Motivation & the mineral COW amendments.

Motivation & the mineral COW amendments.  (Vol. 79)

This article speculates on the motivation behind some COW mineral companies recent signing (12^th April 2017) of contract amendments, and why others did not? This article also looks at the motivation of the Government behind seeking amendments to the mineral COW companies, and speculates if such amendments will bring greater benefits to the Indonesian people.

This article is based on simple Google background checks, and some discussion with industry players. No interviews were conducted with the affected parties, for concern formal interviews may reflect a position of public stance, rather than some possible underlying motivation. The purpose of this article is to promote discussion on the COW amendment process.

Legal Background.

The option for the Government to introduce negotiations to amend the Contract of Work (COW) agreement before their expiration has a valid legal basis.

The Mining Law 4/2009 Article 169 (b) triggered the Mines Department to start negotiations with the COW holders to amend their contracts. [“The terms that are stated by articles of Contracts of Work and coal contracts of works as intended by point (a) shall be adjusted at least 1 (one) year from the promulgation of this Law, with the exception of state revenues”]. After the one year negotiation period, the Industry has not claimed that the negotiation period is legally expired, but the miners are showing good faith in that negations are ongoing, in following the COW law Article 23.3 (a) that allows for mutually agreed changes. [ At any time during this Agreement, upon request by either Party, the Government and the Company shall consult with each other (i) to determine whether in the light of all relevant circumstances, the financial or other provisions of this Agreement need revision in order to ensure that the Agreement operates equitably and without major detriment to the interests of either Party”.]

Negotiation Process.

The early phases of negotiation saw various long wish-lists from both the Mines Department and the Companies. The Mines Department, as the initiator of the negotiations, trimmed this down to a more manageable 6 main point sought by the Mines Department. Announcements by the Mines Department were made in meetings attended by all the invited Companies, but negotiations were strictly one-on-one bases. The Companies typically sent their directors to undertake the negotiations, however the Mines Department’s early negotiation team were typically lead by a mid-level bureaucrat. The company’s request for the meetings to include officials from the ministry of finance or other ministries that would be impacted by the outcome of such negotiations were not agreed to, though on rare occasions such officials attended as observers. The negotiation process was sometimes frustrated by the appointment of new Ministers or Director Generals, and some Mines Department officials were moved in and out of the negotiation team. The Companies tended to retain the same directors or legal advisors involved in the negations.

The Mines Department made a number of press releases on the progress of such negotiations, while various industry bodies (IMA and others) made short announcements that kept the issue in the public eye. The politics of the situation may have reinforced each party’s stance and heeded in the finding of a mutually agreeable solution. Some independent legal opinions pointed to the difficulty of developing suitable wording for the amendment.

The ESDM website news relating to the 12 April 2017 signing of COW amendments, mentions that 102 mineral and coal COW’s needed to be amended by the 2009 Mining Law, wherein the 12 minerals and 15 coal COW’s signed that day added to the 31 COW’s previously signed in 2014 and 2015, bring the total to 57 COW’s amendments signed. The government is committed to the completion of the amendment program by conducting intensive discussions with the COW parties and the Ministry of Finance.

The Government’s amendments include adjustments to the six strategic issues, namely 1) the area of ​​the agreement, 2) the continuation of mining operations, 3) revenues, 4) processing and refining obligations,5) divestiture, and 6) the obligation to use local labour, goods and services within the country. It is not known if each individual amendment is identical or different in relation to each phase of signings, or consistency of terms for each separate company.

The companies acknowledge these six points have different weightings of importance, wherein reducing land area may be more acceptable, but divesture and smelters are significant difficulties. Apparently, there are also many further changes that are introduced through the extensive wording changes in the Agreement document, as drafted by the Mines Department, a form of “mission creep”. Significant issues include the changes to arbitration, and the adherence to “prevailing law”.

The ongoing negotiation process appears to be maturing. The negotiation meetings are now being chaired by a more senior Mines Department staff, and the Ministry of Finance is taking a more active role. The Mines Department negotiation team is asking the Companies for technical reports to back up their fiscal arguments. The negotiation outlook is also becoming more rational, with the Mines Department calling for the negotiation process to be based on a business-to-business bases, and that the Government has no intention to kill the COW’s company business. The Mines Department remains firm on some key concerns, that the outcome should be in line with government regulations and state revenues should increase.

Positions and Motivation.

