At a glance:
Indonesia’s draft Mining Law:
- Stipulates that COWs/CCOWs will be replaced with IUPKs, within one year of the law being passed
- Seems to introduce a greater degree of flexibility with regard to the obligation to refine ore/coal
- Seeks to introduce tax incentives for mining companies carrying out processing/refining activities.
- Relaxes foreign ownership restrictions, so that foreign owners can retain control of mining companies
- Sets out that divestment to non-state/state-owned owned entities will need to be carried out by IPO
- Increases the initial production period by 10 years for companies doing integrated mining and processing
- Prohibits Central, Provincial, and Regional Governments from imposing non-tax levies, without the Ministers approval
- Permits holders of IUPKs to apply for an extension IUPK five years (but no later than one year) prior to expiry
- Permits mining services companies to extract mineral ores (not just removal of overburden)
- Stipulates that PMA mining companies with foreign shareholdings below 34% are regulated by the Provincial Government.
Following the appointment of a new Minister and deputy Minister to the Ministry of Energy and Mineral Resources (“MEMR”), revising the current legal and regulatory regime for miners will be a key priority. We have recently reviewed a discussion draft of a proposed new mining law circulated by the MEMR (“Draft Mining Law”). The Draft Mining Law, if enacted, would replace Indonesias existing mining law (Law No 4 of 2009 on Minerals and Coal Mining – “Current Mining Law”). It is likely that the Draft Mining Law will go through further iterations before reaching a final form; however, it provides a useful insight into the current thinking of the Government in respect of many issues of importance to investors in the mining industry in Indonesia. We provide our observations on some of the issues tackled by the Draft Mining Law in this alert.
Contracts of Work
The Government seems determined to drive a stake through Contract/Coal Contract of Work holders once and for all. The proposed legislation requires all COW/CCOW holders to be converted into IUPKs (see below) within one year. The period of the IUPKs will be the same as the remaining period under the COWs/CCOWs, with the rights and obligations under the IUPK matching those under the contracts, as amended.
The draft law is silent as to what happens if the COW/CCOW contractor does not agree with this process. The proposed draft also seems to assume that contractual rights and obligations under a COW/CCOW can be easily converted into licences. Query whether this process will be so straightforward. How, for example, will the IUPKs incorporate binding arbitration provisions, or the attempts of some generations of COWs/CCOWs to nail down tax rates, etc.?
In this connection, the reference to the rights and obligations of the IUPKs matching those of the amended COWs/CCOWs would seem to be an indirect attempt to resuscitate the concept under the Current Mining Law, that effectively the more disadvantageous fiscal terms should apply. On top of this, an additional 10% royalty on net profits will be payable by IUPK holders.
Processing and refining
The Draft Mining Law contains provisions requiring domestic processing and refining of minerals and coal which are more detailed than in the Current Mining Law but largely replicate existing regulations which have been issued under the Current Mining Law. Domestic processing/refining is a compulsory term to be included in each IUP and IUPK.
This being said, the Draft Mining Law refers to the requirement for mining companies to increase value through processing and/or refining. Both terms are clearly defined, with processed minerals retaining their original physical/chemical properties, and refined materials having different properties from their constituent ores. If this distinction is maintained, query whether, in fact, the Government is trying to move away from requiring the construction of smelters to accepting that beneficiation of ore is an equally significant “value add”.
In this connection, the amount of value adding which needs to be performed is stated to be determined based on a consideration of the quantity of mineral or coal reserves available and domestic industrial demand. On one interpretation, this would appear to leave the door open for export of raw ore without any processing or refining if there are sufficient reserves and insufficient domestic demand.
Notwithstanding this, it seems that there is still every likelihood that the Government will seek to impose smelter construction requirements for most minerals, while at the same time allowing itself some additional flexibility with regard to others.
Another new aspect is that provisions have been included which provide that fiscal incentives may be provided to holders of mining licences who construct processing and/or refining facilities. Unfortunately, it is not clear from the drafting whether this means that new fiscal incentives may be provided under the Draft Mining Law as new incentives or whether those incentives only consist of the general incentives available under other prevailing laws and regulations. Nor is it clear that these incentives would apply to smelting companies, as opposed to companies holding mining concessions and seeking, also, to build their own smelters.
The Draft Mining Law contains divestment provisions that are similar to those contained in the implementing regulations of the Current Mining Law. However, the ultimately permissible level of foreign ownership before divestment will apply has been changed from 49% to become 51%. This means that foreign shareholders will be able to have a controlling interest in the mining company, rather than the situation under the Current Mining Law, which requires that foreigners ultimately divest to a level where their interest is a minority interest. This is an improvement for foreign investors over the current situation but still much worse than the originally permitted 80% foreign ownership, which applied when the implementing regulations of the Current Mining Law were issued in 2010.
