Homework for Coal Caps – Growth or Stagnate [Coal Asia Vol. 40]

HOMEWORK FOR COAL CAPS – GROWTH OR STAGNATE

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.

 

Introduction

The Government has publically terminated much of the mineral mining industry, and is now quietly squeezing the coal mining industry through coal production caps.

Coal Asia Vol 30 article by Cepi Setiadi refers to an interview with R. Sukhyar, new Director General of Mineral and Coal where his outlook on coal caps is expressed …”the 2009 Mining Law, under which the government holds the right to regulate production scale of coal and the coal export as well and can even it can regulate production at each province especially for mineral and coal. And we should apply this policy. Frankly speaking, I haven’t known about the (production) volume yet, but this is going to be my homework. I think in the future the natural resources management will become an important thing. If we want to have (greater) value added from out natural resources, then we should conserve our natural resources persistently, including the allocation of the resources.”

A more recent news release (Tito Summa Siahaan – 28 Jan 2014) announced that lawmakers had approved a new government energy policy on that date. The policy apparently includes the concept that the government will gradually reduce exports of coal and natural gas, and sets a deadline for when these exports will have to cease. The policy is not available at the time of preparing this article.

This article has been prepared with input from a number of industry leaders. This article may help readers with their homework on understanding coal caps, and promote further discussion on this subject.

 

The Coal Caps

Domestic Market Obligation (DMO) and the basis for control of coal production is set out in the Mining Law No. 4 /2009, Article 5(1) “In the national interest, the Government upon consultation with the House Of

Representatives of the Republic of Indonesia may adopt a policy on preference for domestic

mineral and/or coal needs” and Article 5(2) “National interest as intended by section (1) may be realized by making supervision of production and export”. The implementation is supported by regulations PP 23/ 2010, KP 84P/2009, PMESDM 003/2005 & 34/2009.

The ESDM record of approved coal production is summarized here for the period 2010 to 2014. The regulations also provide lists for each company’s DMO production target.

Target Year	Minister Decree No….K/30/MEM/…	DMOMill ton	% of total production	Total Production Mill ton	PKP2B	State Co.	IUP
2010	1604/2010	64.96	24.75	262.48	36	1	6
2011	2360/2010	78.97	24.17	326.65	42	1	10
2012	1991/2011	82.07	24.72	322	40	1	22
2013	2934/2013	74.32	20.31	366.042287	45	1	28
2014	2901/2013	95.55	25.9	368.899464	50	1	34

In this summary table we can see the industry has broadened its supply base and the industries export expansion has allowed the domestic consumption to grow with confidence of stable supply.

The Indonesian Extractive Industries Transparency Initiative (EITI) lists 35 KP2B and 105 IUP coal companies in the 2010 – 2011 scoping study. The EITI criteria are that participating companies have paid more than $500,000 in royalties etc. There is likely to be many smaller registered coal producing and exporting IUP’s. Recent press releases indicate Indonesia produced some 421 million tonne of coal in 2013. From these numbers it can be seen the table of approved coal production only partially reflects Indonesia’s actual coal production.

National Energy Policy

Regulations on energy conservation apparently started with Presidential Instruction (PI) No.9/1982, and were followed by various PI, Ministerial Decrees etc.  The National Energy Conservation Master Plan (2005) sets a goal to decrease energy intensity by an average of 1% per year to 2025. Thereafter this 2025 date often appears as some ongoing milestone date. The National Energy Policy (Presidential Regulation No. 5/2006) states that “The goal of the National Energy Policy is to direct efforts to the creation of sufficiency of domestic energy supply”. Since then various affiliated bodies have developed their own version of this policy.  The National Energy Management Blueprint (NEMB-2006) objective is “to conserve natural energy resources and increase energy supply resilience to support sustainable development”. This 2006 policy was developed at a time when demand outstripped supply of energy in Indonesia and saw the introduction of such conservation measures as government buildings banning the use of lifts to the lower floors. The National Energy Council (NEC) based on Law 30/2007 objective was to “achieve energy independence and security to support national sustainable development”. Since then there have been several government agencies, NGO’s and the President’s 19 October 2011 speech outlining possible direction for the next version of the national energy policy.

The Politics of Coal Caps

The historic purpose of introducing a coal production cap was to ensure adequate coal for domestic needs (DMO) and to conserve coal for the future. Since then various parties (Government agencies, NGO’s and industry etc) have added their own outlook on coal caps. Perhaps we can also now add the reputation of the government in making workable and clear regulations.

