AFG Venture Group Dispatches

Corporate advisory and consultancy in Australia, South East Asia and India.

Changes to Indonesian Mining Law – Peter Church & Mitchell Brown, AFG Venture Group

AFG Venture Group has been working closely with the leading law firm of Blake Dawson to which our Chairman, Peter Church is Special Counsel in relation to the interest of Indian companies in the resource sectors of Australia and Indonesia. We are also keeping an eye on the opening up of the Indian mining sector to foreign involvement which will create significant opportunities for Australian miners and service suppliers to that sector. Each of AFG Venture Group and Blake Dawson maintains its own offices or has affiliated offices in each of Indonesia and India.

Whilst Chinese interest in Australian and Indonesian resources is well known in Australia we believe in the coming years we are going to see a massive increase in Indian investment in those countries whether that is by acquisition, joint venture or offtake agreements.

Whilst Australia’s foreign investment and mining laws are relatively well understood, the situation in Indonesia is far less so and particularly in the light of its new Mineral and Coal Mining law which came into effect in January of this year. We thought our mining clients might like a short summary of the current Indonesian position.

The new law implements a new system for obtaining mining permits and replaces the former system under which there were two separate types of mining rights, one for foreign miners and one for local miners. It is seen as an attempt to attract new investment from major global mining players into the Indonesian mining sector which has struggled in recent times, due to issues such as uncertainty over mining regulations, disputes with local governments and illegal mining.

The new law has made the position clear in some areas but, until the implementing regulations come into force and the mining industry understands what they mean, considerable uncertainty will remain. With Indonesia in the midst of a Presidential campaign we are unlikely to see definitive answers to areas of uncertainty until later this year.

The recent downturn in prices of natural resources, combined with uncertainty about the enactment of the new law has had a negative impact. Many major mining companies have chosen to defer investments and total investment in the sector is expected to drop below US$1bn in 2009, down from US$1.6bn in 2008 – when natural resources accounted for roughly 11% of Indonesia’s Gross Domestic Product. The sector has also been a strong contributor to the country’s terms of trade, with mineral products making up 11% of total exports – second only behind manufactured goods. Interestingly, Indonesia’s total exports are equivalent to only 30% of its GDP, compared to Malaysia where it is 95%, and in the current economic environment this should place Indonesia in a strong position going forward. The Indonesian mining sector is accordingly a very important sector of the economy and the legal situation is being watched with great interest both locally and internationally.

The new mining law replaces the existing Contract of Work (CoW) system under which foreign investors could invest in special-purpose companies which obtained long-term mining contracts from the Central Government. It also replaces the current Kuasa Pertambangan licences (literally “right to mine” known widely as “KPs”) which can only be granted to Indonesian nationals but which, through contractual arrangements, have increasingly been used by foreign investors as new CoWs have not been granted for many years. These existing mechanisms are to be phased out and the new, unified licensing system is to be applied to all new licenses.

The Mining Business Licenses (IUPs) to be issued under the new law are divided into two types, Exploration and Production Operation. Exploration IUPs for ferrous minerals are valid for 8 years (7 years for coal) and Production Operation IUPs for ferrous minerals (and coal) are valid for 20 years (with two 10 year extensions possible for a total of 40 years). Progression from an Exploration IUP to a Production Operation IUP is expressed to be ‘guaranteed’, however how this operates in practice remains to be seen and has been one area of concern for investors; both foreign and Indonesian.

IUPs are primarily issued through an auction process and the primary issuing authority for IUPs is the relevant Regional Government, of which there are almost 350 in Indonesia. In the case that the proposed mining area spans more than one region, the Provincial Government and, if multiple provinces, the Central Government are the relevant bodies to issue the licence. This was the position for KPs under the previous law. Some analysts have commented that dealing with “local government” is likely to favour local companies that have established relationships, and that working with this level of government rather than a specialist Mining Department may cause unnecessary delays and “red tape”.

With respect to ownership, IUPs cannot be directly granted to a foreign entity, so in most cases foreign companies will gain access through an Indonesian holding company, of which 100% can be owned by foreigners for the first 5 years of production. After 5 years, 20% must be progressively (over 4 years) divested to Indonesians. However this only applies in cases where 20% is not already owned by Indonesians meaning ultimately, that 80% of the holding company can be foreign owned.

The Indonesian Government has stated that the new law was drafted with a number of purposes in mind. Firstly, the law aims to provide equal treatment for foreign and domestic investors which in theory seems to be correct, although in practice this may not be the case. Secondly, the law aims to build local mining services’ capacity through provisions requiring the domestic processing of minerals and the use of local mining services contractors (where possible). This requirement to process domestically has been raised as a potential issue by many foreign investors. Thirdly, the Government is empowered to set production caps, benchmark prices and export controls which, needless to say, is also an area of considerable concern to both foreign and Indonesian investors.

Needless to say Blake Dawson is keeping well abreast of the legal position and, if any of you would like to receive updates as the situation evolves, please do not hesitate to let Gordon Hart, Mitchell Brown or Peter Church know and we will put you in touch with James Donoghue of Blake Dawson and his Indonesian colleagues with whom we are working closely.

About the Authors
Peter Church, OAM is an international lawyer and business adviser who has lived and worked in the South East Asian region for more than 30 years. Peter advises a varied group of major Australian and international companies in relation to their Asian investment and trading activities. He was for many years President of the Australia Indonesia Business Council and sat on numerous Australian Federal Government Boards such as the Trade Policy Advisory Committee.

Peter was awarded the Medal of the Order of Australia in 1994 for his services to the promotion of business relations between Australia and the South East Asian region. Later this year his Short History of South East Asia will go into its 5th edition and his forthcoming book on the life stories of leading Indian businessmen and women will be published in India. He also sits on a number of Boards and is Special Counsel to Blake Dawson, one of Australia’s leading law firms.

Mitchell Brown has a degree in Agricultural Economics from the University of Sydney where he majored in Economics, Finance and Agricultural Economics. He has also completed a Graduate Diploma of Applied Finance and Investment at FINSIA.

Mitchell joined AFG in 2001 and his role includes managing and undertaking research for a variety of projects, including assisting in the management and execution of mandates.

Copyright 2009, Peter Church and Mitchell Brown, AFG Venture Group. All rights reserved. All material in this article is the Intellectual Property of Peter Church and Mitchell Brown, AFG Venture Group and cannot be reproduced, copied, published, quoted or disseminated without the prior permission of Peter Church and Mitchell Brown, AFG Venture Group.