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    Southeast Asia
     Feb 10, '14

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How to kill an industry in Indonesia
By John McBeth

How many times have international executives in Indonesia heard such empty promises? With national oil production sinking from a million barrels to just 850,000 barrels a day over the past decade, ExxonMobil has been battling licensing and land issues for most of that time to develop its Cepu oilfield in East Java.

The 165,000-a-day field is still not on stream, despite the fact that ExxonMobil's partner in Indonesia's biggest onshore discovery in 30 years is the once all-powerful Pertamina state oil company. A senior mines official explained the delay during a presentation last year: "Too much democracy."

Since the government embarked on its current mining policy, most exploration has dried up because, miners say, increasingly

onerous regulatory changes have made it impossible to raise the finance needed to open any sizable mine.

In the mid-1990s, there were 150 junior exploration firms in Indonesia. Today, the number is down to five. For one of them, Kalimantan Gold, the export ban - and the subsequent loss of operating capital it was receiving from Freeport - may be the last straw.

"I gathered my staff of 100 and told them I had good news and bad news," says Australian vice-president for exploration Mansur Geiger, who has lived in Central Kalimantan for decades. "The good news was they would get a year-end bonus. The bad news was it was their severance pay."

Moreover, not one of the 111 affected mining companies met the December 31, 2013, deadline for re-negotiating adjustments to their COWs to conform with the new licensing regime prescribed under the 2009 Mining Law.

One major reason is that Ministerial Regulation 27/2013 not only increases the pace of divestment laid out in attachments to the 2009 law, but also erodes the principle of "fair market value" if the government wants to take a stake.

Arbitrary decree
Jakarta-based resource lawyer Bill Sullivan calls last September's bombshell decree a "tipping point", noting that it appears to disregard the rights of the COW holders to a degree that may invite additional arbitration.

As things stand, a lack of domestic capital means government divestment targets will be tough to meet - more so after Regulation 27 inexplicably ruled out a public listing as one way for a foreign company to meet that obligation.

As the two biggest companies on the block, Freeport and Newmont serve as trip wires for an industry still baffled by a policy that would make a lot more sense if it was applied selectively and in accordance with realistic timetables.

Newmont is in the worst position because its Batu Hijau mine on the island of Sumbawa has much lower ore grades. Executives have said the company will be forced to close and lay off its 9,000 workers if the smelting and tax requirements remain in place.

Freeport's situation may be more urgent. Indonesia's sole Mitsubishi-run smelter in Gresik, East Java, which processes 35% of the company's concentrate, is down for month-long maintenance. With its port-side warehouses likely to reach capacity in mid-February, it will have to curtail mine operations and lay off staff.

Perhaps even more concerning is the fact that the 10,000 artisanal miners panning for gold in Freeport's downstream mine waste will suddenly have their livelihoods disrupted, leaving security forces guarding the Papua mine with an unruly mob it may be unable to control.

The firm's workforce has risen from 19,000 to 30,000 in the three years since it began the $10 billion process of moving from an open pit to a wholly underground operation. Each year, it is spending $550-$600 million building a tunnel and electric rail and conveyor system that will tap into five separate ore bodies and eventually extend to a staggering 950 kilometers.

Yet with only seven years to go, Phoenix-based parent Freeport McMoRan Copper & Gold still doesn't know whether the government will honor an implied pledge in its 1991 COW for two 10-year extensions - and what the terms will be if it does.

Chief executive Richard Adkerson told analysts last year the contract had "undisputed firm legal standing", apparently referring to wording which says approval for the two extensions "will not be unreasonably withheld". After what transpired during a recent trip to Jakarta, he must be feeling a lot less confident.

Given the imperatives of maintaining production at the world's most profitable mine, which has already been hit by two prolonged closures in the past two years, the country's largest single taxpayer can not just stop work and wait for that to happen.

When Hatta Rajasa met Freeport executives in 2012, he demanded the company build a smelter and associated fertilizer plant - in addition to a power station and a cement factory already on the table - as the price for a contract renewal.

Where it gets confusing is that among the minister's expert staff at subsequent sessions has been a prominent businessman with links to one of the two copper smelter projects planned by Indonesian joint ventures.

While Freeport and Newmont have always said up to now they will not invest in such a marginally profitable business, they have agreed to supply their remaining concentrate to any new smelter - as long as it is at commercial prices.

Looking at the financial track records of Freeport's own smelter in Spain and the sole Indonesian facility at Gresik, the only way to turn a profit is for the new ventures to acquire the concentrate at a cut rate. The latter facility, for example, has an operating margin of 1%, compared with 35% for the mining operation.

As it has now indicated, Freeport may end up-biting-the bullet, simply because it has too much at stake. But that would be conditional on the government dropping the export ban and entering into a public-private relationship that would carry with it the promise of incentives.

The power requirements alone for what would be a $2.7 billion smelter on the south coast of Papua would add significantly to the additional 130 megawatts it will need for its extended underground operation.

The company is working with the provincial government on a planned "run-of-the river" hydro-plant, 100 kilometers to the northwest, which it hopes will negate the need for another coal-fired station.

While its current contract frees it of any divestment requirement until it runs out in 2021, Freeport will clearly still have to make some significant concessions as the price for retaining control of the fabulously-rich Grasberg deposit it has been mining since the early 1990s.

The company continues to toy with the idea of giving a stake to Papua's provincial government. It should have been done years ago and probably would have, if a politically connected Jakarta lawyer hadn't intervened at the last minute and told the Papuans they would get a free carry if they waited a little longer.

John McBeth-is a former correspondent with the Far Eastern Economic Review. He is currently a Jakarta-based columnist for the Straits Times of Singapore.-

(Copyright 2014 Asia Times Online (Holdings) Ltd. All rights reserved. Please contact us about sales, syndication and republishing.)-

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