RECENT ECONOMIC REPORTS

Company statements and recent press reporting suggest that foreign mining companies, if not stampeding for the exits, are sharply reducing their investment in Indonesia. The uncertainty of government decentralization and draft mining legislation has contributed to decisions to cut back on exploration. Other problems arise from inconsistencies in environmental and forestry legislation and challenges from environmental, labor, and community groups. Mining’s biggest problems, however, may not stem from legislation, but from a decline in law and order accompanied by inflated compensation claims for all kinds of grievances. The claims have driven up operating costs at the same time Indonesia is suffering from an international image problem. The government cannot fix law-and-order problems as easily as it can change legislation. End summary.

1. The Indonesian Mining Survey 2000, issued by PriceWaterhouse Cooper’s (PWC) Indonesia office in October 2000, reveals declining interest in Indonesia’s mining sector. Supplemented by government statistics, the survey reported that mining’s total contribution to the Indonesian economy grew to Rp 11.48 trillion in 1999, from Rp 2.68 trillion in 1995. (Note: The increase in dollar terms using the exchange rate of the time is not as impressive, growing to US $1.44 billion in 1999 from US $1.2 billion in 1995. The average exchange rate in 1999 was Rp 8000/$ but only Rp 2,250/$ in 1995.) In 1999, export revenues of survey respondents totaled US $3.1 billion; minerals and related products represented 11.2 percent of Indonesia’s total exports. Government revenue derived from the mining sector totaled Rp 6.88 trillion (US $860 million at Rp 8000/$) in 1999.

2. During the 1995-1999 period, mining investment in development and fixed assets totaled US $5.58 billion. Expenditures on mineral exploration and feasibility studies, on the other hand, were US $75.5 million in 1999, representing only 66 percent of the average annual expenditure in the study’s five-year period. Significantly, fourteen producing companies and five exploration companies who responded to the survey were planning investments for 2000 of just under US $500 million -- only half the US $951 million of actual investment in 1999.

3. A spate of recent announcements suggests a further decline in mining activity in Indonesia:

• Australia-based mining company Aurora Gold said on April 16 that it would put its North Sulawesi Toka Tindung gold mine on the market; shut down its Mount Muro mine in Central Kalimantan; and close its Jakarta regional headquarters. The Mount Muro mine was scheduled for closure soon, but news reports indicated Aurora was likely to take a huge loss on its US $30 million investment in Toka Tindung after suspending development in September 1997. Two Indonesian companies are reportedly negotiating to purchase Aurora’s mining rights after as many as 40 other companies declined to buy the project, due, in part, to the presence of thousands of illegal gold miners on part of the projected mine complex.

• Newmont’s Indonesian subsidiary informed the Energy and Mineral Resources Ministry in a February 7 letter that it would suspend exploration activity for new sites. Newmont also announced on March 8 that it would close the Newmont Minahasa Raya mine in Ratatotok, North Sulawesi, in 2003 due to the depletion of the gold deposit. Newmont will close a second mine in nearby Lobongan in 2003, because of problems with illegal mining.

• Rio Tinto President Noke Kiroyan told reporters on March 12 that his firm would not make any investments to expand operations in Indonesia, but spend only the money required to purchase materials and replace machinery.

A mining industry observer commented that, within a few years, the only foreign mining investors remaining in Indonesia would be the five that had already made sizable investments, viz., Freeport, Newmont, Rio Tinto, Inco, and BHP.

4. The mining industry has long complained about problems of conflicting legislation and legal definition. Two issues of particular concern have arisen in the last few years:

• Forestry Law: Forestry Law 41/1999 essentially prohibits exploration and exploitation of natural resources existing within a "protected forest." If interpreted literally, the law would prohibit exploration and operations even if the protected status was conferred subsequent to the issuance of a Contract of Work. According to the Indonesian Mining Association (IMA), 68 percent of the area potentially available for mining exploration in Irian Jaya is covered by protected forest. In Sumatra, the figure is 53 percent; in Maluku, 50 percent; Sulawesi, 39 percent; and Kalimantan, 33 percent. In one case cited by the mining industry, protected forests cover 60 percent of a contract area.