Exploration and mining are recognized as a very high risk long term investment that requires significant funds over many years before a profit can be recovered. Many mineral deposits may take around 15 years, and may pass through several disappointing exploration phases before a deposit can be realized, or the project is abandoned. Company management’s persistence is essential to success, and attracting ongoing investment also depends on changes to all forms of project risk. Since the introduction of law 4/2009, the drawn-out negotiation process of the COW’s has added significantly to the Indonesian country risk, making many investors put ongoing work on a care-and-maintenance position. The extensions of negotiations is also frustrating for the Mines Department.

Responsible exploration and mining company’s principal objective is to make an honest profit. Without a profit, there are no funds to undertake CSR activities, pay staff, pay taxes and fees, repay loans or reward investing shareholders with a profit.  Companies can only move forward if the new terms are conducive for business, and will stubbornly hold firm if they feel the new terms will destroy their business.

The Mines Department see the objective of the negotiations as an opportunity to improve the benefit to the State, through greater monetary income for the State, increase employment opportunities for Indonesians, increased government control to direct the exploration and mining industry, along with development of downstream smelting to broaden the countries capabilities. There is also a political agenda of driving Indonesia’s pride through taking control of foreign companies.

The slow negotiations frustrate some politicians who are eager to see ongoing exploration and development to create employment, income and development in their areas. However, there are other politicians with patience for a variety of reasons. I recall the negotiations in 1978 between Shell Coal and the Mines Department that fell through after Shell had spent years and huge funds to define coal resources and reserves in South Sumatra. On the side, the Mines Department officer indicated they did not mind losing this opportunity to develop the huge coal resource, and thus kick start much needed development in Indonesia, as the coal would stay in the ground for their children or grandchildren to exploit. Indeed, it took more than 10 years of ongoing poverty and pain in that area before the World Bank agreed to assist Bukit Asam in the development of coal fields that had been defined by Shell Coal. Another possible reason for the slow progress is that in Indonesia we like conspiracy theories. There is even one extreme theory that some politicians and related powerful parties want to increase their chances of winning the next presidency through making the present policies fail, through pulling strings in the Mines Department.

Justification of greater benefit for the People.

I have not seen any government research document to demonstrate, in a measurable material way, how the Governments negotiation of the COW amendments will result in “further benefits to the people”. Clarification on this issue is needed by a transparency seeking society.

• One of the easiest avenues to demonstrate greater benefit may be to list the partial relinquished areas, and estimate the future income from issuing such areas to new investors though the new bidding process. There is no schedule as to when such areas may be put up for bidding, and indeed, even if they will be taken up by active explorers. However, this potential future benefit may need to be offset by the cessation of ongoing dead rent & land tax already being paid annually by the COW company, and ongoing exploration budget & use of local manpower in retaining such areas. An English saying is; “a bird in hand is worth two in the bush”.
• Another avenue is for the government to quantify all the new fees and taxes it expects to raise through the amended contracts. However, such higher fees and taxes would drive companies to either close, or to change their feasibility studies. Higher costs will immediately impact on minimal acceptable break even mineral grade boundaries, leading to a smaller reserve base. Smaller reserves will reduce the viability and longevity of a project, leading to shorter employment opportunities, and shorter periods of paying taxes and fees. The net effect may actually be less overall benefit to Indonesia.
• The proposed divestment and higher taxes & fees may also lead companies into a survival mode by “high-grading”. We saw this in the coal sector when low prices squeezed profits leading to a reduction in Strip Ratio as the only means to survive – but this has led to a significant reduction in the nations coal reserve bases, and will shorten many mining companies project life. There are concerns the new nickel smelters in Sulawesi are “high grading” through selecting only ores of 2% Ni. The government has acknowledged this concern and made new regulations targeting the increased use of 1.7% Ni grades. The proposed divestment starting after the 5^th year is already leading to mineral mining company decisions not to continue to explore for certain types of large low grade deposits (porphyries) that require large capital to be recovered over a long term.
• The Mines Department may examine each mineral commodity and report, in a measurable material way, on the potential that smelters may actually bring to Indonesia. There is likely to be little extra benefit from the gold industry, as the Antam smelter is already well established. The new iron smelters in Kalimantan are a record of failure, the bauxite smelter in W. Kalimantan is presently in trouble (less taxes). The zinc and led exploration industries are largely stopped. There is much political controversy about building a second Freeport copper smelter. I have yet to see a government report quantifying the short-term losses (national income, employment, along with multiplier factors) of lower production during the construction period against the long-term benefit of a second smelter.

The Indonesian government is following a number of other Nations in seeking to improve their index of “ease-of-doing-business”. Perhaps a review on the best approach to the contract amendment is required to optimize the “the benefit to the people”.

