MINING LAW AND POLICY (REGULATORY FRAMEWORK): AN IMPACT TO FOREIGN DIRECT INVESTMENT AFTER CoW Novi Yanthy Tinauw

Abstract When it comes to mining Indonesia is a massive player. The country is characterized by its massive exports of coal, tin, gold and copper. Abundant resources and favorable government policies have historically marked it as an attractive destination for foreign investments. Exploitation of mineral and coal (Mining) in Indonesia began intensively to take place in Erstberg, Timika, Papua, after the extractive mineral rights have been granted to Freeport in 1967. This partnership supported by a Contract of Work (COW) Freeport Generation I (GI) which was signed in 1967 and its essence was the origin of the various terms contained in Mining Law no. 11 of 1967. Within the period of 1967-1998 there were seven generations of contract of work (COW) in lieu with the foreign capital investment in the field of non-coal general mining and three generations of coal contract of Coal (CCOW) in Indonesia. After the Reformation in 1999 as the marked of fee elections, Indonesias government announced new regulation that will require foreign mining companies in Indonesia to increase domestic ownership of their mines to at least 51 percent by the 10 th year in which the mine has enjoyed production. This paper evaluate how far that mining law and policy especially regulatory framework could give impact to FDI as an contract of work system being replaced after 14 Reformation. Keyword: Indonesia Mining, COW, FDI, Mining Law, Regulatory Framework. Background and Introduction Indonesia continues to be a significant player in global mining industry with significant production of coal, cooper, gold, tin and nickel. This fact supported by datas of MINISTRY OF ENERGY AND MINERAL RESOURCES OF THE REPUBLIC OF INDONESIA looking from INDONESIA MINING IN THE WORLD CONTEXT such as: World Market Within the global context, Indonesia is one of the major mineral within the global context, Indonesia is one of the major mineral producers and exports numerous commodities around the world, producers and exports numerous commodities around the world, such as: tin, copper, nickel, bauxite, gold). Mining production growth is relatively high. At the last ten years the average growth production are coal 15%, copper15%, gold 15%, average growth production are coal 15%, copper15%, gold 15%, nickel 9% and tin 7.5%. Nickel 9% and tin 7.5%. Export demand relatively higher than domestic demand. For Export demand relatively higher than domestic demand. For instance, export demand to total production are coal 75%, tin instance, export demand to total production are coal 75%, tin 87.5%, gold 87.5%, silver 80%, tin 96.5% and nickel 100%. 87.5%, gold 87.5%, silver 80%, tin 96.5% and nickel 100%. Within the year 2007-2015 domestic coal demand will increase significantly, mainly due to the crash program of coal power plant development. GOI has decided to GOI has decided to reduce oil share in energy mix from 55% (2005) to 20% in 2025, and that coal share from 15.7% in 2005 to 33% in 2025. The current situations of Indonesian mining resources are: Coal resources estimated around 61.3 billion tons with mine able reserve approximately 6.9 billion tons (15th rank of world coal reserve). Gold resources estimated around 6,369 tons with mine able reserve approximately 3,254 tons (7th rank of world gold reserve). Copper resources estimated around 68.11 million tons with mine able reserve approximately 31.85 million tons (7th rank of world copper reserve). Tin resources estimated around 0.622 million tons with mine able reserve approximately 0.462 million tons (5th rank of world tin reserve).

Nickels ore resources estimated around 1,412 million tons with mine able reserve approximately 485.33 million tons (8th rank of world nickel reserve). Compared with other countries of Asia from Kazakhstan to Philippines, Indonesia is still a leader in copper, gold, silver, nickel and coal resources and production.

In particular, Indonesia remains among the worlds larger exporters of thermal coal. Global

mining companies consistently rank Indonesia highly in terms of coal and mineral prospects; however assessments of its mining policies and investment climate have not been so positive. As such, in recent years there have been limited levels of investment, particularly in Greenfield project other than in the coal sector compare with abundance recourse which are represent on table 1. (Source: http://psdg.bgl.esdm.go.id).

