Added Value – time to review. Vol 113

September 23, 2022 Ian Wollff Coal Asia publications 0

Introduction.

On first appearance it would appear that the purpose the Indonesian added value is to contribute to the States monetary system. The principal manner to achieve this added value is to change the minerals into metals, or coal into power or other products. There are only a few adequately documented studies on the success or failure of such added value projects in the mining sector. Some of these studies have opened our eyes into a broadening concept of added value, particularly in terms of employment and social advancement.

It is now a decade since the introduction of the new era of added value. This article may provide input for future discussions on the 2020 reviews of the “added value” aspects of the mining and omnibus laws.

Regulation bases for Added Value.

The Mining Law’s opening “consideration” mentions that minerals within Indonesia are for the nations benefit and are thus under the State control “to bring real added value to the national economy in efforts to arrive at public welfare and prosperity in a just manner”. Therein we may interpret that just mining minerals & coal is compliant with this consideration of bringing added value to the national economy. Conversely, any regulations that hinders the establishment of mines may be seen as opposing this opening consideration.

The Mining Law 4/2009 sets out the authority of the Government to manage the mineral and coal industry. The Law does not seem to define “added value”, and only mentions “added value” in a few articles. For example, Article 6 (1) t “to develop and increase added value to mining business activities”. Article 102 goes a little further in requiring added value for mineral and / or coal mines, processing and refining/smelting as well as utilizing minerals and coal, with the elucidation of “added value” in this provision as intended to increase end products of mining business or utilization of associated minerals. Article 103 mentions further regulations on added value to be issued.

ESDM Regulation 05 of 2017 on added value is replaced by Regulation 25 of 2018. This 2018 regulation defines increment of value adding as an attempt to increase the value of minerals through processing or purification. The regulation goes on to set out fields of added value, and finishes with a clear statement [Article 16 (6)] that added value mays be undertaken “provided that technology is available and economically feasible”. Article 17 states that an increase in value adding is required before export permits will be issued.

Regulation 35 of 2017 (Article 1) goes further to define mineral processing as an attempt to improve the quality of minerals without changing the physical and chemical properties of the minerals. Purification of minerals is defined as an attempt to improve the quality of the metal minerals wherein the product is physically and chemically different to the original mineral.

The 2020 draft Omnibus law seeks to regulate value adding at the national level only, and under regulation 169A links added value to increased state revenue.

Raw Ore Export Restriction.

The Constitutional Court decision 10/PUU-XII/2014 determined the raw ore export restriction was to be upheld. This decision provides some insights to the comparison of the raw ore mining and export compared to the of smelting etc. It would seem the concept of added value again was considered in terms of national income. The court petitioners of miners and service providers mentioned the effective raw ore export ban led to some direct losses of Rp 856 billion, plus operational lost opportunity of US$ 63 million per year along with 1,010 lay-offs of manpower, for these 9 petitioners only. Many of the companies had invested in the added value aspects of building local infrastructure, use of mining and ore transportation equipment and systems, etc, but were now faced with bankruptcy and closure.

The Governments argument was that mineral revenues in 2013 amounted to Rp 22.04 trillion, that will decrease to Rp 16.48Trillion in 2014 (due to ore export ban), but in 2017 there will be a surge to 43.70 trillion (due to the added contribution from smelting). A similar Ministry of Finance argument asks if Indonesia is now exporting $ 5 billion worth of raw minerals, then this could be 5 or 10 times export foreign exchange value after smelting, perhaps being a quarter of Indonesia’s foreign exchange reserves. Other government claims that Indonesian will be able to but finished good quality metal products cheaply. Unfortunately, there is no follow up study to determine the real outcome.

UI Study on W. Kal Bauxite.

The University of Indonesia’s (UI) faculty of economy and business (LPEM) was contracted by Tambang magazine to prepare the report “Study of the estimated potential illegal export of bauxite from West Kalimantan” [UI report]. The study was completed in December 2016 and was set against the backdrop of recent forced closures of bauxite mines in response to the ore export ban. At that time only one W. Kalimantan bauxite processing plant was struggling to remain viable. Methodology includes processing primary, secondary, reference, modelling and in-depth interviews. Estimates of economic benefits are done by applying a multiplier models derived from the national Input – Output model 2010 (IO) table and the IO table of West Kalimantan. This report is significant as it provides much technical and fiscal data, and outlines methodology etc. Selected report notes include: –