Some unintended consequences of delayed agreement.

Some of the governments proposed new non business friendly terms have led to the drawn-out negotiations, that in-turn have created further disincentives for some investors to continue backing these COW companies. Note that in some CoW Agreements there is a clause that states “In reaching agreement on any revision of this Agreement pursuant to this paragraph 3, both Parties shall ensure that no revision of this Agreement shall prejudices the Company’s ability to retain financial credibility abroad and to raise finance by borrowing internationally in a manner and on terms normal to the mining industry”. In addition the CoW company’s funds are being drained by the Government’s insistence that all contract costs be paid during this negotiation period. Thus, more restrictions to undertake further exploration and development. The drawn-out process has also seen a significant drop in exploration activities, leading to no new deposits and thus no current work or future development, resulting in less employment and taxes from this sector. The drawn-out negotiations have also damaged the Government’s investment and credibility image to both foreign and local parties.

In some cases, the negotiation process is further compounding the company’s inability to obtain other permits necessary to continue exploration. In at least one case an application for a forestry permit is in limbo, wherein locals have taken the lack of ground work by the company as an opportunity to conduct illegal gold mining.

In another case [not just Freeport] the drawn-out negotiations has led to a slowdown of field exploration and development work. The lack of ongoing local employment has expanded unrest (including violence) and divisions within the community of pro and counter to the proposed development. Over time this has become further politicised, with agitation to change the Regent, or for opportunistic parties to try to take over the project all together.

Why did some companies agree to sign now (April 2017)?

On the 16 April 2017 some 12 mineral mining companies signed contract amendments. These included; . PT. Gag Nickel, PT Sorikmas Mining, PT. Pelsart Tambang Kencana, PT. Gorontalo Minerals, PT. Dari Prima Mineral, PT. Galuh Cempaka. PT. Woyla Aceh Mineral, PT. Pasifik Masao Mineral (Ratu Prabu), PT. Kasongan Bumi Kencana (Gaja Tunggal), PT. Citra Palu Mineral (Bumi Resources), PT. Ensbury Kalteng Mining (Blackgold), PT. J.Resources Bolaang Mongondow (J.Resources Asia Pacific Tbk). Note that a further two COW companies [PT. Natarang Mining and PT. Indomuro Kencana] were invited but did not sign the amendments on the scheduled day.

A simple Google search indicates that the signing companies were typically not making rushed public statements on their recent signing of the COW amendments. In preparing this article, the writer undertook a quick Google review of the companies to look for indications that may suggest their motivation to sign the amendments. It is postulated that these reasons may include; –

• Some companies have the State-Owned Enterprise (SOE) mineral mining company PT Aneka Tambang (Presero) Tbk [Antam] as their minority shareholder. We may suppose that Antam was able to lobby the other shareholders to support the Governments wishes. Perhaps the private shareholders felt that having Antam as their supportive partner, they may find it easier to process the bureaucracy to obtain various permits (annual work plan, forestry etc.) necessary for ongoing exploration and development. Antam also has recourse to finance, and could possibly contribute to ongoing costs.
• Some companies apparently have stalled development that may be associated with lack of immediate funds. In one case of potential bankruptcy, it seems the Government is concerned that the companies continue to struggle so that wages and local debts can be settled. It would seem these companies may have signed, in order to extend their opportunity to raise make-or-break finance to continue, that may be easier once the issue of the amendment is behind them.
• Some companies have a strong local / Asian partner that may be able to provide funding based on their conglomerate of businesses, and work with the government under the new amendment conditions. These companies may expect that signing the agreement will lead to smoother working relationships with government for issuance of permits (annual work plans, forestry etc).
• One company stands out as having a different profile to the others. PT. J.Resources Bolaang Mongondow (J.Resources Asia Pacific Tbk) has several years of successful gold production at various sites over Indonesia and other Asian countries. Their 4^th quarter 2016 report shows they have further reserves and ongoing production plans, along with a profitable production program. Like many other mining companies, they also have considerable debt financing. It is understood that the long-term success of the company relies upon finding more economical ore reserves, and these are likely to be found through undertaking joint venture / buy out of various independent IUP’ The COW company is just one source of the groups gold production. The Mines Departments approval is essential to work in such a business model of accessing other IUP’s.

Motivation to continue to negotiate.