Table 1 Indonesias Mineral Production Untapped Potential Mining Companies rank Indonesias investment climate as among the worst in the world. But its mineral wealth gets a top score from miners asked to assess countries assuming they implemented investor-friendly mining laws. Investment Climate Resources Potential Top Score= 100* Top Score= 1

Nevada Chile Western Australia Mongolia South Africa Bolivia Russia Indonesia Congo Zimbabwe 2 13 24 23 22 54 45 73

93 87

Indonesia Congo Russia Nevada Chile Western Australia Mongolia Bolivia South Africa Zimbabwe

1 1 1 1 0.97 0.97 0.96 0.91 0.91 0.9

*Score

based on a number of factors including regulatory consistency, security of investment and taxation policies.

Source: Fraser Institute 2005/6 Survey of Mining Companies.

Source: Wall Street Journal, February 7, 2007

Table 2 Indonesia Mining Production 2003-2010 325 300 275 Index (basis 100 in 2003) 250 225 200 175 150 125 100 75 50 25 2003 Gold 2004 Cooper 2005 Silver 2006 2007 Tin Metal 2008 2009 2010 Coal

Nickel Matte

Source: http//www.djmbp.esdm.go.id/index_dbm.php Current exploration spent in Indonesia is only 2% of the global total (Table 3). Expenditure on Greenfields explorations is critically low in Indonesia, and dropped from an average of US$40 million (1995-1997) to US$7 million (2001-2005).

Table 3 Indonesias Exploration Spending 13% Australia 16% Rest of World 8% United States 2% Indonesia 4% Pacific % South East Asia

17% Africa

18% Canada

22% Latin America

Source: mineIndonesia 2006, PricewaterhouseCoopers

Table 4 Factors deterring investment in Indonesia % of Respondents who Consider Factor to be a Strong Factor Comments Deterrent to Investment in Indonesia Uncertainty concerning the administration, interpretation and Enforcement of Existing 53% 10th Lowest Rank Regulations Infrastucure 34% 8th Lowest Rank Source: Fraser Institute Source: mineIndonesia 2006, PricewaterhouseCoopers Regulation of mining areas perceived less friendly toward FDI due to such a tax / royalty is high, the overlap with forestry issues (Law no. 41, 1999), decentralization and environmental concerns. Basically the priority in the grass root exploration activities (Exploration Greenfield areas) in all areas of potential mineral resources, including forests can be done to make inventarisation mineral wealth of natural resources and coal as a bargaining quantitative in inviting investment in Indonesia. CoW (Contract of Work) The CoW system for regulating mining operations has played a key role in the success of Indonesias contemporary mining industry. The CoW system was introduced in 1967 has been gradually refined and modernized over the past forty years to reflect changing conditions in Indonesia and abroad. To date, there has been seven generation of CoWs. A comparison of the various generations odd CoWs are provided in Appendix E. (ww.pwc.com). CoWs were regulated under Minister of Energy and Mineral Resources Decision Letter No. 1614/2004. In essence, a CoW is a comprehensive contract between the Government of Indonesia and an Indonesia Company. The company could be 100 percent foreign-owned. However, if the company was 100 percent foreign-owned, it may have been subject to divestment requirements at latter date. As a practical matter, most CoWs have some level of Indonesian ownership as showed below.

Table 5 Level of CoW in Indonesia Stage Terms (years) Available Extension1 General survey1 1 6 months 1 year Exploration2 3 1 2 years Feasibility Study 1 1 Construction 3 20 or other period as approved Production 30 by the Government 1): Depends on the CoW generations. For the detail, refer to Appendix A. (www.pwc.com) 2): For first generation, the maximum period for general survey until feasibility study was 18 months and can be extended for a maximum of six months. Source: PricewaterhouseCoopers (2011) Some of the important considerations that are covered by a CoW include: expenditure obligations; important and exports facilities; marketing; fiscal obligation; reporting requirements; records; inspection and work program; employment and training of Indonesia nationals; preference to Indonesian suppliers; environmental management and protection; regional cooperation in regard to infrastructure; provision for infrastructure for the use of local population and local business development. Its a tribute to the government and to the industry that these important matters can be appropriately addressed in a concise legal contract.

