World Risk Review Blog

Investing in the Indonesian mining sector has the potential to be very profitable, but navigating the investment landscape can be fraught. The unpredictable regulatory environment is only part of the challenge: dealing with the personalities and vested interests is even more critical. Extensive due diligence is a pre-requisite, not just of the partner firm but of the individuals involved and their connections with political elites. Continue reading ->

Latin America seems to suffer from regionalist inflation. Four new integration projects were born in the last ten years: The Bolivarian Alliance for the Americas (ALBA) launched by President Chavez of Venezuela to counter neoliberal policies and US influence and advocating a radical change of economic and social models; The Union of South American Nations (UNASUR) created and supported by Brazil to give a platform to its regional and global projection; the Community of Latin American and Caribbean States (CELAC) to give the region a single voice in its political relations with international partners; and, most recently, in 2012, the Pacific Alliance, composed of Chile, Peru, Colombia and Mexico with  a view to foster exchanges with the Asia-Pacific. This one has attracted considerable interest and expectations, especially from the international business community.

The economic prospects look promising for the Pacific Alliance area. The bloc has a population of about 204 million people (roughly equivalent to the size of Brazil’s), generates a GDP of 1.4 billion USD corresponding to 34% of Latin American GDP, GDP per capita is close to 11.000 USD per year, and the four countries account for about half of the foreign trade of the entire region. Besides, exports from the bloc grow by 8% a year on average, with a staggering 13% increase in exports toward Asia in the period 2007-2011. The four members are among the fastest-growing economies in Latin America and the declared objective of the Alliance to provide a common platform towards Asia, the fastest-growing region in the world, make economic projections interesting for both investors and domestic political and social planners.

The political picture is equally encouraging. The four members are relatively stable countries. They are generally considered reliable partners and have a record of compliance with international commitments. Colombia has successfully addressed internal problems of guerrilla and drug trafficking reducing risks and improving the country overall performance and image. The arrival to power in Lima of left-leaning president Humala has not brought about a rejection of business-friendly policies adopted by his predecessor. Mexico has positively re-engaged with Latin America in recent years and the newly-elected president Peña Nieto has pledged to modernise the country and tackle alarming violence rates. Chile is on its way to first world status. All the four associates pursue open economy and free trade, maintain cordial relations with the US and have a clear focus on the Asia-Pacific.

However one may wonder what the newly-launched Pacific Alliance may add to this picture. The two principal objectives of the organisation are the free circulation of goods, services, capitals and people; and the creation of a common platform towards the Asia-Pacific. Now, the bloc commitment to free trade is a well-established policy and all members already have in place Free Trade Agreements (FTA) with one another. Furthermore they all have FTAs with the United States and with several Asian countries. The real added value of the Alliance would be a significant progress in the free circulation of services and capital. But it remains to be seen how serious the members are about this commitment. The creation of the Mercado Integrado Latinoamericano (MILA), which brings together and facilitates operations in the stock exchanges of Santiago, Lima and Bogota, was a positive move. Yet the exclusion of most agricultural products from the existing agreements provides a hint of the potential difficulties ahead.

Regarding the projection to the Asia Pacific, for the time being the Pacific Alliance does not have juridical personality. This means that the organisation is not able to sign any agreement on behalf of his members. Negotiations for new treatis with Asian countries will have to be conducted and concluded by member states. In this case, the real added value would be the ability of the Council of Ministers of the Alliance to exercise strong coordination on policies towards Asia. The extent to which this will be possible remains to be seen. Latin American precedents and traditional adversity to any form of supranationality cannot be discounted.

The Pacific Alliance looks more the reflection and consolidation of changes and policies that have already taken place rather than a driver of change. The enthusiasm it prompted might have been not only premature but slightly overstated. The good political, economic and social performances of its members predate it and transcend it. Its future impact and real weight will depend on the extent and consistency of its members’ commitment to it. After all, the Alliance is not even one year old.

In our previous blog, we set the regulatory context for foreign investors in the Indonesia mining sector. In the following, we’ll explore the raw production, prices and quota data and the implications for investors.

Indonesia coal production levels have risen steadily despite the fall in prices from 2010, which led to a decline in revenue for government and private companies (Table 1).

As export prices for coal are far higher than domestic prices, one of the key provisions of the 2009 mining law was the development of a preference for allocating coal and mineral resources to meet domestic needs through production and exports restrictions known as the Domestic Market Obligation (DMO).

Table 1. Indonesian coal production, 2003 – 2011

Source: BP, Statistical Review of World Energy

Within the coal sector, the DMO stipulates that 25% of coal must be sold in the domestic market to ensure that power plants could access sufficient supply. The law came into effect on 31 December 2009, at which time the 25% requirement equated to approximately 80 million tpa of coal.

This requirement was subsequently scaled back to 65 – 67 million tpa because the state had not built power plants at the pace anticipated to absorb the allocated coal. The imposition of production quotas has been debated as the government has become concerned that Indonesia’s 20 billion t of coal resources were being depleted too quickly. Most of Indonesia’s coal reserves are situated in Sumatra in the south, with the balance located in Kalimantan, West Java and Sulawesi. Coal quality varies, with lower grade lignite (59%), sub‑bituminous (27%) and high grade bituminous and anthracite (14%).

Production has increased from 254 million tpa in 2009 to 390 million tpa in 2012, with projections that it could reach 450 million tpa in 2013. Were quotas to be introduced, the government claims they would be set at limits higher than current production levels, which means their impact would be felt in the medium term.

Indonesia coal sector dominated by domestic companies

The coal sector differs from the rest of the minerals sector because it is not dominated by foreign companies. Therefore, the main beneficiaries would be politically well-connected conglomerates who are likely to receive a disproportionately large quota of shares. The coal mining sector is dominated by Indonesian companies with significant political influence. Some the largest producers, such as Bumi Resources, Kaltim Prima and Arutmin, are owned by Aburizal Bakrie, the chairman of the Golkar party, the second largest party in parliament. Bakrie is also a presidential candidate for 2014. Meanwhile, the owner of Adaro is a supporter of the current President Susilo Bambang Yudhoyono. These firms exercise great influence over policy making.

Irrespective of the imposition of quotas, the largest mining companies have indicated that they may limit production in 2013 until they have a clearer view of international demand. China stockpiled coal during the boom and in a downturn it is unclear how long it will take the country to work through its reserves.

A reduction in coal exports from Indonesia will impact Asian coal importers. India and China rely on Jakarta as their largest supplier of thermal coal, while the country as a whole is a major supplier to Japan and South Korea.

In the third and final blog, we’ll highlight two case studies that illustrate the challenges of doing business in the Indonesia mining sector – and the opportunities presented by Political Risk Insurance.