The government should be entitled to receive several forms of income from the 58 million ton (2013) of exports of raw ore, including VAT on contract mining, barging and other forms of contract works, on income tax for wages plus company profit tax. Cessation of bauxite mining activity significantly lowers aggregate income, reduces foreign exchange reserves from exports, creates unemployment, and reduces government revenue. Termination of bauxite mining activity has also likely contributed to the decline of heavy equipment rental industry, transportation and construction.” There are ample resources of bauxite that are being withheld from delivering a livelihood and a future for many hundreds of thousands of Indonesians across several provinces. The raw ore export ban and the smelter program only benefits a very few selected Indonesians. Note that the 58 million ton of export ore compared to 3.42 million ton of bauxite ore needed to feed PT. Antam’s proposed Smelter Grade Alumina (SGA) and Chemical Grade Alumina (CGA) plants. There are two more planned smelter will be built in West Kalimantan, namely smelter PT. Alumindo Borneo Prima (PT. BAP) and PT. Well Harvest Wining Alumina (PT. WHW). The current reserves are about 500 million ton.
The WHW smelter capital cost is about US$ 1.5 billion, and includes a US$ 455 million loan to a syndicate of overseas and local banks. The WHW smelter is 70% foreign owned.
The WHW smelter is located in a remote area to reduce raw ore transportation costs. The district and province are not sufficiently developed to take full benefit for the construction and operation of the smelter. Fuel oil, heavy equipment, chemicals and workers are brought in from other parts of Indonesia, or imported. The downstream options (shopping etc) are also few. The multiplier index captures the change in the economic spill over between industries.
If the ore is processed into alumina, either in form or in the form SGA CGA, it is classified as basic chemicals table IO. From The multiplier output sector type-1 is 1,425 or much larger than the multiplier bauxite (1.074). If only half of the bauxite is processed domestically, the economic impact is only 1:24 times the value of the sale of bauxite.
However, it would seem most of this WHW product is exported, and thus the real multiplier index may be much lower.
The UI report is very useful in providing some manpower information for West Kalimantan, wherein the mining and associated sector employed around 80-85 thousand people between 2011 –2014, however this dipped to 37,312 workers by 2015. The UI report attributes much of this drop of 47,000 people to the 2014 raw ore export ban leading to dismissals from the West Kalimantan bauxite mining industry. WHW plans to employ about 2,500 people for smelting and transport of its product. The UI report derives the manpower multiplier effect of 1.42 for mining without a smelter, as compared to 1.87 people employed with a smelter. So, if we look at the wider picture (47,000 X 1.42 = 66,740 for mining lost jobs) and (2,500 X 1.87 = 4,700 for mine & smelter new jobs). The distribution of jobs is not bought out by the UI report, whereas the raw ore export was carried out from multiple mines that brought jobs to a wide range of small towns, districts and provinces, to be replaced by just a few mines to feed the smelters in one or two districts.
The UI report considers the comparative Environmental Quality Index of West Kalimantan (2014) is better than the national average for air and water, but the oil palm plantations bring the forest index slightly lower than the national average, while bauxite mining is not considered a major cause of the reduction of forest index. Similarly, it appears the Village Office reports or natural disasters ratings do not highlight mining as a major consideration.

ESDM Performance Reports.

The 2016 annual ESDM performance report is somewhat typical in that it starts out with lines such as: “The ESDM sector is a strategic sector and still remains a mainstay in supporting national development and economy, both through fiscal, monetary and real sectors”. This is followed by basic outline of increases in mineral production, construction of smelters, optimizing of State revenue along with ESDM administrative performance factors etc. The development of domestic processing and refining facilities mentions “providing a multiplier effect both economically, socially and culturally, as well as increasing state revenues”, but provides no related information on these non-production / fiscal factors. The latter 2014-2019 ESDM performance report does also not include any significant report on “added value”.

ESDM Bauxite Report.

The ESDM web site provides the Bahasa Indonesia report; “Impact of the downstream bauxite industry on the West Kalimantan regional economy” dated December 2016.

