Cowboys and Investing in IUP’s. [Coal Asia Vol. 37]
Cowboys and Investing in IUP’s
By Ian Wollff
The author is an expatriate principal geologist of about 28 years experience in the Indonesian exploration & mining industry, and is employed by an international consultant company.
There are many responsible local government officials, both Bupati’s and mines department officers that follow the government regulations and perform their duties professionally, and there are many earnest investors that can achieve entry into the IUP based mineral and coal business without undue improprieties. However this article reflects on the cowboy image, rumors and some associated potential pit falls that can accompany the local and international investors wishing to enter into the mineral and coal IUP business. The author has no records to support the nature of the items covered in this article, and much of the material is derived from long forgotten third parties. The incentive to write this article is to place on record an outlook of Indonesia’s social history during this exciting period of mineral and coal development.
Background
Under the Contract of Work (COW) system for mineral and coal tenements, the applicants (domestic and foreign) went through a process to demonstrate their capabilities (personnel and financial) to fund and perform the work and then committed to a work program with a minimum expenditure commitment. As these COW companies advanced through their exploration programs they either raised more funds to continue, or formally relinquished portions or all of their tenements. Some COW’s raised funds through bringing in or changing shareholders to their off shore holding entities, and so their Indonesian responsibilities continued in a smooth manner. The raising of capital or changing of share holders was sometimes facilitated by financial brokers, wherein the business to business transaction tended to progress in a professional manner. Indeed many of the tenement holding companies were listed on stock exchanges, whereby responsible changes to share holdings followed transparent regulations.
The Kuasa Pertambang (KP) system for granting smaller tenements was introduced for Indonesian only entities, wherein the standards of entry (personnel and financial capabilities) were less stringent than the COW system. In 2009 the government introduced legislation whereby the KP’s were to be converted to Ijin Usaha Pertambangan (IUP) and by this time such standards of entry were largely nominal at best. The preferred manner in raising extra funds to undertake exploration and further development in these IUP’s was to seek a private investor (either Indonesian or foreign) with various arrangements to enter into business partnerships, Joint Venture (JV) or outright sale of the concession, using local applicable regulations. IUP’s were rarely formally relinquished, but tended to lapse into a grey area of non compliance, leading to some unfortunate cases such as the Churchill incident, and in turn stimulating the central mines department towards the development of the “Clean & Clear” listing.
Early Grey Areas
Under the KP system it was confirmed by legal opinions and district mines department officials that the first phase of acquiring a KP was to book an area with the district mines department (Penyelidikan Umun_PU) and this entitled the interested party to exclusivity over the set area, and to undertake reconnaissance surveys for a very limited period. It was clear to all that this PU did not constitute ownership, as the next step of formal application, payment of rents, and Bupati’s signature on the KP document constituted formal concession ownership rights. This PU process was welcomed by the industry, as it allowed investors to briefly look at a number of small areas before committing to a particular tenement of limited size.
Sometimes the owners of the KP’s would not find any significant mineral or coal, and would simply come to an arrangement with the district mines department to relocate their KP to another area, even into adjoining districts. In many cases the relocation was accompanied by a letter from the Bupati, but not all cases were formally recorded, or such records were misplaced.
Initially there were no GPS instruments, and tenements were defined as being along a survey path starting from some fixed point. Often this was a river junction or the flag pole of the local village chief’s house. Over time these fixed points could move – with the village chief changing to different household or the names of creeks being lost or changing. The paper documentation of such tenements was also subject to being lost through carelessness, local fires or floods etc.
It was through such grey areas that allowed government officials and investors some flexibility that could be beneficial for all parties, but also undermined the certainty of the tenements.
Throughout the early KP and later IUP periods, government records of tenement registration at the district level were sometimes poorly managed, and in most cases were subject to very limited public access. In some places this aspect of record keeping improved with the introduction of regional autonomy, but in other places the pattern of poor record keeping became even more opaque. The spread of nepotism, where sometimes the Bupati’s family or close friends were appointed to the head of the district mines department, accompanied by practices of signing and storing documents outside the office left good office administrators out of the loop. Such poor record keeping has introduced significant grey areas and lead to some overlapping tenements. These issues are being slowly sorted out by the Clean & Clear program.