The State enterprise PT. Bukit Asam (BA) was originally charged with ensuring cheap coal supplies to PLN. However BA recently needed to export some coal to improve its overall profitability, particularly when it became an IDX listed company. Free enterprise in the coal mining industry was encouraged to grow through the Coal Contract of Work (PKP2B) system, and later through the KP / IUP system. These systems developed a large export industry that enabled economies of scale, strong supportive industries, development of manpower, plus diversity of market to ensure a robust industry. During the coal export boom period, the Government introduced the DMO concept to ensure adequate coal supply for Indonesian needs, while preserving the fair price structure for the miners, to ensure their ongoing economic viability. The 2011 presentation on DMO coal policy in Indonesia by G. Gushka, (deputy director of coal production supervision and marketing)  shows records from the Geology Agency (2010) that Indonesia has 105.187 billion tons of coal Resources and 21.131 billion tons of coal Reserves made up of 18.6 billion tons with CV <5,700 and 2.5 billion tons with CV >5,700. The presentation also indicated Indonesia’s DMO requirement for power plants would grow their coal requirements to 100 million tons in 2017 and 125 million tons by 2025. These figures indicate that coal Reserves are adequate for 50 years and the coal Resources adequate for some 200 years. However the National Energy Council (DEN) issued recommendations in July 2013 to reorient the national energy policy to stop exporting coal and natural gas by 2050, so they could be used as alternatives to oil. This recommendation included estimations that the nation’s coal reserves are enough for 80 years. Both of these estimates of coals limited production period exclude the concept that 1) further work shall upgrade the know coal resources to reserves, and that 2) more reserves shall be found through ongoing exploration or 3) advances in industries ability to exploit deeper or more remote coal resources. For more than 100 years the industry considered Indonesia to have no significant iron ore resources, but today there is a different realization.

Should our politicians urge conservation of coal, then perhaps the most logical place to make the largest coal export cuts is at PT. Bukit Asam Tbk.  Indeed the NEMB – 2006 implies that State Owned Enterprises (SOE’) should take the leading role in energy conservation. This SOE’s mandate is to reflect the government’s policy, just as Pertamina has to assist in the provision of subsidized fuel. However the strategy of conservation may not be in Indonesia’s best interests. The Dayaks followed a “conservation strategy” of tradition gold mining where each year a modest amount of gold was taken from the rivers for the “sustaining” of rural life, for perhaps thousands of years. This helped them to survive, but not prosper. The Dayaks were rapidly overwhelmed by the influx of Indonesian migrants from Java, Sumatra, and Sulawesi who followed a “growth strategy” based upon exploiting resources (gold, minerals & forest products) to focus the wealth, and so grow their urban based communities.

Growth comes from using resources, not leaving them in the ground. Properly managed, growth pays for research in the energy sector that is designed to lead to improved solar panels, wind turbines etc. Indonesia’s oil production has benefited from secondary recovery techniques, and more recently advances to access deep water oil & gas targets. We have seen the recent innovation of shale gas in USA completely revolutionize the worlds outlook on recoverable fossil fuels. There are still immense resources of coal available to Indonesia through underground mining, or futuristic techniques (including CBM) of recovering energy from deep coal. History has shown us we should use today’s resources to consolidate wealth, a part of which should be allocated to undertake research to develop the future energy supply. Now that’s sustainable growth.

President Soeharto used Indonesia’s oil wealth to kick start the wider development of Indonesia, tackling literacy, food sustainability, infrastructure and education to deliver the foundations for today’s prosperity. The recent catch cry of resource nationalism and the concept of treating coal as energy, rather than as a commodity, wherein one expectation is that cheap and easy energy will underline Indonesia’s long term energy needs. This outlook includes the concept that energy should not be so readily shared with its ASEAN neighbors. We must be careful this does not lead to a breakdown of ASEAN principals, of growth through cooperation, to be replaced with selfish competition between Nations. There are many examples where governments have invoked resource nationalism that was followed though poorly (Zambia, Argentina etc) ending in poverty, conflict and reduced quality of life for entire countries. Politicians proposing resource nationalism need to ensure such plans deliver a better quality of life for all, and that the policy does not end up driving the politicians to defend their personal reputation at the expense of the country.