As with the Current Mining Law, shares which are to be divested must first be offered to State-owned enterprises (at the Central, Provincial and Regional levels). However, in contrast to the Current Mining Law, if these entities do not wish to take up the shares, the mining company is required to divest by offering new shares on the Indonesian stock exchange, rather than directly to private entities. The shares that are offered on the stock exchange may only be taken up by Indonesian entities (not foreigners or foreign-owned entities). Query, however, how on-sales will be restricted.
Longer production periods for integrated projects
The Draft Mining law provides an additional 10 years to the initial production period of a minerals IUP provided that the project is integrated with processing and refining facilities. Similarly, an IUP for coal mining will obtain an additional 10 years for its initial production period if the project is integrated with a thermal coal power plant (a mine-mouth project). Presumably this is to allow a greater time for return on investment given the additional capital costs involved in also establishing the processing or power facilities. The extended time periods also apply in relation to IUPK projects that are similarly integrated.
For IUP projects, applications for extension of the production period must be filed no earlier than four years before expiry and no later than one year before expiry. For IUPKs, applications must be filed no earlier than five years before expiry and no later than one year before expiry. So IUPK holders are given a minor degree of additional flexibility as to when they can apply.
The concept of an IUPK is defined under the Current Mining Law as a mining area with strategic value to the State. That said, their precise purpose was never clear under the Current Mining Law and no IUPKs have ever been issued, although in the intervening years since the introduction of the Current Mining Law, the Government has come to the view that IUPKs should be used to replace existing Contracts of Work.
The Draft Mining Law defines the area over which an IUPK may be granted as being an area to be used for mining operations “in light of national strategic interests”, not too dissimilar from the Current Mining Law. A new development though is that the detailed provisions in respect of IUPK areas provide that the areas must be areas “to be used for the sake of national interests in fulfilling domestic industrial raw materials and energy needs”. This contrasts with the provisions on determination of areas for IUPs, which merely require that the areas must be “used for sustainable mining activities”. This contrast suggests that coal and minerals derived from an IUPK area may need to be used domestically and may not be able to be exported. The result is that IUPK areas are effectively national strategic reserves. This concept seems to sit uncomfortably with the concept of COWs/CCOWs being converted into IUPKs.
As with the Current Mining Law, the Draft Mining Law gives priority to receive an IUPK to national State-owned enterprises (BUMN) and Regional Government-owned enterprises (BUMD). IUPKs may be granted directly by the Government to BUMN and BUMD based upon an application from the relevant BUMN/BUMD. They may only be granted to private business entities if there is no interest from BUMN and BUMD, in which case the grant will occur after a public auction in which the private business entities are requested to bid for the relevant IUPK area.
As mentioned above, IUPK holders may apply for an extension five years before the expiry (but no later than one year before the expiry) of the IUPK. The concern with this is that where the extension of a COW/CCOW/IUPK requires more than 10 years to be viable, it is not at all clear that it will be possible to request the second extension until half-way through the first extension. Given depressed commodity prices, and the extra burdens being heaped onto mining companies, the absence of any clear certainty on the second extension of any mining concessions may prove fatal to raising finance, and to these projects.
Bidding directly for Production Operation IUPs
Consistent with the Current Mining Law, holders of Exploration IUPs are entitled to upgrade to Production Operation IUPs provided they perform their obligations under the IUP and continue to comply with the various requirements under the law and regulations. However, the Current Mining Law does not provide any method for the Government to issue a Production Operation IUP to a mining company without first issuing that mining company with an Exploration IUP. This does not work in circumstances where, for example, an Exploration IUP holder may have fully explored the area and then chosen not to upgrade to Production Operation (relinquish their IUP) or has otherwise failed to comply with its obligations.
The Draft Mining Law allows existing IUP areas that have previously reached the feasibility stage (meaning that the Government already has sufficient data on the reserves in the area) to be auctioned to interested mining companies. The price that is being bid upon is the price that will be used to compensate the Government for the resource information that will be handed over to the successful bidder. The successful bidder can then be directly issued with a Production Operation IUP without needing to go through the Exploration IUP stage. The provisions in the Draft Mining Law that relate to IUPKs also implement the same concept.
Project financing difficulties not addressed
Sadly, the Current Mining Law does not address one of the main difficulties in respect of project financing involving mine-mouth power plants and mineral smelters: the fact that the foreign ownership requirements for mining companies are different from those for power plants and smelters. This currently complicates project financing as the differing foreign ownership requirements (and divestment regime under the Current Mining Law and Draft Mining Law) mean that there will be different sponsors (with different proportions of equity) in the mine part of the project compared to the power or smelting part of the project.
The Draft Mining Law seeks to address this to some extent by giving a longer period to divest for integrated projects; however, this does not necessarily solve the issue as it still means that a change in sponsors could be required at a point in the project lifecycle that may not be the most desirable.