The Rush
On the introduction of the new mining law (No 4 of 2009) the concept of transferring all KP’s to IUP’s was introduced, along with a moratorium on the issuance of new KP’s / IUP’s. By this stage the KP’s had developed from a few hundred keen explorers to thousands seeking to obtain KP’s for a variety of purposes, wherein the district mines department and Bupati were realizing a significant income and other benefits from registering such KP’s. The moratorium had the unintended outcome of creating a rush for investors and Bupati’s to issue many more KP’s. A sort of “last chance” to get into this exploration business play before the door was shut.
Unfortunately this rush created an incentive for some Bupatis and mines department officers to create schemes that were contrary to the spirit of the intent behind the moratorium. These schemes were formulated in a number of ways, and changed character over the extended time for the moratorium. Initially some district’s prepared many KP documents without private investor applications, and such “blank” KP’s were kept in a “bottom drawer”. An investor could simply fill in the blank spaces and “acquire” a KP that was stamped on the last few days before the commencement of the moratorium. It is possibly more difficult to determine which KP’s were legitimately issued just prior to the moratorium date, and which were acquired after this date. However in some districts the demand outgrew the supply of pre stamped KP’s, and so further KP’s were issued with back dating and stamping as agreed between the district officers and the investor. This back dating approach apparently has continued for years. In the early cases of back dating some smart investors acquired matching older shelf companies to ensure a more secure legal trail, but others found this more difficult or were simply too lazy and acquired back dated KP’s ownership structures with post moratorium companies. It is believed many of these post moratorium KP’s / IUP’s comprise some of the 5,000 or so tenements that the central mines department have correctly not approved for Clean & Clear. There are several ways to detect some of the IUP’s with post moratorium ownership structures, though it appears the central mines department leaves much of this side of the validation process to the districts. One way is to demand a copy from the banks showing the date of the KP applicants initial share equity deposits, that are a requirement for registering and comparing, with the date of application for the KP. This approach assumes it is more difficult to falsify such a bank transaction, and if no equity was placed in a bank then the suitability of the KP applicant to perform the works may be called into question.
Initially the conversion from a KP to IUP was limited to existing issued KP’s, but later this was “stretched” to include PU’s as the district mines department indicated a modest fee had secured the investors options, even though the PU had no legal rights over the area beyond the exclusion period, being typically 3 months. In some cases it seems this stretched period was a lot longer than 3 months.
A further complication is that some Bupati’s refused to comply with the moratorium and other aspects of the new mining law, and continued to formally issue new IUP titles, often without reference to original KP’s. The central mines department issued letters of instruction to the Bupati’s to comply with the moratorium, however in return the mines department received back legal challenges based upon the autonomy law. Overall the central government adopted a softly-softly policy in an endeavor to get the renegade districts to comply. The central government also adopted indirect means to convince investors to comply with the intention of the central government through the development of the Clean & Clear central registration. The mines department backed up this approach with rules for police and trade authorities to block exports for companies not on the Clean & Clear list. This latter program is slowly taking effect, and is largely working. Unfortunately rumors persist that even today certain Bupati’s are willing to issue a new IUP to an investor with no guarantee of receiving a Clean & Clear. The rumors persist that such innovative investors have also found a way to get approvals from the Clean & Clear system. A further complication is that there are apparently some IUP documents that are counterfeit, including counterfeit signatures and government stamps. Fortunately the central mines department issues the Clean & Clear list on its web site, and thus lessens the risk of false Clean & Clear.
Agents
With the realization that there was a boom market for KP’s / IUP’s, the nature of the investors changed from earnest explorers to paper traders seeking to on-sell their concessions to other investors. Some of the secondary investors were true explorers, but often the next buyer was another entrepreneur seeking to on-sell again to a larger investor. Just like other traders in property, coffee etc, the IUP traders expected a windfall profit and a fast turn over. Typical examples being the acquisition of a concession document for say US $ 100,000 and on-selling for US $ 5 million. In this scenario traders were targeting one sale a year. This was a large incentive for many to enter this lucrative field, attracting house wives, society figures, politicians, and a variety of entrepreneurial businessmen. This business approach attracted a large group of middle men and women who became “agents” touting their associate’s concessions to prospective buyers. In many cases a hierarchy of agents developed, wherein the owner may assign three agents to assist in finding a buyer, and each agent would then find several sub agents etc, with hefty margins expected by all.
