonesia but investors haven’t been rewarded recently. The profitability of mining companies is much higher than in most countries but it hasn’t been channeled into exploration or development. I sit on the National Economic Council and [I] have pointed out that it is strange that although the sector is so profitable, it receives so little capital investment. And the reason is largely regulations, such as the Mining Law, the export ban on unprocessed ore due to come into effect on 1 January 2014, and a plethora [of] local government rules compounding the problem. We seem to love to shoot ourselves in the foot. However, this environment means that it is essential to partner with domestic miners in order to navigate through all the rules and regulations.
Bhagyesh Dash: Yes, Sandiago mentioned several points that are absolutely correct, and I’d like to elaborate on them. Firstly, Indonesian mining companies’ profitability tends to be higher than their peers elsewhere, and that’s because Indonesia was more or less virgin territory 20 years ago. I came to Indonesia in 1993 when total annual production was only 36 million tonnes and [since then] it’s grown tenfold in two decades, and the country is ramping up production in nickel, gold, copper and other minerals. Initially, Indonesia’s coal mines were open pits, so the cash cost was low, and the same is the case for gold mines, compared with [Australia's] for instance.
Secondly, Indonesia is vast with many areas such as Papua, Aceh and Sulawesi under-exploited but now new deposits of minerals such as iron and bauxite are being discovered. Thirdly, although Indonesia is ranked among the top-10 countries for its geological potential, in 2011 only 1.8% of global-exploration US dollars was spent in Indonesia, even lower than a year earlier when it was 2.6%. This is something that needs to change. Domestic companies must exploit the reserves in their backyard and raise their risk appetite and the government must find a way to encourage foreign firms [to] invest in exploration.
Jacqueline Chan: I think mining in Indonesia is an industry that can only progress, and there are huge opportunities but also challenges. Unfortunately there is a lack of clarity surrounding many of the laws and regulations imposed during the past couple of years and that causes uncertainty for investors who wonder “what is next?”
Nevertheless, we do find that investors are enthusiastic and that they recognize that the country, like others, is justified in wanting to use its natural resource wealth to help its own development. For domestic investors leverage is especially important, whether from private equity or public or private debt, and the attraction of an investment depends very much on the nature of individual companies — for instance, the location of its mines and [terms of any] offtake agreements.
Sity Leo Samudera: Our presence in Indonesia is certainly a long-term strategy for ANZ and it is worth stressing that 70% of lending to its mining companies comes from banks, with the rest from capital markets. Going forward, the country should deepen and increase the liquidity of its capital markets. We have a “super-regional” strategy that stretches across the world, combining the use of our balance sheet with advisory work. It is based on connectivity and a long term view.
Could private equity, where risk appetites tend to be bigger, be the greatest source of capital for the sector?
Bhagyesh Dash: There have been notable cases of US private equity groups partnering with local private equity firms. In contrast, there has been little raising of public equity, despite the presence of leading Australian and Canadian mining companies. Of course, public markets have shut down in recent months but in future they should be an important source of capital, particularly because Indonesia has such a burgeoning investor base.
Jacqueline Chan: Mining companies really started to attract private equity investment a few years ago and also the peak of hedge fund interest was in 2007-2008, attracted by hybrid instruments which combined features of equity and debt. But foreign interest has declined during the past couple of years, partly due to the uncertain or onerous regulatory environment — for instance the divestment requirements for holders of IPs [in] the 2009 Mining Law — and also the downturn in coal prices. Now one could argue that depressed valuations make a compelling case for investment, especially among many who are committed to Indonesia for the long haul, but regulatory issues [still] must be addressed.
Will Rathvon: You mentioned two words Jacqueline that resonate strongly with me: long haul. The question is: how long is it? About $100 billion a year of public investment over the next three years will be needed to bring Indonesia’s energy infrastructure to a level where it will contribute to the country’s economy and about 30% to 40% would be in the oil and gas sector alone. Indeed, I believe that oil & gas could fast-forward the development of the economy and it might ensure that it doesn’t reach a plateau.
What are the main investment hurdles?
Jacqueline Chan: Changes in regulations always provide a jolt to international investors, although that really lasts for as long as it takes people to get used to new regulations. People adjust and adapt. I think were it not for depressed coal prices, there would have been a lot more investment in the mining sector as familiarity grew with the 2009 Mining Law, for example. In addition much of the investment that has occurred has been on a bilateral rather than institutional basis. Another trend is that many private equity funds now prioritise ESG [environment social governance], which makes their involvement in the mining sector more challenging. More and more ESG principles are also included among bond covenants.