• Hazardous Waste regulation: The government issued Presidential Decision (PP) number 18 regulating the disposal of hazardous waste in Indonesia on February 1999. Drafted by the Environmental Impact Management Agency (BAPEDAL), the attachment to PP 18/1999 revised toxicity characteristics leaching procedures (TCLP) numbers for waste material, including copper tailings, coal fines, dust, and ash. PP-18 designates such substances as "B-3" (dangerous poisonous material – "badan berbahaya dan beracun") hazardous waste pursuant to the 1989 Basel Convention on the Control of Transboundary Movements of Hazardous Waste and Their Disposal. PP-18 exceeds far exceeds standards in the U.S., Canada, and Australia and has the potential to shut down companies in the mining sector and other industries. The mining industry has pointed out that permissible limits on fluoride is set at 0.004 milligrams per liter while laboratory tests are only capable of detecting hundredths of a milligram. The mining industry estimated that it would need to spend as much as US $650 million on remediation costs under the new regulation.

5. The mining industry also complains about other factors in the Indonesian Government’s mining investment regime.

• An Arthur Andersen analysis concluded that Indonesia’s tax and royalty burden on mining operations is the highest of eight countries surveyed. Indonesia’s rates are nearly double that of Peru, the country with the most favorable rate.

• The industry argues that Indonesia should eliminate "ring-fencing," the requirement that companies must establish separate subsidiaries for each contract of work, so that income statements cannot be combined. This means that exploration costs in one area cannot, for example, be applied to the profits of an operating mine to reduce the tax burden.

• Mining investors are unhappy about the Finance Ministry’s efforts to reduce tax exemptions written into Contracts of Work. Companies are being required to pay taxes for which they had not been previously liable, and advised to argue their case with the Finance Ministry only after payment. Mining companies are also unhappy about long delays in obtaining VAT refunds.

6. The Forestry Law’s restrictions recently tripped up PT Citra Palu Minerals (CPM), 90 percent owned by Rio Tinto, in its attempts to develop a 60-ton gold ore body in Palu mayoralty, Central Sulawesi. CPM secured a Contract of Work in March 1997, received a license from the Directorate General of Forest Conservation and Natural Resources Preservation, and started drilling in September 1998. It suspended activity in June 1999 after the area surrounding its activity was designated as Paboya Forest Park by a ministerial decree in January 1999. In February 2001, Palu’s Deputy Mayor announced that CPM had received permission to develop a gold mine on 500 hectares of the forest park, with the final approval contingent on arrangements to redraw the park boundaries. Environmental NGOs have mobilized groups in opposition, and the Central Sulawesi Natural Resources Conservation Center declared that it must also issue a license and announced its "vehement rejection" of the plan.

7. The Forestry Law has also stalled PT Gag Nikel’s development of a nickel mine on Gag Island, Maluku. PT Gag Nikel, 75 percent owned by BHP with the remainder held by state-owned PT Aneka Tambang, received a mining Contract of Work in February 1998. PT Gag Nikel spent US $50 million on exploration activity and found 240 million tons of high-grade nickel and cobalt resources when it suspended activity after enactment of the Forestry Law, which prohibits open-pit operations in protected forests. In its first quarter 2001 report, BHP said it "continues to have numerous meetings with the Indonesian Department of Forestry seeking recognition of PT Gag Nikel’s prior right to use surface mining techniques in a later decreed protected forest." (Comment: Individuals who have visited Gag Island and Paboya "Forest Park" say that, ironically, there are no forests in either location.)

8. Implementation of government decentralization on January 1 has compounded the uncertainties of environmental and tax regulations. Law 22/1999 transfers authority for mining regulation to city- and county-level governments (regencies). Local administrations are now responsible for issuing mining licenses, replacing the previous "contract of work" system. Law 25/1999 provides that 80 percent of net revenues from mining royalties will be channeled to local governments. A number of details remain to be worked out, including whether or when management of existing contracts of work will be transferred to the local administrations and whether mining companies will pay their share of royalties directly to the local administrations. Mining executives complain that even minor matters, such as who would issue explosives permits, are unclear.