The West Kalimantan bauxite export industry reached about 40 million tons in 2011, then in 2014 the new regulation was imposed effectively stopping all bauxite exports. “The ESDM wishes to perform an analysis of the bauxite industry to identify the social and economic impacts felt by the local community by the processing and refining industry in the region”. This academic report only indirectly examines the social and economic impacts on the local community. This desk top report uses an “Input – Output Analysis” method, and makes no reference to a site visit to affected communities. The Input – Output analysis looks at the flow of goods and services from one production sector to another. The authors acknowledge the data is limited to 2010 for a bauxite mining economic data, and to 2015 for bauxite processing economic data, and further warn that the data may not “be trusted”. In order to get a comparison of economies involving both bauxite export and bauxite processing, then some projections are undertaken. The model sets various scenarios. The modelling assumes bauxite and aluminium prices remain fixed at 2015 levels. However, outside of this report we know aluminium prices are more volatile. The data for the smelting case relates to the planned production of the two smelters in West Kalimantan, though at the time of the report, only 1 smelter was in operation.

The ESDM report acknowledges the adsorption of labour into the smelter bauxite industry is very small, particularly compared to the much bigger agriculture/forestry and transport sectors. The report makes an interesting statement; – “But literally, the absorption of labour even insignificant amounts is better than the absence of employment at all”. This ESDM report acknowledges that the effect of mines in remote areas means that “people around producing regions will be more advanced”, and that CSR programs will bring further benefits to remote communities.

An analysis of the smelter-only industry (2015) shows “not very significant growth (<3%) in GDP, income growth, profit growth and tax growth, and the multiplier effect on output, income, tax, profit and labour is not much. This ESDM study confirms the earlier UI study that found the short-term effect of starting the alumina industry lead to negative impacts on income, tax and labour.

The ESDM report then looks at a number of scenarios for various levels of bauxite ore exports and aluminium production for the years 2015 to 2025. In each case the analysis concludes that if the “total impact” is accumulated, then the negative aspects from a planned decline in bauxite ore exports could be compensated for by the positive impacts resulting from increasing alumina production. Some scenarios include the – prohibition of smelter grade alumina exports starting in 2021 with alumina available only for DMO, and another scenario that chemical grade alumina can still be exported. Overall, the study endeavours to see which scenario gives the higher value for the same raw materials. However, the additional scenario that allows direct export of bauxite shows the greatest significant additional value (4 – 19 times) for Indonesia. The study cautions these findings could vary in relation to changes in the world bauxite and derivative commodity prices.

The ESDM report concludes the maximum value from the bauxite industry can be obtained by continuing raw bauxite ore exports alongside the smelting industry. The report further encourages the government to develop the infrastructure to support the growth of the bauxite smelting industry, and so encourage & support private investors into this industry. Finally, the report recommends further attention to be paid to the supply – demand side of the alumina & bauxite industry.

MIND ID bauxite reports on multiplier effect.

MIND ID (Inalum) has shown a number of slides at various conferences that refer to the multiplier effect in the bauxite industry. The material referred to in this article comes from the Institute for Economic and Social Research, Faculty of Economics and Business, Indonesian universities.

Executive Summary: – The role of the mining industry is changing from a foreign exchange earner to a driver of domestic growth.Literature tracking methods and secondary data are applied to describe the contribution of the coal and bauxite mining sector to the national economy. The economic multiplier method derived from National IO Table 2010, South Sumatra Province 2010, North Sumatra Province 2010, and West Kalimantan Province 2010, is used to calculate the industry’s contribution to the national economy and state income (fiscal). Descriptive and econometric approaches are applied to analyse the CSR constituents of the company for the surrounding community. The report looks at the impact at the national, provincial and district levels. Some key findings include; –

Coal: –

The added value for using coal as a raw material for power plants reaches 1.8 times the value of coal sales.
On a national scale if all coal commodities are exported then the industry only has an output multiplier of 1.36. This means that for every million rupiah of coal sales will have an impact on increasing the economic output of Rp1.36 million. Meanwhile, if all coal is sold domestically for fuel or industrial input, the output multiplier will be 2.65. This means that every million rupiahs of coal sales will have an impact on increasing economic output by Rp2.65 million. This means that domestic coal sales for power plants and industrial fuels will generate new outputs along the supply chain of the coal user industry, and also encourage the development of output in a number of related industries that supply production needs.
Each PT Bukit Asam (BA) employee is able to create employment for 2.40 job opportunities on a national scale.