A meeting between investors, owners and agents was an entertaining event in itself. Hotel coffee shops from Jakarta to Makassar boomed with people huddled over maps and debating deals at all times of the day and night. Others were willing to meet in the owners or investors office. Some agents took this informal agent aspect a step further and developed a formalized business out of it, complete with plush offices and offering services to investors that included linkages to due diligence parties (technical and legal), investment bankers and setting up new structures for Joint Venture etc. It was not uncommon for an investor to be offered the same project by separate agents, or even different shareholders of the same prospect without the offering party realizing it has previously been promoted to the investor.
Speculative Business Strategy
Like all businesses, the concession owners and agents adopted a number of selling strategies. The simplest was to follow the old path of portraying some link to an influential party, such that the transfer of ownership, and further permits required for operation, would be easy. Typically this would involve an indirect link to the Bupati, but some sellers were more aggressive and claimed links to key national political figures. Interestingly it was only very rarely did they imply some high level connection within the central government’s mines department, suggesting this was not a salable linkage (presumably as it is the district mines department that issued such permits). Such linkages were never clear or documented, and thus the promised ease of future cooperation could not be substantiated.
Another popular selling strategy was based on the concept that the tenement had “green fields” value until proven otherwise. This approach is undertaken by some foreign junior stock exchange players, but simplified here. The agents encouraged the investor to buy a concession sight unseen – the term used “beli kucing dalam karung” (to buy a cat in a sack). From the owners perspective this was a quick sale with no downside should there be no discovery of good coal or minerals in the tenement.
A variation on the green field approach was for some owners to “invent” outcrops, or even invent bore holes complete with coal geophysical logs and fictional JORC reports. Sometimes an investor may be taken to a key outcrop, or even a small mine that was later found to actually lie outside the owners tenement boundary. The wise investor soon realized the usefulness of the hand held GPS instrument and how to read a concession map.
For some tenement owners with sufficient funds, one on-selling strategy was to convert their exploration IUP, with a period of up to 5 years into a production IUP with validity for up to 20 years. This enabled the owner to have “added value”, more time to on-sell the concession and better legal position to on-sell. Unfortunately for the investor, some such IUP production licenses were derived on very little compliance with the statutory reporting. In some cases AMDAL’s (environmental permits) appear to be “cut & paste’ jobs and feasibility studies were unrealistic, having as little as a couple of poorly defined coal outcrops plus some imaginative speculation on resources and reserves.
The IUP’s could also be used as a form of currency in a more indirect manner. Some Bupati’s sought to issue tenements to their friends as a form of repaying monetary debt or social debt. This social debt can also be interpreted where the IUP’s have been issued by the Bupati to parties that he wants to keep on a short leash, or those who he can further milk for funds or perhaps appease political opponents. Such IUP’s can be speculated in some cases where the IUP’s have been issued for very short periods – typically 2 years for exploration instead of 5 years, 3 years for production instead of 20 and so on.
Rumors circulated that some Bupati’s wanted an indirect share (from 5% – 30% free carried) in the IUP as a signing commission for a new IUP, or for even signing the conversion of a valid IUP from exploration status to production status. This share may be for their families or their community, through BUMN’s that they may have some control over. Another form of fee extraction was to stipulate that the investor should become a member of the local chamber of commerce, for which there turned out to be a non refundable deposit of up to US$1 million. Unfortunately once the investor had acceded to extortion and acquired the permits, their willingness to pay was seen to be a weakness for further exploitation, and thus various local operational licenses were then needed to be “obtained”. A variation on this theme is the ongoing aspect of environmental reclamation bonds to be placed in weakly controlled local banks, where such banks can make soft loans out the banks side door to the Bupati’s associates etc.
Another variation was for those without IUP’s to claim historical rights under the old Dutch patronage system or even earlier fiefdoms. In some cases village cooperatives sought to be considered as rightful land owners and thus have preemptive mineral rights which they could in turn sub contract out. Some informal claimants of mineral rights were locked in legal disputes over ownership with the government appointed IUP holder or the local government itself. Generally such old claimant parties look for investors to back their claims and support them in court proceedings in return for a piece of the reclaimed mineral rights, or nothing if they lost!
