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Mining in Indonesia – A pragmatic response to uncertainty

Indonesia's Mining Law remains a work in progress, writes Linklaters partner Sophie Mathur, but high commodity prices are helping mining players adjust to the "new normal".

Almost three years since its introduction, implementation of the 2009 Mining Law is an on-going process. In spite of the uncertainty, significant transactions have continued to take place in the mining space, recent examples being the $3 billion acquisition by Vallar (now Bumi) of stakes in Berau Coal Energy and Bumi Resources, and the IPO of Atlas Resources. In addition, Indonesia’s mining sector remains a place of interest for resource-hungry Chinese and Indian companies.

Do these transactions tell us that market players have adjusted to the “new normal” under the existing regime? Or merely that the lure of the sector is strong enough to outweigh the uncertainty of the regulatory regime?

The key areas of continued uncertainty, which we will discuss in more detail, are the re-negotiation of the Contracts of Work and Coal Contracts of Work (CoWs), the issue of new licences, overlapping rights and the obligation to refine onshore.

Re-negotiation of CoWs
The Mining Law states that CoWs remain valid but at the same time requires CoWs to be amended to conform with the Mining Law. It is not clear how these two provisions of the Mining Law are being reconciled, particularly as many CoWs contain “change in law” provisions that are intended to protect the miner from precisely this scenario.

In any case, the January 2010 deadline for amending the CoWs came and went with no significant CoWs having been amended. The Minerals and Coal Director General, Thamrin Sihite, was quoted in the Jakarta Post in October this year as saying that 65% of the mining companies operating in Indonesia had agreed to renegotiate their CoWs. There is no indication, however, of when the negotiations will end.

The CoW provisions that have been subject to negotiation include provisions relating to royalties, area size and the domestic processing and refining requirement.

The legal basis for renegotiating the royalty payments is unclear as the Mining Law expressly states that provisions “relating to state revenues” (ie, royalty payments) shall not be amended.

In relation to area size, the maximum area for a mining licence for a production operation is now 25,000 hectares — a significant decrease from the previous regime where areas under the CoWs ranged from 25,000 to 140,000 hectares. It is unclear how the Ministry of Energy and Mineral Resources (MEMR) proposes to manage the transition from the CoWs to the new licences (the Izin Usaha Pertambangan or IUP) in this respect without causing significant disruption to the mining operations at the relevant sites.

Meanwhile, holders of CoWs seem to be undertaking “business as usual”. For example, the approach in the context of public listings, as seen in the London listing of Bumi, is to simply disclose the areas of uncertainty.

Issue of licences
Under the Mining Law, IUPs for exploration may only be issued by tender. The concept of requiring a competitive tender process rather than direct appointments is laudable. However, only certain details of the tender process have been set out, with further details to follow. Also, the land areas available for tender are not yet confirmed. As a result, no new exploration IUPs have been issued. Production IUPs have been issued but these are based on pre-existing exploration IUPs.

Once the tender procedures are settled, the regulations in relation to forestry may present another hurdle for mining companies to clear. Under the relevant regulations, mining can only be conducted in production or protected forests under a “borrow-use” permit. A Ministerial Decree issued in March 2011 prescribes that the validity of a “borrow-use” permit for exploration is two years. Unhelpfully, this is significantly shorter than the validity of an exploration IUP for coal, which may be given for a maximum of seven years; for metal minerals, which may be given for a maximum of eight years; and for rocks and non-metal minerals, which may be given for a maximum of three years.

The current reality, however, is that the issuance of new “borrow-use” permits in primary natural forests is suspended as of May 20, 2011. The president of Indonesia issued a Presidential Instruction instructing all central and regional authorities to support the moratorium by suspending the granting of permits for the use of “primary natural forests”. Exceptions to this include where the applicant obtained an in-principle approval from the Minister of Forestry before the moratorium became effective or if the applicant is seeking to renew an existing borrow-use permit, which has expired. Other exceptions include strategic industries or economic needs. This Presidential Instruction is part of Indonesia’s efforts to comply with the bilateral agreement between Indonesia and Norway on forest conservation.

