A year ago, Indonesia said the results of its controversial mineral export bans would bear fruit in 2016. As we hurtle towards that deadline, Finbarr Bermingham looks at the progress of a play that could change the rules of the commodity game forever.
For almost four decades from the 1950s, the west lived in perpetual fear of what it termed the Domino Theory. Taking root in Russia, spreading through Eastern Europe and down through the Southeast Asian corridor that was then known as Indochina, the Domino Theory proposed that if one state fell to communism, it would only be a matter of time before the same fate would befall the next, then the next; so on, so forth. Ascription to the theory formed the bulk of the US foreign policy through this period and led to lengthy wars in Korea and Vietnam.
Times have changed, but it seems that the domino is back in vogue in Asia – although the trajectory it’s taking is greeted much less suspiciously by policymakers and wonks in the west. In 2015, the domino ripping its way through East and South Asia is one emblazoned with the word: “reform”, as one emboldened leader after another steps up to the plate with a view to changing how things are done.
In Hong Kong, the debate wages over how much of a reformist Xi Jinping, sitting in Beijing, actually is, to what extent he will continue with his policies of economic liberalisation and whether he will marry them with political equivalents. Since Narendra Modi’s eye-catching electoral victory in India last year, much chatter has been devoted to how he will transform the systemic bureaucracy that threatens to squash the country’s shot at being the next trading superpower. Shinzo Abe in Japan has embarked on a radical journey of currency devaluation, with a view to boosting exports, on which the jury is still out.
And then there’s Indonesia, which has arguably undertaken some of the boldest export reform steps in recent years across major economies. In restricting the export of minerals, Indonesia has risked choking off the lifeblood of its economy. Changeable regulatory landscapes are nothing new in developing economies, but Indonesia has been growing in prominence as an exporting country and investment destination: in 2012, only China outgrew it among the G-20 nations. It is the world’s largest producer of tin, has more coal than Russia, and is the second-largest producer of nickel and fourth-largest producer of bauxite. So when things begin to change, people take notice.
Shake it all about…
It’s been a tricky story to follow. Indonesia’s mining regulations have, in recent years, taken the form of a high-stakes hokey-cokey (in, out, in, out). But, to summarise some of the key points and rulings:
In February 2012, the government introduced new divestment requirements, which stated that foreign-owned mining companies must divest their shares in stages to Indonesian participants, commencing after five years of production. The timeline requires that companies divest at least 20% of their shares after six years, 30% after seven years, 37% after eight years, 44% after nine years and 51% after 10 years.
In the same month, the government announced plans to prohibit the export of unprocessed raw materials or ore. The raw materials will have to be processed in Indonesia, rather than being exported in a raw state, a move intended to develop the country’s downstream mining industry, increase domestic revenues, and ensure availability of refined products for domestic use (this does not apply to coal). If companies wished to keep exporting the minerals, they were forced to commit to constructing facilities in which to process them (such as smelters), so that there was a definite timeline towards exporting value-added goods.
And from April 1 this year, the trade ministry has ruled that commodity exporters must use letters of credit in their overseas shipments of coal, oil and gas, palm and palm kernel oil and minerals including tin – which together accounted for some 41% of the country’s total exports and which are worth US$71bn to the national coffers. This is designed to allow the government to monitor the minerals and currency leaving Indonesia.
While these regulations seem to be tweaked on a regular basis according to political climate and the direction in which the wind is blowing, they seem to be here to stay. Last year saw the election of Joko ‘Jokowi’ Widodo as the country’s first non-military or political elite leader. And as well as pledging to narrow inequality, boost healthcare and spend big on infrastructure projects, Jokowi – another self-ascribed reformer – has maintained the commodity regulatory plans of the previous government.
How’s it going?
When the export bans came into place, the Indonesian authorities conceded that it would provide some short-term shocks. Give it time, they said, promising that the plan would see the country shimmy up the value-add chain and that fruits would be borne post-2016. As the calendar ekes perilously close to that deadline, how has the regulatory environment impacted Indonesia’s economy?
