Divestment of Foreign Mining Interests Set to Hurt Indonesia

By webadmin on 10:35 am May 15, 2012
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Simon Butt & Luke Nottage

The Indonesian government issued a regulation in February requiring majority or wholly foreign-owned companies holding mining licenses in Indonesia to divest a majority share of the company to an “Indonesian participant” after 10 years of production.

For many foreign investors, this will mean a mandatory divestment of equity.

An offer to purchase the share must first be made to the central government. If the central government is not prepared to purchase the share, then it must be offered to the provincial government or city/county government. And if they also refuse, then the shares will be offered by auction to (in order of priority) a state-owned enterprise, a regional state-owned enterprise or a national company. Failure to divest according to this schedule can lead to suspension of production and even a revocation of the mining license.

The concept of divesting foreign interests in Indonesian mining firms is not new. The 2009 Mining Law required a divestment after five years of production, but did not specify the amount of divestment. A 2010 regulation required Indonesian participants to hold 20 percent equity in foreign-owned mining operations after five years of production, but did not require further divestments. And mining companies operating in Indonesia have long had divestment obligations under “Contracts of Work” with the Indonesian government, as outlined under the 1967 Mining Law. But the new regulation goes much further by requiring divestment of a majority share.

Predictably, many mining companies argue that 10 years is insufficient for them to make an adequate return on their investment. They also complain about the uncertainty the new regulation brings. In particular, some companies operating under a Contract of Work with less onerous or no divestment provisions fear they will be required to renegotiate their contracts to comply with the regulation’s mandatory divestment provisions. But on this, the government appears to have given mixed signals. Some officials have said the regulation only applies once the Contract of Work has expired or when an extension to that contract is sought, while others say they can be renegotiated whenever the government deems necessary.

Mining companies have also faced difficulties with the divestment process. It is often hard to find a tier of government or Indonesian company with sufficient funds to purchase the stake. And if funds are available, national and regional governments sometimes bicker over which of them should have first priority.

The main problem with the divestment policy, miners and Indonesian economists point out, is that it significantly reduces the Indonesian mining sector’s desirability to investors. Mining contributes 17 per cent to Indonesia’s GDP and a significant proportion of Indonesia’s foreign direct investment ($3.6 billion of $20 billion in 2011).

One explanation for the new regulation is “resource nationalism” — a response to demands from Indonesians, particularly those who live near mining sites, for “a share of what the companies are earning.” The regulation’s preamble explicitly states that one of its rationales is to allow more Indonesians to participate in mining. This may be part of a broader wave of political nationalism, which many within government and various other political parties support. The exploitation of natural resources by foreigners is not publicly popular anywhere in the world, but in former colonial states such as Indonesia the sentiment has even greater currency.

East Asia Forum

Simon Butt is a senior lecturer at the Sydney Law School and the University of Sydney. Luke Nottage is a professor and associate dean at the same school.