Investing in Exploration for minerals & coal.[Coal Asia Vol.63, Jan-Feb 2016]

Investing in Exploration for minerals & coal.

Introduction.

While chatting with the Canadian trade commissioner, David Williams, he reflected on the difficulty to provide incentive for Canadians to invest in Indonesian mineral and coal exploration activities. The traditionally risk-on investors had previously been big players in the earlier exploration gold rush of Indonesia, but were now reluctant to invest in the Indonesian exploration industry. Their outlook is that; 1) why should they invest if a discovered mine will undergo 51% divestment, 2) they are explorers & miners and not smelter companies and finally 3) the immigration restrictions won’t let them appoint their chosen expatriate staff to run the business. While there are ways through these arguments, their outlook is that it is easier to invest elsewhere in the world. The discussion explored the option that perhaps there are openings for Canadian smelter companies to expand to include mining, but David indicated that such smelter companies are not explorers and only want to invest once the deposit has been found and defined.

The industry recognizes that from the start of a greenfields exploration program to production takes much time, money and commitment. So what does the Indonesian exploration industry look like to investors and players?

Opportunity outlook in the Coal Industry.

There are mixed signals about the upside of the Coal industry. The Jakarta Post (2 Dec 2015) reported on the bond buy back options in the coal sector included a quote from one asset manager that is quite negative “I don’t think any meaningful industry recovery is possible”. Yet other E-news stories indicate the Philippines, Vietnam and India are poised to become significant coal importers. A number of surviving coal mines has reduced operational cash costs by reducing their strip ratio (including Bukit Asam). This survival approach reduces the reserves, shortens the mine life that may lead to earlier mine closures. Countries such as Australia require their publically listed companies to annually update their reserve status, however Indonesia is more opaque in this area, so the time for this shallow strip ratio to affect national production is more difficult to determine. At a recent seminar the president of the ICA suggested that at current coal prices Indonesia’s coal reserves are now estimated to be only for about 25 years, assuming the 35GW program is realized. It would seem that new competitive mines with shallow strip ratios are some way off, though there may be more immediate term exploration opportunities for selected high rank or coking coals for export.

Much of the coal industry is looking to the Governments 35 GW power program for mine mouth power stations. Most players have completed their exploration to a high level of certainty in order to submit their bids. However the awarding of the IPP has been delayed several times, wherein the bidders are often required to update their resource and reserves for bid compliance. This updating typically only requires a desk top study and site visit, but in some cases there is a potential of some further coal exploration to increase the competitiveness of such bids by increasing the confidence level of such reserve reports.

Fortunately there are a few coal investors taking a longer term view of the coal industry, and are quietly looking towards the next generation of significant coal mines. These new mines may typically have longer logistic costs, but can have shallower stripping ratios. The emerging new big coal importers, or ASEAN national coal companies may be tempted to invest in new mines as part of their strategy to secure long term supply reliability, and as a hedge against future Indonesian government restrictive regulations.

Minerals and Smelters.

The mineral industry is also not running so smoothly, with Indonesia’s political reputation relying largely on the new nickel smelting industry. Some 30 companies applied for nickel smelting permits, with 7 expected to be complete this year / early next year. But many others need refinancing, as reflecting the current LME nickel prices ($ 8,850/t) that are generally below these proposed smelter costs, wherein project viability wants nickel prices above $10,500/t. [Note that different sources give slightly different statistics of smelters]. There was a burst of nickel exploration in 2014 to early 2015 to provide certainty of resources to supply for these nickel smelters, but it would seem with so many smelter projects on hold, there will be little incentive to undertake more nickel exploration.

It would seem the aluminum industry is heavily reliant upon a SOE joint venture enterprise, where national objectives play a more significant role in financing such development than simply free enterprise. There is little public news of bauxite exploration activity.

Minerals that require relatively small smelter investment, such as gold, silver, tin, lead and some manganese products are seeing limited exploration, typically in small deposits. Some industrial minerals that are amenable to relatively simple processing are being explored for by a few players, but interest is limited by Indonesian parties that are less familiar with the business risk associated with such products. However minerals that require expensive smelters, including some complex ores, are less desirable exploration targets. The smelter law has created an effective financial “filter” on what ore’s and commodities are suitable for exploration, and which ore’s are effectively excluded from the ability to provide “benefit for the people of Indonesia”.

The traditional business financing industry understands that junior companies undertake exploration and then scale up through public floating or joint ventures to develop the mines. The Indonesian formula of an exploration company becoming a smelting company is not a good fit with most of the world’s financiers, as this involves a less well understood complexity and risk. During the boom upswing periods it was not just the geologists and mining entrepreneurs seeking funds to poor into exploration where such funding programs are a significant source of work and profit for the finance companies.