While the price of coal was rising on the international market, Indonesia enjoyed steady growth, with the royalty and taxes flowing to the national and local governments. The coal mining industry became a significant contributor to Indonesia’s GDP.  The fall of international coal prices, along with Indonesia’s new prominent coal supplier position, stimulated the government to look harder at influencing the international coal price. OPEC has for many years exercised significant control over world oil prices, and more recently BHP and others managed to influence world iron ore and coking coal prices. Indonesia’s role in the Pacific thermal coal trade is significant but the present over supply has contributed to lower coal prices. The introduction of coal caps may be designed to reduce the coal volume available for international trade, to a point where demand is higher than supply, in order for Indonesian miners to become effective price setters and therefore return to higher prices for “added value” to Indonesia’s resources. The recent policies in the Indonesian tin industry are held up by the government as an example of this market control strategy. However the Indonesian coal industry has strong international competitors (Australia, South Africa, USA) that are free to grow and fulfill the market needs, wherein Indonesia may simply lose market share. The present statements of capping coal production and terminating future coal exports from Indonesia may create a reaction in the market, prompting expansion programs in competitor countries, simply based upon the buying countries need to diversify sources of coal supply and ensure their future energy needs are met.

China is held up as the environmental example for cleaner air where plans are to cap coal production at about 3.9 billion ton per year by 2015 as compared to approximately 3.8 billion ton produced in 2011. However China is also progressing with the construction of hydro electric dams and a significant increase in nuclear power stations etc to meet their growing energy goals along with a cleaner environment. Indonesia is following the environmental low emissions trend, although it prefers to attract the new generation cleaner and more efficient coal power plants, and is looking at the next generation of coal fired power plants. This means more coal is needed to meet Indonesia’s growing needs for cheap power. West Kalimantan Governor Ishak Faroek has led a personal approach for less coal mining in order to have a reduced impact on the jungle environment. Responsible coal miners have world class reclamation programs, and the governments (including Faroek) are responsible to ensure their implementation. In reality the area covered by coal mining is extremely small, and many field geologists and village people have seen how quickly the jungle returns to consume everything.

For some 30 years Indonesia has planned to develop low value / low energy (CV) coals for domestic use, and exporting high value / high energy coals as the optimum strategy for the national benefit from coal. This outlook was one of the factors behind the government’s recent considerations to ban low energy coals, with much discussion as to where to define the boundary for low energy coals. There has been significant opposition from local companies and delegations from India etc. Indeed India’s energy strategy includes a significant component of importing such low energy coals from Indonesia, and such a ban may have regional political overtones.  Another motive behind the consideration of banning low CV coals was to encourage the development of coal upgrading technology, and thus “add value”. Fortunately the government realized that such technology was not yet commercially feasible, and the proposals were dropped. This is a good example of politicians listening to scientists, and deferring their political ambitions. It is understood that the Indonesian government is still considering banning <4,400 GAR coals!

Lower coal output through production caps will mean less royalty for the districts and provinces. The government may argue that later the price of coal will increase and the level of income will be restored. However future coal price rises are not guaranteed and the loss of royalty income is now. The policy on coal caps may test the harmony between central and regional governments.

We saw in the late 1990’s thousands of small remote villages developed employment and benefit from a growing free enterprise rotan industry. Then the Soeharto government took the initiative to “add value” to the industry by passing regulations so that raw cane could not be exported, but had to be made into furniture for export. However the lack of an established manufacturing base and lack of sales planning for such furniture saw the spectacular crash of this developing primary industry. This failure led to a return to poverty for many of the villages and personal hardships for those working in the industry. There are many other examples of government dreaming up schemes for development that don’t work and end up causing great misery on the “marhaem” farmer or truck driver. Thus, the manner of implementation of a coal production cap is vital for doing the least harm to the Indonesian people while achieving Indonesia’s development goals, and reflects upon the reputation of the Mines Department.

National energy policies have largely focused on the wise use of energy, particularly in reducing the fuel subsidy, and improving the efficient use of electricity. To determine a new policy emphasizing coal & gas conservation implies the government’s implementation of energy efficiency aspect of the policy is not working well.

Implementation

The government process of setting coal production caps is apparently related to the annual production targets (RKAB) sought by each producer and their performance over the past year. The company makes a presentation on its capabilities, strip ratio, markets etc then the Mines Department special team makes its own assessment of the company’s capabilities and a period of discussion follows. For example, if a company was approved to produce 28 Mt in one year, but actually produced 30 Mt, and submits a new production plan for the following year of 31 Mt, then the Mines Department may set the new production cap at 26 Mt (28 Mt minus over run of 2 Mt). Another example is a new company with the startup year producing 1.5 Mt and wanting to have the next full year production at 4.5 Mt may be allowed only 3.2Mt. In another case a company failed to reach their production target and so the following year the production cap is set relative to the failed production figure. Not all companies are obliged to reduce production. The Jakarta Post (6 February 2014) reports that PT. Adaro Energy plans a 6% growth in production in 2014 to 56 Mt, and PT. Toba Bara Sejahtra plans a 20% rise to 7.8 Mt in 2014. Apparently there is no published formula for determining production caps, and coal caps apply to all grades of coals, including coking coals.