A combination of the above factors means that new IUPs are not being issued save as a result of conversions from the previous form of mining authorisation, the Kuasa Pertambangan or KP. However, given that from 2000 until 2009, it is estimated that almost 4,000 KPs were issued (of which 3,000 were exploration KPs), the more pressing issue facing the industry is not the issue of more IUPs but rather the rationalisation of the licences that have already been issued.

Overlapping rights and illegal mining permits
The sheer number of KPs issued under the old regime was in part the unintended consequence of Indonesia’s Regional Autonomy law that gave regional governments the authority to issue KPs. The lack of a central registry made it difficult to ascertain the existence of overlapping rights as it required checks to be made in person at a host of different authorities. The MEMR is now tackling this issue and has set up a central database on mining rights. The first such database was published on July 1 2011. The database classifies IUPs as either “clear and clean” or “non clear and clean”. A “clear and clean” IUP is one that is validly issued prior to 1 May 2010 and where there are no overlapping IUPs.

The MEMR faces a herculean task in reconciling all the existing IUPs and those KPs that are yet to be converted into IUPs, but this is a significant advance towards achieving legal certainty and should be welcomed. Other state-related entities are presenting a coordinated approach; for example, PLN has announced that it will only purchase coal from a holder of a “clean and clear” licence. This is a move that should galvanize IUP holders to obtain this “clean and clear” status (and makes this an even more important point to check in acquisition due diligence).

Even once an IUP has been validated, there remains a practical risk that a local authority may issue licences in respect of the same area or over parts of the same area. In addition to seeking the support of MEMR to invalidate such permits and robustly enforcing its rights in court, the IUP-holder should also establish a programme of surveillance to guard against encroachment. Technology such as remotely operated surveillance equipment has helped mining operators cover large areas with less time, cost and manpower.

The issue of overlapping rights can also arise where there are allegations that mining is being conducted on indigenous land. Such situations may be more challenging than a traditional commercial dispute as when negotiating with indigenous people, representatives may be self-appointed with questionable capacity to act on behalf of the affected indigenous community and even where they have authority at the time an agreement is reached, there is always a risk that a new tribal leader will refuse to be bound by agreements reached with his predecessor.

Disputes over overlapping rights often end in a long drawn-out litigation process and the best defence for a mining company is to show that all necessary permits and consents have been acquired and that appropriate compensation was paid to all relevant parties.

Obligation to refine on-shore
The Mining Law contains a ban on certain raw material exports from 2014 and processing and refining is to be undertaken in Indonesia.

While the aim of this law is clearly to develop the downstream mining industry, there is a gap between the current processing and refining capacity, and the capacity that will be required to fulfil this obligation. A ministerial decree on this is expected at the end of the year and given the public statements from officials so far, it seems unlikely that such a decree will attempt to close the gap.

This obligation is another aspect of the tension between existing CoW holders and the Indonesian government as the new obligation would go further than the existing obligations in respect of refining and processing in the CoWs. In February this year, in relation to the processing and refining requirements, the CoW holder Newmont Nusa Tenggara made a public statement that it was not feasible to build gold and copper smelters in Indonesia.

In conclusion, almost three years on, the Mining Law remains a work in progress. While there has been tangible progress, for example in the form of the central database, challenges remain. And in some cases, such as the on-shore refinery obligation, the reality is a long way from the aspiration.

Players in the mining sector, however, are well practised with the vagaries of regulation in emerging markets and pragmatic in their response to the challenges of investing and operating in such markets. For as long as commodity prices stay at current levels, the continuing uncertainty in the Mining Law may well be chalked up as just another aspect of doing business in Indonesia.

As Michael Carl, a leading natural resources lawyer from SSEK, says: “The Mining Law has not changed the recipe for successful risk management. Do your homework and work to develop relationships with the local community and the local government. An investment in the Indonesian mining sector in the present environment is as much an investment in a dynamic, growing nation as it is in the specific mining asset.”

¬ Haymarket Media Limited. All rights reserved.
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