Sandiaga Uno: Private equity investment in our mining sector is relatively new and even more so in oil and gas. In fact we at Saratoga were pioneers to a large extent, partnering with Bhagyesh back in 2004. Private equity is entering other parts of the mining space too. But the regulatory landscape can be a hindrance and it is caused less by resource nationalism and more by what I call resource “scatterisation” — where government departments are too often uncoordinated.
I agree with Jacqueline that ESG is increasingly important and we were one of the first funds in Indonesia to incorporate the principals as part of our mandate, not least because the sustainability of the country’s resources is essential.
Bhagyesh Dash: A large element behind an investment decision in perception: beauty is in the eye of the beholder. Too often Indonesia falls down here. Investors need regulatory certainty and get scared by constant changes and inconsistency, especially in the mining sector where it takes time to enjoy the fruits of your labour, so rules about divestment and constant changes therein, for instance, can be very damaging to confidence.
On the other hand, swathes of the country have yet to be fully explored for its mineral wealth. The key once you have found a prospect is to find a good local partner.
Sity Leo Samudera: Having a good local partner with a strong balance sheet also inspires a bank’s confidence and, therefore, its willingness to lend for a project development.
Is it easy to find a good local partner?
Bhagyesh Dash: Well, there’s Sandi right here! Going back 20 years ago, it was tough. But now there are many young, professionally-run groups, often inspired by Saratoga’s successful partnership with Adaro. It is important to do your homework and find someone suitable.
Will Rathvon: At ANZ we are keen to work with these partnerships that combine local expertise with technical know-how and [we] aim to identify those groups that will become major successes in the future. 25 years ago the mining industry was dominated by promoters, then after the lull forced by the Asia crisis more mature companies with expertise emerged. Now a new wave of local companies that are financeable on the international stage are becoming prominent. Meanwhile, countries such as Indonesia have to decide how much foreign involvement in their industries they want.
Bhagyesh Dash: Without a doubt there has been the emergence of many more viable local groups in recent years that would make good partners over the long term.
What is the [Indonesian] government’s and public’s attitude towards the presence of the large foreign mining companies?
Sandiaga Uno: I think Indonesia is generally open to overseas investment...As a nation we recognize that we need not only foreign capital for the natural resources sector but also expertise and technical knowledge. In addition, there is a revolution taking place in the energy sector with the discovery and development of shale gas in the United States, and companies are likely to relocate back to their home-base. In Indonesia, we have many different energy sources — such as geothermal — that have barely been tapped and we need to market them to foreign investment.
On the other hand, we need a new deal that incorporates social and environmental investments so that local communities feel the benefits.
Jacqueline Chan: In my experience domestic investors definitely want to attract overseas capital and foreign investors emphatically believe in the upward potential of Indonesia. The issue then is to present them with the ingredients to make investment attractive. These include: regulatory certainty which is critical to give investors confidence for the long haul; a great local partner is a key element and it can often help manoeuvre through the regulations; and also, of course, access to finance and here ANZ has a very important function, not least because it has [a] deep-seated industry knowledge as well as [a] commitment to Indonesia. Investors are looking for advisers, partners and finance for the long term.
How can Indonesia leverage its vast natural resources to promote stronger economic growth and raise per capita income? What needs to be done next?
Bhagyesh Dash: Regulatory certainty, as we have all stressed, is key. International mining executives in surveys continually point to regulatory uncertainty as a disincentive to come to Indonesia. Again, one way around the obstacle is to find a good local partner.
Will Rathvon: Yes, less scatterisation is necessary. I also agree with Sandiaga that a new deal is in order and that includes the involvement of large international firms capable of making substantial investments, for example to inject $20-$30 billion into an LNG project. At the same time, foreign companies must recognize that they have obligations operating in countries such as Indonesia and, increasingly, I think the smaller companies will provide services for local firms in the energy and mining sectors. Meanwhile, competition will increase, which will be good for Indonesia.
Sity Leo Samudera: ANZ is in a position to help foreign companies find a suitable local partner as a result of its long experience in Indonesia and its extensive banking relationships. Investors need to have patience and understand the country [while] local partners can help navigate a way past any obstacles.
Will Rathvon: It is going to take a lot of capital to develop Indonesia’s natural resources. ANZ can help in its role as a global local bank, dedicated to Indonesia and its mining and energy sectors. In fact we have doubled our headcount from a year ago and [we] are well-positioned for the growth and recovery of commodities markets. The bank’s board of directors have clearly identified Indonesia’s natural resources sector as major commitment.