There are a number of mineral COW companies that have not given up and walked away like many other companies have done. They have stayed to sort through the history of many obstacles; from changing regulations, forestry restrictions, overlapping IUP claims, local anti-mining NGO’s, and attempts of overcharging /extortion from many different government officers. These companies are “not the enemy” but actually exhibit the strongest commitment to Indonesia. In some cases, the directors who signed the original COW still live in Indonesia and have committed themselves to the law abiding and ethical management of their business in Indonesia. This current issue of negotiation is simply another obstacle where the COW directors seek the moral / legal adherence to the terms of an international contract. Indonesia’s ongoing negotiation approach demonstrates its commitment to the legal validity of such contracts, and to demonstrate on the wider international stage that foreign direct investment contracts can be honoured.

Some of mineral COW companies have chose not to sign the amendments now. The most apparent reason is that they cannot see any advantage to their business, and are concerned the amendments will actually weaken or destroy their exploration / production business opportunities. In most cases these companies have a strong commitment to their local and foreign shareholders to protect their existing investment in past exploration, often amounting to many millions of dollars. These companies still hope to successfully develop a mine in Indonesia, or are presently running a successful mining business.

Incentives for remainder to sign.

In the past, the motivation has been “win-win”. Recently the government seems to be using the “carrot and stick” approach to influence private enterprise. For example the raw ore export ban linked to the development of smelters. No amount of “stick” (fines, permit limitations etc.) will encourage a company to alter its business such that it will then make a loss. One of the key business obstacles is that the proposed terms make it difficult, or impossible, to raise further funds based on the merits of the amended COW as a stand-alone company.

To entice the remaining companies to sign amendments, the government may consider finding suitable “carrots’ to make the amendments work for (not against) the companies. “To get something, you first have to give something.”

One concern is that the divested shares to the government may be “dead” shares, unable to contribute further equity in a timely manner. As may be seen with the State-Owned Company (SOE) Antam that has a number of mineral exploration properties in which it has not invested in exploration for many years, and also has joint ventures that are in default of payment on outstanding loans. Indeed, there is a scenario where the government may acquire an initial 20% package of shares, and then not contribute to the advancement of the company in building its value, thereby acquiring the latter 31% shares at a cheaper price. Once gaining the 51% control of the company (over an awkward 5 year period) , then the government may add value to the company, along with pressing the foreign party to contribute further capital. To avoid such dead shareholder concerns, the Government may consider the new shareholders agreement to contribute immediately to equity. Perhaps this approach could be further secured through inserting “claw-back” provisions in the new shareholder’s agreements?

Perhaps an incentive to some COW companies may be for each branch of government to decline in advance to take up their divested share option, and to fully support an IDX listing option.

Perhaps another “carrot” may be for the government to offer to buy out 100% of the existing shareholders at a mutually agreeable price. This is a standard business practice for responsible companies and contractors, and may be an attractive offer for some companies that are becoming disenchanted with their Indonesian investment. The government may be able to recoup such costs through the process of reissuing the exploration area.

One of the outstanding issues the COW companies are concerned about is legal & fiscal certainty. Part of this uncertainty is the ability of the Regents, Provinces and Central Governments to issue new regulations and fees. A dramatic example is the recent proposed increase of hundreds of millions of dollars for Freeports water fees. Perhaps the amended COW agreement could specifically list which regulations and fees are mutually agreed to be applied, and then agree there shall be no modifications or further regulations / fees to be applied thereafter. This could follow the grandfather-style-clause such as; – “The Company shall not be subject to any other taxes, duties, levies, contributions, charges or fees now or hereafter levied or imposed or approved by the Government other than those provided for in this Article and elsewhere in this Agreement”. Such agreement may need to be signed by the Regent, Province and Central Government.

Perhaps another incentive is for the company’s directors to negotiate directly with the Mines Department decision makers, the Director General and the Minister, and for the companies to be more involved in drafting the proposed wording.

Conclusion.

These COW Agreements were signed many years ago in good faith for a win-win outlook. The governments states that the purpose of this amendment is for the mining contractor to provide further economic and social benefits for the greater prosperity of the people of Indonesia. Unfortunately, the writer has not been able to find any independent technical reports to demonstrate, in a measurable way, the predicted further economic and social benefits expected from this amendment program. Similarly, the writer has not found any evidence of additional benefits derived from those companies that have already signed the amendments. However, the drawn-out negotiation process has clearly destabilized the investment profile for exploration and mining in Indonesia, and in some cases has brought uncertainty and instability to some districts.

The sooner this amendment process is completed in a mutually agreeable manner, the sooner the exploration and mining industry can begin to grow and create jobs for industry professionals and for the benefit of many people in the remote site locations.

It is hoped the Mines Department will learn from this negotiation process for what to include in the business acceptable agreements for the future new IUP’s.