Investment Opportunities.

There is limited apatite by investors for distressed exploration assets. Many small IUP’s are nearing the end of their exploration period, with little meaningful exploration having been undertaken and with little to attract a discerning investor. Some brown-field projects are still overpriced, and often with large debts that are disproportional to the perceived value of the property. Many exploration and brown-field projects have been “picked over” by potential investors, and not taken up. Fortunately the serious investors are still willing to take a closer look at some prospects, particularly when they engage an experienced geologist or engineer that can foresee opportunity where others failed to do so. Also there are several dedicated project managers who believe in their projects and are active to seek out investors. Typically these project managers are “old hands” (often expatriates) in the exploration industry, who have persistence & faith in their prospects and that of the Indonesian exploration industry.

Mergers and acquisition are still ongoing, with a trend towards several Indonesian conglomerates seeking to become major players in some sectors of the mining industry. This growth through mergers includes some SOE’s. These refinancing or acquisition deals may bring some opportunity for geological and mining consultants for project reviews for confirming reserves and valuations etc. However the trend is that once deals are done, then adding further value through exploration is “measured”, reflecting a cautious approach to the present low commodity market prices. The preferred corporate strategy seems to be A) to get into position for the next upsurge in commodity prices, or B) to progress “under the radar” so as not to be distracted by too much political attention.

Commodity Cycle.

The coal boom saw a number of marginal mines open, typically with low value coal and high transportation costs. The down side of commodity price swings tends to impact most heavily on the “low profit margin” mines first, with closures continuing till only those with a positive operating cash margin remain. On the 8th August 2015 the Jakarta Post reported that some 66 coal companies in Jambi were headed for bankruptcy. Another example comes from the 2012-2013 EITI report confirming that 2 companies are no longer in operation, and the 18 companies that failed to submit their reports to EITI within the given timeframe suggests they may be simply walking away from the coal industry altogether. An example of a well established producing coal company changing its business outlook is that of Bukit Asam (SOE) that has publically stated it is ceasing coal exploration altogether, increasing coal output and moving into other businesses, including hospitals, palm oil and energy sectors. There is little to no public news about mine closure work programs, or suspended production care and maintenance programs.

The price of manganese recently dropped and with it one of the existing Indonesian smelters closed, placing further downward pressure on the manganese exploration industry. It is understood that the falling iron ore prices put smelter performance pressure on Krakatau Steel to terminate a number of local iron ore purchase contracts in favor of reliable (volume, quality, delivery) bulk imports of iron ore from Australia. The Indonesian iron sands industry is also under threat from low international price of iron ore. Seasoned investors recognize this economic fundamental of lower cost quartile survival of the fittest (for mines & smelters), and will wait for signs of price recovery before investing to reopen selected mines, and then perhaps start exploration.

Ernst & Young (EY) annual report [Business risks facing mining and metals 2015-2016] analyses and ranks the top business risks in the global mineral and coal industry. “Mining and metals companies that best understand the risk scenarios and potential impacts on their businesses are better positioned to manage these risks and seize strategic opportunities”. One current trend is a drastic reduction in exploration across the industry in 2013 – 14, indicting a future supply shortage and thus a return to a commodity upswing. One cost minimizing option is to invest in green-fields exploration, where choosing the right target and engaging experienced exploration managers will reduce the exploration risk. Greenfields exploration takes time to deliver results, and thus such exploration should start now. The EY report goes on to look at funding options for exploration.

Unease with legal & financial certainty.

The Churchill international arbitration case carries a heavy burden on would be international and domestic investors, as it reflects doubts about Indonesia’s reputation for the government to honor its exploration and mining tenement system. This Churchill event may have helped trigger the Central Government to take back certain powers to issue and monitor tenements, giving some new encouragement towards legal certainty. The investment industry seems to be “standing by” to see how this move will be implemented and many will carefully watch the first few investment movers under this new system. The industry is also looking at how the Freeport divestment program turns out, to see if it is an agreeable solution that enables future investors to have confidence in the long term Indonesian mining sector.

Another company, the Indian Metals and Ferro Alloys Ltd (PT. Sri Sumber Rahayu) has become impatient with the prolonged time to sort out tenement overlapping issues and is taking the Indonesian government to court. At present some industry observers feel that this case reflects more on investor due diligence rather than on government disincentive to the mineral industry.