9. GOI and local administration officials respond that decentralization is a multi-year process. By its very nature, decentralization will be implemented unevenly, with some local administrations rising to the challenge better than others. We found, for example, that East Kalimantan’s Kutai Kartanegara regency, which contains five coal mines, was doing well. It had issued a mining regulation on January 23. Fajar Bumi Sakti, operator of a Kutai Kartanegara coal mine that is one of only three underground coal mines in Indonesia, was exhausting its underground reserves and needed to move to surface operations. The company had tired of waiting for central government approval, canceled its application, and was now seeking a mining permit from the regency.

10. Mining companies are also concerned about the possible impact of a draft mining law, designed to replace law no. 11/1967 on general mining. While details have not been fixed yet, the law aims to update the regulatory framework by recognizing the changing role of government, especially with regard to implementation of regional autonomy and fiscal decentralization; enhance protection of local community interests; and further safeguard the natural environment. Energy and Mineral Resources Minister Purnomo has, however, stated the mining bill will be taken up only after a new oil and gas law and electricity law have been enacted, making passage and implementation unlikely before the end of the year.

11. Rather than the vaguely defined problems of decentralization, however, the biggest challenge to mining development may arise from the steep decline in law and order. By increasing costs and halting production, the problems immediately hit mining investment’s bottom line and may discourage exploration and expansion more than other issues. Some examples are:

• Land compensation: One gold mine operators complained about rising lawlessness that had encouraged local residents to make increasing claims for land compensation. Landowners would sell land twice, once to the mine and a second time to a neighbor. The company would pay the neighbor’s bogus claim for land compensation to avoid trouble. The company was also prey to squatters who planted palm oil trees in areas cleared for exploration, gambling that they could harvest their crop before the mining company returned. If not, they would still receive company compensation for the "lost" harvest.

• Labor: Labor problems forced the Kaltim Prima Coal’s (KPC) East Kalimantan coal mine to shut down intermittently in the third quarter of 2000, losing some 1.8 million metric tons of production. KPC had to declare force majeure to all its customers before starting back up on August 18. This year, labor strife has beset a major contractor to KPC. Liebherr was not able to perform proper maintenance after striking workers entered a maintenance yard and hijacked two loading machines weighing 600 tons each and worth US $6 million. The strike action has continued with a few diehard participants into May. In this and other labor disputes, foreign companies complain not about the labor actions but about the illegal measures (blockades, assaults of other workers, arson, etc.) taken by strikers and the absence of an adequate police response.

• Illegal mining: Illegal mining has long plagued Indonesian mining, but has mushroomed in the post-Soeharto era. Illegal mining operations occur on the periphery of legal mining operations in 16 provinces, mainly in West Java, West Sumatra, North Sulawesi, and throughout Kalimantan. The biggest illegal mining problems used to center on state mining company PT Aneka Tambang’s gold mining area in West Java and state-owned PT Batubara Bukit Asam coal mines in West Sumatra, but have now spread to a number of privately owned operations. The problem may be intensifying. As noted earlier, illegal mining is among the reasons Aurora and Newmont cited for quitting their respective Toka Tindung and Lombongan developments.

12. Although Newmont’s Batu Hijau and Freeport’s Grasberg mines should maintain operations for a decade or more, several of Indonesia’s goldmining centers are scheduled to shut down in the next few years. In addition to Aurora’s Mount Muro and Newmont’s Minahasa Raya mines, Australia-based Newcrest’s Gosowong gold mine in Halmahera, Maluku will close as will Rio Tinto’s Kelian gold mine in East Kalimantan. State-owned PT Aneka Tambang’s Pongkor mine in West Java is also depleting its gold ore reserves.

13. A country such as Indonesia, with geologic features indicating great potential, would normally have several medium-sized resources under development. The absence of such mine development reflects not only the negative indicators described above but also the "CNN factor," Indonesia’s dismal international reputation as a politically and economically unstable place. Mining industry executives also say the Bre-X scandal has a continuing overhang with respect to gold exploration. As a consequence, junior mining companies are no longer receiving the funding to carry out the high-risk grassroots exploration that they have in the past. The image and law-and-order problems described above are not easily remedied. The Indonesian Government will need to be more supportive of mining if it wishes to attractive future investment to the sector.

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