CoW itself covers all tax/royalty and others fiscal changing including: dead rent in the Contract Area; production royalties; income tax payable by the company; employees personal income tax; withholding taxes on dividends, interest, rents, royalties, and similar payments; value added tax (VAT); stamp duty, import duty and land and building tax. Indonesias long standing Contract of Work (CoW) framework for foreign investment and listening system for Indonesian investor, have been replaced under the Mining Law. The Mining Law implemented a new area-based system of licensing, incorporating transparent tendering producers for granting licenses. Indonesia FDI situation Foreign direct investment (FDI) is a key pillar of sustainable economic growth and offers non

financial benefits, most notably positive spillo vers such as productivity gains and knowledge transfers. Aware of this, Indonesia seeks not only more but also better FDI, the kind that reduces unemployment, social inequality and poverty. Foreign direct investment in Indonesia grew 20% last year to 175 trillion rupiah ($19.3 billion), the country's Investment Coordinating Board said Thursday. At that rate, Indonesia now appears to be significantly outpacing many other Asian countries that used to easily surpass it in drawing foreign money, such as Thailand. China still attracts much more, with $116 billion in FDI in 2011. This graphic below shows the growth of Fixed Investment in Indonesia.

Table 6 Fixed Investment in Indonesias Mining Sector

2 1.8 1.6 1.4 1.2 1 0.8 0.6 0.4 0.2 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Source: PricewatershouseCoopers. 2008 The New Mining Law Mineral and Coal mining activities are governed under the Law on Mineral and Coal Mining No. 4/2009 dated 12 January 2009 (Mining Law). This Law replaces the predecessor Mining Law no. 11/1967, which provided the framework for all of Indonesia of Indonesias pre-2009 mining concessions including all of the existing CoWs and CCoWs. The Mining Law is dependent on a significant number of implementing regulations have recently been issued, a number of regulations and clarifications in respect of key areas of the new law area still to be issued. The introduction of the Mining Law in 2009 represented a significant change to the previous Indonesia Mining regulatory regime. Contractual-based concessions are no longer available for new mining projects. Both the well-regarded CoW/CCoW framework for foreign investor and Kuasa Pertambangan (KP), or mining rights, framework for Indonesia investor, were replaced by a single area-based licensing systems based licensing system based on specified mining areas.

The Mining Law provides for three categories of mining license, depending upon the location and nature of the resources. Unlike the restriction on ownership of KP license to Indonesian nationals, the IUP based license are open to the both Indonesian nationals and foreign invest who own Indonesian companies. Mining Regulatory Framework Indonesia Mining Regulatory Framework was created as the Mining Law and Policy changed. These regulatory frameworks below are some of them which give direct impact to foreign direct investment itself and local investment. a. Domestic Market Obligation (DMO) The Mining Law and implementing regulations contain a framework for DMO (Domestic Market Obligation) where the Central Government has the authority to control production and of each mining product. The regional government is obliged to comply with the production and exports control controls imposed by the Central Government. This policy is to guarantee the supply for increasing domestic demand, especially for coal. Details of the DMO procedures were issued in PerMen 34 on 31 December 2009. This policy provides that DMO applies to all types of coal and minerals. Broadly, mining companies must comply with the DMO requirements by telling to domestic consumers of mineral coal. Neither PerMen 34 nor GR23 provide for a specific DMO percentage rather the decision for particular years is to be made by the Minister upon the following procedures: 1. Domestic users submit their forecast requirements by no later than March of the preceding year. 2. The Minister review and calculate the domestic requirements submitted and the production plans of the mining companies. 3. The Minister must then issue a decree on the minimum DMO percentage by no later than June of the preceding years. The decree must also list the domestic users and their respective needs: and 4. The mining company must then submits its work program and budget for the relevant year to the authority that issued its license (Minister, Governor or Mayor/Regent) and the Director General of Minerals and Coal

stating its commitment to the DMO percentage. b. Divestment The Mining Law provides that foreign capital controlling shareholders must divers part of their interest in a mining concession company by the fifth year of production. GR23 provides that Indonesia Nationals must own a minimum of 20% of the shares in an IUP holding company. Divestment is to be made to (in order of preference) the Central Government; Provincial Government or business entry. c. Mandatory in-country processing

Under the Mining Law, holder of IUPs and IUPKs are required to carry out in-country processing and refining to increase the value of the relevant mineral or coal. They may also have processing and refining undertaken by entities which have already obtained a Special Production Operational IUP/IUPK for processing and refining. d. Royalties All IUP/IUPK holders are required to pay production royalties, the rates which wall vary depending on mining scale, production level and mining commodity price. Currently, a range of percentages of sale proceeds applies for the different types of coal and mineral mining and it is expected that such an arrangement will continue under the Mining Law. The stakeholders will be required to pay an additional royalty of 10 percent of net profit. The Central Government is entitled to receive 40 percent of this additional royalty while the balance is to be shared between the relevant and regencies. Since this additional royalty is determined based on net profit, it is expected that government will have a greater monitoring role over capital expenditure and mining operating costs in the case of IUPKs. The current production royalty rates for a selection of key Indonesia commodities are set out in the following table. Table 7 Production Royalty Commodity Coal : Open pit underground Production Royalty Rate