The change of ownership of the Bukit Tujuh gold & copper prospect (from the Australian Intrepid Mines Ltd to the Indonesian PT. Bumi Sukese Indo) represents another aspect of legal certainty for the local and international investor. Once a high risk exploration investment is successful in finding a worthwhile deposit, then some maneuvering by some of the ownership parties can effectively disrupt the original high risk investors. Trust between investor and local partner is always an issue for international and local investors. In another case Orpheus Energy is taking its Indonesian partner PT Mega Coal to the bankruptcy courts.

The smelter regulations have focused some exploration towards minerals that can be smelted relatively cheaply, such as gold, tin, manganese, lead, but excludes zinc, some copper and certainly excludes complex ores. The government appears to be considering relaxing some of the high purity aspects of the smelter regulations, thus more ores may be worthy to explore.

The government has stated it is to revise the Mining Law in 2015, but this has been delayed, presumably to early 2016? One lesson from the law 4/2009 was that initial divestment was set at 20% but later changed to 51%, and the manner in which the smelting requirements were implemented has left all investors concerned. Some investors are clearly holding back until the new law, and its implementing regulations, are made clear.

Research and Development.

There are exploration opportunities that come from research and development. The gold exploration boom of the 80-90’s was largely driven by new geological theories of epithermal systems and refinement of the porphyry systems etc. The boom was also technology driven by switching from slow & expensive fire assay to faster and cheaper XRF assays, along with refinement of bottle leaching for stream sediments etc. Alteration clay mineralogy also took giant research steps, with instruments such as the PIMA becoming available to vector exploration. Should new exploration technology be developed that is suitable to be applied in Indonesia, or if new geological theories are developed to direct exploration, then those parties applying such new developments may seek to exploit such research advantages.

Several of Indonesian’s large producing mines have significant exploration budgets to expand and further develop their reserves. For example Freeport (Cu, Au, Ag in Irian) is spending around $15 million / year on exploration, and will continue to do so for many years. Robust Resources (base metals on Romang Is) 2015 exploration budget is $4 million, and G-Resources Martabe (Au in Sumatra) 2014 exploration budget was $13.2 mill with some $2 mill spent in the first 6 months of 2015. Typically these exploration activities are often referred to as “brown field exploration” being extensive drill programs to expand and further define resources close to the existing mine.

A snapshot of investment in the Indonesian exploration industry is taken from the recent Coal Asia magazine Vol. 61 (November – December 2015) as;

• PKN coal – “We have already stopped the exploration activity in the Rangau concession since a couple of months ago, so far it was not more than 50 holes”, and when the situation turns conductive it would resume exploration activity.
• Asiamet Resources – BKM Cu deposit continued the 2015 drill program and expanded resources. A private placement of shares on the TSX will be used to continue the company’s 2015 infill and expansion drilling.
• Barisan Gold private placement on the TSX includes $350,000 for exploration work on their Upper Tengkereng project in Indonesia. Trenggalek Au-Cu project in E. Java had an exploration expenditure of US$49,390 as reported by Arc Exploration Ltd (ASX).
• Kingrose Mining Ltd (ASX) upgraded its resources at Talang Mineral Resource with additional 39 drill holes for 3,200m, and further drilling is recommended.
• Western Mining Network has secured a share placement for $6 million from a UK institutional investor, part of which shall be used for upgrading the JORC report for the Balai Sebut graphite deposit in C. Kal.

This snap shot shows some ongoing interest from Australia, Canada and UK, however this snapshot is bias towards public reporting as stipulated from international stock exchanges. It may be possible to research more mining companies through various public records to gain a broader list of exploration expenditure in Indonesia. Unfortunately the mines department does not provide public information that subdivides its annual statistics on the reported budget realizations for mineral & coal exploration into the categories of greenfields, brown fields, production control and tends to lump in construction to make its reporting on the mineral industry look robust. For example the 29 September 2015 Jakarta Post article on the ESDM reporting; “Minerals and coal director general Bambang Gatot Ariyono said that realized investment in the minerals and coal sector was about 54 percent of a full-year target of $6.1 billion. Despite the weakening economic growth and plunging coal price, the investment keeps flowing. Smelters projects are also progressing,” Bambang said”. Clearly this statement includes construction of smelters and such, wherein the budget component for exploration is much smaller.

Summary.

Investment in the Indonesian mineral exploration sector is ongoing for large expanding mines, while the coal industry is hoping for some relief through the 35 GW power program. Smaller mineral and coal exploration projects are getting some funding by investors seeking counter cyclical investment opportunities, and by dedicated project owners convincing investors in the long term viability of the Indonesian mining sector. The government can best contribute to supporting investment in the exploration industry through prioritizing the revised mining law (and implementing regulations) to be investor friendly, to end the moratorium on applications for new tenements, and easing regulatory barriers, particularly with manpower & forestry.