Site Visit
Fortunately most owners allowed due diligence site visits for prospective investors. Some concession owners had genuinely undertaken some exploration in a responsible manner, some had barely two outcrops defined while others had no geological data outside some desk top government maps as reviewed by an unnamed geologist. Some concession owners demanded a deposit in return for a limited exclusive period, typically up to 3 months, wherein the return of the deposit relied largely upon good faith of the owner. Others would allow a free non exclusive site visit of a few days. The investor invariably was asked to provide compensation for the owner to send his representative to facilitate the site visit. Indeed it was essential that the owner provide an “authorization to enter “letter to the visiting party, particularly as many village heads demanded some form of contribution for allowing the concession owner or visitors to enter his village. It was implied that local guides would be paid a “good” daily wage to accompany such visitors to the various localities within the tenements.
In a few cases this fee for site visits or fee for exclusivity became an end in itself, wherein the owners were content to use the tenement like a tourist business, gaining a suitable profit from visitors or offering exclusivity (being rumored to be up to several million dollars over few years) without actually completing a deal.
Ownership
Determining the true owner of some IUP’s is difficult. In some cases the true owner hides behind proxies, typically a past driver, a distant family member, a retired government low level officer and such. Sometimes these proxies were not aware of their stated ownership, but in many cases there is an informal modest retirement package implied. In some cases the registered owners are apparently fictional with false identity cards and nonexistent addresses. It is understood that many of the hidden owners are people in local government, ex military or political parties. Honest business parties have little need to hide. In a few rare cases the IUP lists an owner as “the republic of Indonesia” or simply the share holding does not add up to 100%. This implies the Bupati or some local BUMN (State owned cooperative) has a direct shareholding, but is again hiding the true shareholder. In the future the central mines department could scrutinize the IUP owners through requiring copies of their identity cards, tax number and bank accounts.
Conclusions
It would seem the Bupati’s have developed an excellent network amongst themselves wherein if one Bupati devises a way to work around the edges of the system, some quickly follow while others observe with interest. This may be a first step towards unifying the Bupaties into a much stronger political force and eventually make the Forum of Regional Representatives (Dewan Pimpinan Derah – DPD) a more significant body.
The districts approach to devising informal fees is spreading down the social ladder to village heads and land owners where more creative forms of compensation are demanded for entry and activities for the exploration IUP concession areas. There are clear signs this will broaden into demands for a free carried shareholding when the IUP’s come into production. This intrusion into the IUP system needs to be actively combated by the mines department, as it is ultimately a threat to the elected government’s exclusive rights to implement the constitution, and not some alternative form of people’s spontaneous rights.
Through the Clear & Clean program the central mines department must be realizing the variability in the competency, transparency and professionalism of each districts mines department and Bupati. It is hoped the implementing regulations to undertake new IUP concession issuance under the management of the district mines department and Bupati shall take into consideration these capacities. Within the new mining law (No. 4 of 2009) there is provision to incorporate an element of central mines department participation, and this needs to be meaningfully applied for a fair outcome. Perhaps the draft regulations on revising the regional autonomy law may need to be passed and enacted!
There are a number of IUP’s that have progressed well with exploration and production. However there are a significant number of IUP’s that have had little or no exploration, reflecting their lack of budget, good will and ultimately the unsuitability of these parties to be awarded the IUP. To avoid a generation of grey concessions, the mines department, in conjunction with the district governments, needs to ensure a legal and secure manner to formally terminate non performing and expiring IUP’s.
One of the contributing factors for so much “cowboy” activity IUP dealings is that good investors do not have access to new ground due to the continuing moratorium. The extended moratorium on issuing new IUP’s plus the down turn in the nickel and coal price and the mineral export limitation means the central and regional governments have now missed out on the opportunities for gaining legitimate and significant signing bonuses.
The longer the moratorium lasts, the more anxious districts will be to restart exploration as a way to develop their local economy. The central mines department’s ongoing delay in restarting the issuance of IUP’s means the longer period that the mines department is not fulfilling its own policy of pro growth and pro poor.
The delay in lifting the moratorium on new IUP’s contributes to the opportunities for cowboys, and thereby detracts from the industries good reputation.