3%-7% 2%-6%

Nickel

4%-5%

Zinc 3% Tin 3% Cooper 4% Iron 3% Gold 3.75% Silver 3.25% Source: PricewaterhouseCoopers (2011) e. Reclamation and Mine Closure

On 20 December 2010, the Government released Government regulation No. 78/2010 that deals with reclamation and post-mining activities for both IUP-Exploration and IUPProduction Operation holders. An IUPExploration holder, among other requirements, must include a reclamation plan in its exploration work plan and budget and provide a reclamation guarantee in the form of a time deposit it placed at a state-owned bank. The requirement to provide reclamation and postmine guarantees does not release the IUP holder from the requirement to perform reclamation and post-mine activities. The above is a brief analysis of some of the key terms of the Mining Law likely to be interest to investor. Through the enactment of the Mining Law, the Government has sought to create more certainty about Indonesias Mining. This certainty will only crystallize, however when all the regulations implementing the Law are in place. Impact of Mining Framework Law and Regulatory

This policy will threaten Indonesias mining investment climate. That may be true, to a degree. Indonesias mining prospects are about large numbers. Last December, AFG Venture group completed a survey of 3,000 companies interested in Asia, and found that 77 percent were considering investing in Indonesia. Comparatively, only 60 percent saw China and India as targets. Such figures are unlikely to be replicated in the wake of these new regulations, but the numbers were large enough to suggest that not all interest will wane. The terms of the Mining Law may be adequate to encourage some investor especially foreign investor to take directly equity stakes in IUPs for relatively small-scale projects. However, there is likely to be greater uncertainty around proposed large-scale projects as the Mining Law does not offer the long-term protection of the CoW system for large, long-life projects which require significant investment. Investor will also be relying on the effective operation of the Indonesian legal system to protect their investment in these large projects, which are the life-blood of a strong mining sector. Conclusion The Mining Law is expected to provide greater certainty for investment in the mining industry in Indonesia. However, it is evident from the provision of the Law that Government has had a difficult task in balancing the interest of foreign investor wishing to invest in Indonesia highly lucrative mining industry with those of Indonesian Nationals, wishing to ensure that a fair proportion of the wealth derived from the exploitation of Indonesias minerals is retained by Indonesians for the benefit of Indonesia. The balance formulated by the Government in the Law is intended to achieve the best result for Indonesia. Under the Mining Law, the Central Government will determine areas that can be mined, which is still pending to date. With this mechanism, it is expected that the Central Government will have more control over determination of areas open for mining, and this may reduce the instances of overlapping mining concessions with areas reserved for other purpose, such as forestry. The new rule does particular harm by clouding the countrys mining industry under even greater uncertainty. Is there more government regulation to follow? Is that a risk one is willing to take? And what are the added costs

Many foreign players, such as Newmont Mining Corp. (NEM) and Vale SA (VALE3), are still planning on further investing in Indonesias resources. Edward Rochette, chairman of East Asia Minerals, exclaimed Indonesia is, without doubt, one of the top three places for current investment in mineral projects, suggesting the country offers too much opportunity to turn down. David Lennox, analyst at Fat Prophets, also shared the belief that this rule wont make a company go away from Indonesia. He also noted, however, that it would obviously mean [companies] will look over their shoulders if an opportunity pops out elsewhere. But it may have a heavier effect on prospective investors. Syahrir Abubakar, Executive Director of the Indonesia Mining Association, noted, Im sure foreign investors will not invest in the mining sector anymore in Indonesia.

of such policies? There is also a concern over the proper allocation of greater government wealth. Foreign miners have had to overcome Indonesias weak infrastructure, and they hope greater government financing will reduce such burdens on the industry. But with a history of corruption, many have their doubts. Future Work After three years on, the Law still requires some further implementing regulations which References

have not been issued yet. Furthermore some implementing regulations are not entirely clear in addressing the issues and further guidance is required. This may cause further uncertainty for investor. As the major concern of Indonesia Government should have to ascertain if the new mining law will be a winwin for both the investors and the country.

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