New Indonesian Mining Law’s Rules on Outsourcing Spook Foreign Investors

By webadmin on 11:04 pm Nov 23, 2009
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Fitri Wulandari: Analysis

A new government mining rule, limiting contract work that can be outsourced and favoring local players is shaping up as a fresh blow to plans to boost mining investment in the economy.

The rule, attached to a mining law passed last year, presents an immediate challenge for new Energy and Mining Minister Darwin Saleh, who was sworn in last month amid hopes that a new government could boost the resources sector.

The mining law, which replaced one passed 41 years ago, aims to squeeze more benefits from rich mineral reserves in the country, as the world’s top exporter of tin and thermal coal and a key producer of zinc, copper, nickel and gold.

However, the country has seen little new foreign investment in metal mining in recent years and the ministry’s new rules seems likely to dampen enthusiasm among potential investors.

“It will increase costs for miners because they have to buy their own equipment and hire new people,” said Priyo Pribadi Soemarno of the Indonesian Mining Association.

To contain costs, most mining firms in Indonesia, particularly coal firms, rely on contractors for work ranging from actual mining to stockpiling of minerals.

But the new regulation limits contractors to stripping away top soil and transporting mining products, while the miner itself has to extract minerals.

The move would encourage inefficiency and was out of step with global trends, Priyo said.

“Mining companies globally are trying to slim down their organizations,” he said.

Former Mining and Energy Minister Purnomo Yusgiantoro signed the new regulation at the end of September.

His successor, a surprise pick in President Susilo Bambang Yudhoyono’s cabinet last month, has not publicly commented on it and little is known of his policy stance. Some foreign firms have already shelved investment plans since last year, partly due to uncertainties over the new mining law, which also includes contentious items such as shorter-term mining permits rather than longer-term contracts of work.

Miners will also have to process minerals here and to set aside some of their coal for the domestic market.

The new mining-services rule limits miners’ use of contractors, and when allowed to use one, they must give a local contractor first preference and need the Energy Ministry’s permission to hire affiliates.

David Kiu, an analyst at Eurasia Group, said the new rule was mainly aimed at curtailing transfer pricing, a practice rife in local mining, by which firms in the same group sell to each other at artificial prices to avoid taxes. The new regulation applies immediately to new mining projects but allows existing miners a term of three years to adjust.

The regulation will have a bigger impact on coal producers, since they tend to use mining contractors for nearly all their mining activities, some experts said.

PT Adaro Energy, the country’s largest coal miner by market value, and PT Berau Coal, the fifth-biggest by volume, outsource their entire mining activities.

Sacha Winzenried, a mining partner at PricewaterhouseCoopers Indonesia, said coal companies would have to do more themselves and weigh up local contractors over foreigners.

“This will result in increased expenditures on capital equipment,” he said, adding that miners whose affiliates carry out mining activities might need to restructure their businesses after the end of the exemption period. “It’s either by merging the contract mining business with the mining company or transferring the assets, or selling off the contract mining altogether,” Winzenried said.

But an executive at a top coal firm, who declined to be named, said the regulation would significantly increase the requirements for capital, possibly limiting expansion. “By employing contractors, this limits the capital requirements for heavy equipment and therefore we can expand faster.”

The mining association fears investment could fall below $1 billion this year due to uncertainty over the new law, although the government has said investment could surpass $2 billion.

“If the regulation is not amended, new investors will think twice before investing because it will increase costs and not every mining company is capable of increasing their investment,” Priyo said.