Within the Mines Department there seem to be conflicting objectives regarding the level of coal production. Some sections want reductions for resource conservation, others want increases to optimize State revenue and a third group seeking to use production caps as a lever to get PKP2B’s to the contract renegotiation table. The Mines Department also seeks to maintain its credibility amongst other government institutions as a body making predictions on revenue (royalties etc) and realization that follow.

The production targets are set at the beginning of the year, with an option to apply for a further increase before the end of July, and options for companies to notify the government of reduced production targets in September.

The rationale and process behind setting each company’s production cap is not clear to the author, however there appears to be an element of negotiation available to the producers. Care must be undertaken to ensure such negotiations do not become a source of “rent seeking”. The DMO obligations for each company are published in the annual Ministerial Decrees on the ESDM web site, along with the overall total predicted annual coal production. However each coal companies production target is not published.

Impact on Industry

Companies reaction to these caps are varied, with some reluctantly accepting the lower caps and hope they can renegotiate at mid year. Others are considering producing at the full rate for 11 months and then standing down the mine for December (wet season). We can assume the international buyers understand the various strategies’s adopted by the Indonesian suppliers, and thus the buyers will top up with Australian or other coal, or arrange their end-user stock piles accordingly.

The mine engineers job is to design an annual mine plan and production schedule of overburden, coal and dump for approval by the company directors and the local Mines Department.  However if a lower production cap is introduced, then this design process may need to be repeated. The real difficulty for Indonesian capped producers may be managing their business around such an uncertain production schedule. With lower production caps, business costs will ultimately be higher, contract miners may impose short fall penalties, and there will be higher overheads for both the contract miner and mine owner. Income will be lowered, making return on investment less attractive for owners, or lowering the public companies stock price, and thus increasing their risk profile to financiers.

Long term off take agreements, particularly those designed to ensure supply to power stations are placed in jeopardy and in some cases a short fall may result in the loss of the entire long term contract.

Getting a new mine started will now have additional risks due to the uncertainty of coal caps. Coal mine Feasibility Studies are set to “optimize” the business and thereby need to meet production goals to meet the business plans. Some business plans are reliant upon funding that is conditional on achieving production levels – so if the government can then change the production plan in the future, then the company may receive “project risk” penalties from management and the finance industry. The coal caps introduce an element of uncertainty to all coal businesses, from mine owners to contractors of barging and mining, forward purchases of fuel and so on.

In the early years of Indonesia’s coal export, buyers imposed a country discount on Indonesian coals, as a reflection of the low reliability of supply, plus being a buyer’s market. The growth and maturity of the Indonesian coal export industry has seen Indonesia now achieve regional parity as coal sellers. However production caps may be seen as a reliability of supply issue, wherein the buyers may look to re-impose a country discount on Indonesia.

Recommendation

The manner of implementation of production caps needs to be undertaken with care so that the objectives can be met without damaging the healthy coal mining industry and without increasing the Country Risk factor. The scale of production caps should be minimal, so that the economies of scale and other factors can continue to work for the industry’s benefit.

The mechanism for setting of production caps needs to be transparent with options for long term periods (many years) to provide stability for the industry, but sufficient flexibility to encourage new coal mines in developing districts.

Coal exploration needs to be encouraged, particularly in areas outside of the main coal production regions, such that all districts have a chance to discover these riches and thereby exercise their constitutional rights to derive benefit from these resources. Perhaps this can be done through a lower royalty over a set period for “new discoveries” or “new development” in targeted districts.

Finding suitable resources is difficult, and can often take much longer that predicted. Coal exploration needs to be continuous, so that we can be assured that consumption is being replaced with a long term reserve horizon.

Conclusion

The National Energy Policy is constantly being adjusted to a mix of the technical realities and the emotive outlook of the politicians of the day. Everyone wants Indonesia not to stagnate, but to develop further. There are many alternative ways to achieve this development, and doing so with the least risk to the coal industry and least hurt to the people is commendable.