Settlement of surface rights with other land users
Unfortunately, the Draft Mining Law does little to ease the ability of mining companies to settle the compensation payable to owners of surface rights over land or to institute a system for settling disputes in this area. It does, however, clearly state that a grant of an IUP or of an IUPK does not include surface rights. The Draft Mining Law also says that settlement with surface rights holders can be reached through consensus by way of purchase, exchange, proper compensation, acknowledgment and other forms of compensation (including the mining companies guaranteeing that they will reach a settlement – having reached agreement – but not yet (presumably) implementing it in full).
In addition to the fiscal incentives which may apply in respect of processing and refining facilities, the Draft Mining Law also separately provides that tax relief and incentives may be provided to increase investment in the mining sector generally (without any linkage to construction of processing and refining facilities).
A welcome addition included in the Draft Mining Law is a prohibition on the Central, Provincial and Regional Government imposing non-tax levies which would add to the burden of financial obligations on holders of IUPs, IUPKs and Special IUPs for Processing and Refining without first obtaining Ministerial approval.
Mining services companies
The Draft Mining Law contains provisions in respect of mining services companies that change the regime applying at the moment. Consistent with the current regime, ministerial approval is required to appoint an affiliated company to provide mining services (in order to cut down on transfer pricing issues). However, in contrast to the current regime, the Draft Mining Law anticipates that mining services companies will be permitted to conduct actual extraction of mineral ores (not just removal of overburden). This will be a welcome change for mining services companies and mining companies who contract out services.
IUPs for Transportation and Sales
As with the Current Mining Law, companies that do not engage in mining but wish to conduct transportation of mine ores or trading of mine ores need to obtain a licence for this purpose (a Special IUP for Transportation and Sales). As referred to above, the Draft Mining Law contains provisions that suggest that holders of such an IUP may only trade minerals and coal domestically. There will also be an additional royalty applied to trading activities.
The Draft Mining Law bolsters the rights of groups that are affected by mining activities with specific provisions that provide that the public is entitled to:
- information regarding the implementation of mining activities;
- benefits from mining activities through the corporate social responsibility obligations of mining companies; and
- obtain redress due to failures to implement mining activities in accordance with legislation.
The Draft Mining Law provides rights for the public to file lawsuits in Indonesian courts to obtain damages as a result of any mining activity that violates laws or regulations. The relationship between these rights and those given to local communities under the Environmental Law and related regulations is unclear.
When the Current Mining Law was introduced, it implemented regional autonomy principles by allowing most decisions in respect of the vast majority of mining licences (IUPs) to be made at the Regional Government level. Unfortunately, lack of capacity at the Regional Government level resulted in many invalidly issued licences, necessitating the Central Government to step in and perform a verification process in relation to the thousands of licences that were issued at the Regional Government level. Seven years after the Current Mining Law was introduced, that verification process (colloquially known as the “Clean and Clear” process) is still ongoing.
The Draft Mining Law addresses this by pushing authority over the majority of mining licences one level up the hierarchy, to the Provincial Government level (consistent with changes introduced by the Regional Administration Law).
Further, authority moves another level up to the Central Government in respect of mining licences where the level of foreign ownership is 34% or greater.
The 34% mark appears to be arbitrary, roughly equal to one-third foreign ownership. Recent regulations under the Current Mining Law, intended to address lack of capacity at the Regional Government level, had moved authority in respect of companies holding mining licences with any level of foreign ownership up to the Central Government level. Consequently, the situation envisaged in the Draft Mining Law is a compromise: the Regional Government level loses authority in respect of the vast bulk of mining licences, while the Provincial Government level gains that authority (so it is not the case that everything is re-centralized to the Central Government) but the Central Government level retains authority if there is a significant degree of foreign ownership.
The same delegations of authority are reflected in respect of authority to issue licences for processing and refining facilities (Special IUP for Processing and/or Refining), for issuing licences for mining services companies (IUJP) and licences for transportation and sales businesses (Izin Pengangkutan dan Penjualan).
The Central Government retains the right to set national policies in respect of minerals and coal mining (including domestic market obligations and export quotas) and also retains the exclusive right to issue special mining licences (IUPKs).
The Draft Mining Law is merely a draft and may be subject to further iterations. Interpretations of these new provisions may also differ. While considering the Governments approach in the Draft Mining Law is a useful endeavor for those interested in lobbying the Government, investors should wait for a final version of the legislation before considering any impact on their investments. This being said, while the Draft Mining Law makes a number of welcome concessions to investors (e.g., by relaxing the divestment requirement), the overall effect of these proposals – given the current stresses being put on the industry – may do little to revitalize Indonesian mining for the time being.
For further information please contact
- Muhammad Karnova
+62 21 2960 8699
- Reggy Firmansyah
+62 21 2960 8570
- Hadiputranto, Hadinoto & Partners
The Indonesia Stock Exchange
Building, Tower II, 21st Floor, Sudirman Central Business District, Jl. Jendral Sudirman Kav. 52-53, Jakarta 12190 Indonesia
Tel: +62 21 2960 8888
Fax: +62 21 2960 8999
*Hadiputranto, Hadinoto & Partners is a member firm of Baker & McKenzie International.