The international trade community was initially up in arms and many are still heavily critical of the rulings. When asked whether the bans were having the desired impact, Rick Beckmann, a partner at Norton Rose Fulbright who works extensively on Indonesian trade issues, tells GTR: “Certainly not at this stage. To the contrary, there has been considerable negative press about the impact, including wind-back of mining operations and worker lay-offs.”
However, the stance has softened slightly in recent months as it became abundantly clear that Jokowi was not for changing. The initial assumption was that the ban would lead to a mass exodus of the Indonesian market by the mining companies. After all, building a smelter could take up to eight years and cost up to US$1bn. In the early days of the new regulations, it was only state-owned Indonesian companies who committed to construction, such as Aneka Tambang, which raised US$1.6bn to build a ferronickel smelter, with the plant recently coming online.
In what seems to have uncanny parallels to the Kübler-Ross model, some companies have begun to move beyond the stage of denial. Many are still angry, but those with most vested interests appear to have entered the bargaining stage and are ready to sit down with Indonesia’s government.
“It appears that the onshore processing requirement is here to stay, and at least some of the larger players appear to now be speaking seriously with the government about smelter development in Indonesia. Ultimately, there is a chance that the intended benefits of smelter development, being increased investment and introduction of advanced technology, could start to be seen,” Beckmann adds.
Tom Rafferty, Asia economist at the Economist Intelligence Unit, tells GTR in an email exchange from Jakarta: “Companies with an existing presence in Indonesia, such as Freeport, still have ambitious plans for their mines in Indonesia and are willing to build smelters in order to ensure they can continue to exploit them, despite the many concerns about the economic value of the smelters.”
It seems, then, that in some cases the coercion worked: Indonesia is simply a market that is too important to be excluded from if you’re a serious player in the mining business. Government data shows that there are 19 processing plants in the development or construction phases, bearing the names of companies from Marubeni to Posco, from Krakatau Steel to Ning Xia Hengshun of China.
But it has not all been plain sailing and the government’s hard-line stance has added to what has become a complicated time for Indonesia’s economy. There has been some talk of other governments and companies trying to sue Indonesia for threatening their assets.
“At a state-to-state level, the Japanese government had threatened to take action against Indonesia through the World Trade Organisation, although the initial Indonesian response was to invite Japan to build smelters in Indonesia. This matter seems to have quietened down, at least at this point. There were also some rumblings from private investors that action would be taken using bilateral investment treaties,” Beckmann says.
Furthermore, the media glare it has received has arguably tarnished its reputation among overseas investors, while also emphasising how over-dependent on commodity markets Indonesia is, at a time when many of their key products are floundering.
“Nickel exports have essentially dried up, while the thermal coal market – also important to Indonesia – has been in the doldrums for quite some time, something we are also feeling here in some part of Australia,” James Glenn, commodities analyst at National Australia Bank, tellsGTR. “Sharp declines in oil prices are not helping matters either. While the ban on ore exports is having a negative impact via lower exports, there may be some long-term benefits should foreign firms decide to ramp up domestic refining operations in response to an undersupply of high-quality ore although political uncertainty may still be an issue.”
There is also the sense that the rest of the world is watching the Indonesian situation very closely. A flavour of how important the nation is to the Southeast Asian supply chain can be garnered from reading press cuttings from the time the mineral ban came into play in earnest in January 2014. “Halting exports of nickel ore could spark the biggest shake-up in the global nickel trade in more than five years, with Chinese stainless-steel factories that make everything from kitchenware to cars and buildings set to hurt the most,” read one report in the South China Morning Post.
And it doesn’t stop there: if the initiative proves to be successful, then other resource-rich economies could take note. Beckmann says there are certain African countries that are already planning to follow the model, even before the results are clear.
What we’re seeing in Indonesia is a play which has the potential to completely transform the way commodities are produced and sold and to turn the traditional extractive industries on their collective head.
First published in GTR