Mining in Indonesia

25 May 2017

*This article was featured in World Coal magazine in May 2017 

Operating in the Indonesian mining sector has the potential to be very profitable, but the unpredictable regulatory environment since 2009 has seen the industry decline significantly. The government recently changed the rules once again in a bid to revive investor interest in the country’s abundant metals reserves. However, it will be coal that will burn brightest in the years ahead.

Eight years of volatility 

Since 2009, mining investors in Indonesia have frequently been subjected to major changes in the legal and regulatory framework. In January 2017, the government announced a relaxation of the controversial 2014 ban on unprocessed metals and mineral ore. Anticipated investment in downstream processing had not materialised and with Indonesian economic growth slowing, it is hoped that an uptick in export revenue could help plug the hole in public finances. Bauxite and nickel ore can now be exported, while the temporary deal to allow the export of concentrates, such as copper, has been extended – to buy more time for investors to build smelters. 

Despite the changes, foreign investors have been spooked by the regulatory rollercoaster of the last eight years. In addition, commodity prices have not yet recovered to the point where investors are willing to take on greater levels of risk. In 2016, BHP Billiton Plc., Newmont Mining Corp. and Sumitomo Corp. all exited Indonesia by selling their project stakes to domestic companies. 

It would be a mistake to think that the government’s latest regulatory changes will signal the start of the recovery of the Indonesian mining industry as a whole. Recovery will very much depend on the commodity in question. For example, the outlook is marginally brighter for nickel and bauxite miners.

In respect of nickel, the timing of the government’s u-turn coincided with the implementation of even greater regulatory challenges in neighbouring Philippines. In February 2017 the Philippine government ordered the closure of almost half of the country’s operational mines – the majority of which were nickel, enabling Indonesian producers to increase market share. Meanwhile, bauxite miners can now extract more as several Chinese-backed aluminium smelters are set to come online during 2017. 

The outlook for other Indonesian commodities, such as gold and copper is remains conservative. The ban may have been relaxed for nickel and bauxite ore, but for concentrates of precious metals, copper and others, export tariffs, requirements for in-country processing and volatile global prices are tempering investor appetite for new projects wand keeping a lid on current production levels.

A boost for coal? 

In contrast, the outlook for Indonesian coal miners is more positive. Two key trends will develop during 2017 and beyond; first, an increase in production that will outperform expectations as Indonesia seeks to capitalise on growing demand for coal from not only China but increasingly other Asian emerging markets such as Vietnam, Malaysia and the Philippines. Second, a sustained rise in domestic demand that will underpin higher production levels as the government invests heavily in power infrastructure and ramps up coal as a share of Indonesia’s energy mix. 

While other coal producing nations are still struggling with subdued coal prices and in many cases, greater regulatory oversight, Indonesia, with its relatively low costs for production, has an opportunity. Crucially, the industry also has the backing of its government, at a time when the regulatory environment for coal producers in Australia, the US and even Colombia and China, has become far more challenging. With many Asian markets commissioning new coal-fired power plants, and as China imports in greater quantities as it restricts domestic production, Indonesia’s mining industry will receive a much needed boost on account of growing demand both at home, and abroad. According to BMI Research, a unit of Fitch Group, Indonesia will increase production by an average 3% annually from 2016 to 2020. 

There are, of course, some headwinds to consider. Firstly, one of Indonesia’s primary export markets, India, is currently juggling a coal surplus, as a result of domestic over-production. In fact, in a major policy shift, India may even export a portion of this surplus. Secondly, the approval of coal-fired power plants takes many years, and typically, for every one plant approved, plans for another plant will be cancelled. In addition, the typical time between approval and commercial operations is two to four years. As such, demand increases from markets such as Vietnam and Malaysia may not be immediately realised. Indonesia’s coal mining market is not going to be transformed overnight, but the fundamentals indicate that there is still strong growth ahead, over the next five years.

Indonesia mining sector

New demand in Asia

Back in 2005, when the Indonesian mining industry was booming, the country overtook Australia as the leading exporter of thermal coal. Production reached a peak in 2013 (despite coal prices beginning to drop from 2011), and while domestic use of coal was slowly increasing, around 75% of Indonesia’s coal was exported. Between them, China and India imported around 60% of Indonesia’s exports. Today, India has overtaken China as the leading buyer of Indonesian coal, however both countries remain crucial markets.

Changing times for China and India

With regards to China, much has been written about how the country’s prolonged reduced demand for global commodities impacts exporting nations such as Indonesia. When China first announced plans to begin to replace coal with cleaner fuels in order to reduce severe pollution, there were fears that coal exporters would be hardest hit. Indeed, it was this shift that has led Indian demand to overtake Chinese demand for Indonesian coal in recent years. 

As the Chinese government cracked down on illegal coal mines, and restricted domestic production, the signs seemed to point at a possible sustained fall in imports of Indonesian coal. The government closed a number of private mines on account of indebtedness and inefficiencies, or absorbed them into state owned mining companies. In addition to the war on pollution, China was struggling with oversupply and as such, took steps to limit domestic output to bolster the coal price so that state owned firms could address their outstanding indebtedness. 

According to China’s National Energy Administration (NEA), the country’s 2017 energy mix will see coal usage reduce from 64% of the total energy mix, down to 60%. China plans instead to lift the ratio of natural gas and other energy sources. Similarly, China aims to cap coal-fired power plant capacity to 1,100GW by the end of 2020; currently coal fired capacity generates 64% of power, at a 960GW capacity. 

However, while China has made strides in changing its energy strategy in an attempt to reduce pollution levels, coal remains a significant component of the country’s energy mix. The government’s may have made a commitment to reducing its dependence on coal over the next few years, in favour of non-fossil fuels, but coal power generation capacity will grow by nearly 20% between 2017- 2022. In 2016, Chinese imports of coal increased by 43 million tons (mt). This bodes well for Indonesia. 

On to India, and there is one potential challenge on the horizon; on account of domestic over production, Indian demand may decline. Despite importing over 200mt of coal annually, India is pushing to become more self-sufficient in energy by increasing its renewable energy mix, reform its energy distribution network and doubling domestic coal production. There are reports that Coal India is opening mines at the rate of one per month so that government plans to boost power capacity can be met. Just like in Indonesia, the government is keen to use increased power supplies as a means of gaining political support. 

Indonesia mining sector

Indian domestic production has increased at such a pace that negotiations are underway with neighbouring Bangladesh and Nepal, in order to offload the surplus, estimated to be 50mt. That potentially means a reduction in demand for Indonesian coal. However, the shift should not be game changing for Indonesia; lower grade coal, higher delivery costs and logistical challenges will limit India’s ability to export coal efficiently in large quantities. In addition, while there is a current oversupply domestically, India’s coal usage is set to continue to rise as the government seeks to increase power capacity. Export of electricity instead could be an option for India in the future, should the domestic miners such as Coal India Limited (CIL) continue to oversupply.

Download Risk Focus

For more information, please contact ClientFirst@jltcanada.com.

YOU MAY ALSO BE INTERESTED IN

contact Harry Floyd
Partner, JLT Mining harry_floyd@jltgroup.com