Bauxite: –

The bauxite ore mining sector currently has a relatively small role in the Indonesian overall economy.
On a national scale if all bauxite is exported, the bauxite mining sector has an output multiplier (output multiplier) of 1.07. Whereas if all bauxite is processed domestically, the output multiplier becomes 1.43.
If all bauxite is exported, 100 workers in bauxite mining will be able to create employment opportunities for 124 people on a national scale.
If all bauxite is processed domestically, 100 workers in bauxite mining will be able to create job opportunities for 374 people on a national scale. (though level of processing not defined for these estimates)
Foreign exchange savings are the amount of foreign exchange that can be saved because the economy is able to produce these goods, the value of which is equivalent to the value of products sold domestically (total production value less exports), and only covers bauxite-based industries. The 2009-2018 period of the bauxite-based industry in the group company contributed to save foreign exchange by $ 513.64 million per year. The 2009-2018 aluminium smelter contributed to saving foreign exchange of $ 511.64 million per year. Smelter Chemical Grade Alumina saved a total of $ 19.96 million in foreign exchange in the 2014-2018 period.

Note further that; –

Three (3) ton of bauxite can produce 1 ton of Alumina, and 1.94 ton of alumina produce 1 ton of aluminium ingot.
Not all bauxite end products are viable.

What are the overall numbers?

The way facts and figures are presented often include an element of bias towards validation of the Governments policy to promote Added Value. We might look at some of these figures slightly differently if we take a more holistic view. For example; –

The 2013 figures of 58 million ton of bauxite exports times added value of 1.07 with bauxite at $40/ton sums to $2.48 billion with 45,000 people engaged. Compared to 3.5 million ton of ore to produce 0.6 mill ton of alumina with added value of 1.42 for product value of $320 sums to $0.27 billion with 2,500 people engaged.
The estimate of Smelter Chemical Grade Alumina is that it saved $ 19.96 million in foreign exchange in the 2014-2018 period. This is yet to be compared with the interest & capital repayment of $ 1.5 billion capital investment (70% foreign owned).
The production of 58 million ton of ore for export requires only modest supportive imports, while production of Alumina may require more imports per unit value.
Are there more profits per ton of the nations ore reserves from raw ore mining that can be contribute greater amounts of VAT & profit tax, compared to what the smelter option provides?
The production of 58 million ton of ore for export allows more people to earn a living from the many mines and associated supporting works. These people can reinvest back into new development over a wider area. The profit margin for the Alumina is minimal, and may contribute less proportionally into developing new business beyond supporting the smelter.
The concepts of added value do not yet seem to include the broader impact of smelter waste disposal, coal DMO subsidies to provide smelter power etc.

Stalled Projects.

It has been 6 years since 2014, when the new emphases on added value took the path to effectively ban raw ore exports with the strategy that this would promote the smelter industry, and provide imagined windfall profits to the nation. As to be expected with such brave-new-laws, some modifications of the regulations have been introduced to ensure viability of the mining industry. It is now recognized that such imagined grandiose profits are not fully materializing, and a combination of some raw ore exports and smelters are required to give the best results.

Indonesian geology gives the nation many different types of ore deposits. Some simple deposits such as gold and tin can be treated in small low-cost smelters. Others, such as Freeports copper smelter, need a giant billion-dollar investment that depends upon high volumes for more than 10 years of product to make the smelter viable. Indonesian has many in-between deposits that are too small to justify a smelter, and the complexity of ore deposits may not allow for a central smelter to treat the various ore deposits. Many of Indonesian’s famous epithermal vein deposits fall into this category, wherein the upper levels are gold and silver rich that grade downwards into the base metals of lead, zinc and copper (plus deleterious elements). The transition zone may have good gold grades that are unviable due to the present regulatory added value processing complexities for extracting value from such base metals.

A list of stalled mining projects, along with their potential value to the nation’s economy, manpower and regional development is not readily available.

Conclusion.

An argument from the Government in the Constitutional Court case to defend the raw ore export ban included the concept “that 5 years was sufficient for IUP owners to construct smelters”. It is now a decade since the 2009 mining law introduced the new emphases on added value adding, and it is time to review the concept of added value.

Suggestions for a review may include: –

The implementing regulations the concept that “provided that technology is available and economically feasible” may be accepted. The government can draw a line under this concept and allow certain projects to proceed without the one-size-fits-all smelter requirement. This would comply with the Mining Laws opening consideration that mining should bring benefit to the people.
The definition and scope of Added Value may be reviewed by a panel of independent experts, wherein fiscal aspects are balanced with non-fiscal aspects – such as employment, environment, spread of benefits, waste disposal etc. The aspect of “added value” may consider positive and negative values.