Royalty hike – discussions to be balanced. Vol 131

Introduction

For more than two years, the government and miners have been discussing a new royalty scheme for coal sales. A Reuters news article (15 Jan) mentioned that “In an effort to increase state revenue, we are in the process of adjusting the gold and coal royalty rates,” Ridwan Djamaluddin, the director general of minerals and coal at the ministry, told an online conference. Companies currently pay 2% to 7% of coal sales to the central government in royalties, while gold royalty payments are now set at 3.75% to 5% of gold sales, based on prices of up to $1,700 per ounce.

The Finance Ministry proposed earlier this year to impose tiered royalty rates. The Indonesian Mines Department has more recently contributed to a number of industry webinars, including the government’s intention to discuss options to increase coal royalties. Such discussions reflect a mature relationship between industry and government, and a healthy democracy at work.

This article has been prepared without being a party to such industry / government discussions, and reflects a perspective from the sidelines.

Royalty regulations.

Law 4/2009 on Coal and Mineral Mining (Law 4/2009) obliges mining permit (IUP) and special mining permit (IUPK) holders to pay dead rent and royalties, which are categorized as non-tax state revenue (PNBP). The guidance for the implementation of the imposition, collection, and payment of royalties is set out in MoEMR Decree No. 1823 K/30/ MEM/2018, concerning the “Guidelines on the Implementation of the Imposition, Collection, and Payment of Mineral and Coal Non-Tax State Revenue”. Holders of an IUPK will be required to pay an additional royalty of 10% of the net profit. The Central Government is entitled to receive 40% of this additional royalty, while the balance is to be shared between the relevant province and regencies.

Proposed Royalty Hike.

In response to the downturn in the overall economy brought upon by Covid event, a number of Government reviews are being undertaken. The governments justification is stated in some media as to; “increase state revenue and national economic recovery”. One such review is looking at coal and gold royalties.

One Government proposal for discussions on changes to the coal royalty appears to acknowledge that the IUPK’s continue with 13.5% royalty, and focus on increasing the royalty of IUP mines. The present IUP coal royalty is 3% for calorie <4,700 Kcal/kg (GAR), 5% for 4,700 – 5,700 Kcal/kg (GAR) and 7% for >5,700 Kcal/kg (GAR), with underground mines having a US$1/ton lower royalty. The proposed changes are to reflect the economic level, wherein each coal quality level is to be further quantified on HBA price of <US$70, US$ 70-90, and >US90/ton, while maintain the underground coal royalty at US$ 1 /ton less than open pit mining. The proposed new royalty rate makes further adjustments from changing the coal quality bases from Air Dried (AD) to Gross As Received (GAR) bases. In all cases, the proposed new royalty rates are higher than the existing rates.

The give or take of the Job Creation Law.

One Government rationalization for justifying a hike in coal royalty rates is that concessions from the proposed lower business profit tax law can be “clawed back”. However, the Jakarta Post article “Key points from impending new tax law” refers to ongoing negotiations over the second draft of the implementing regulations, wherein the proposed corporate income tax cuts may not be implemented for some time. The same article also refers to a proposed Carbon tax, VAT to rise, and individual income tax brackets to be adjusted.

This rational for hiking royalty seems at odds with the concept of the Job Creation Law that recognizes business can be stimulated through lowering taxes; wherein the ensuing growth will lead to more tax collection from a broader section of business.

HBA volatility needs balancing.

The proposed royalty hike sees only cases of increased royalty to all HBA coal price ranges. During periods of high coal price, there can be healthy profit margins. But this proposal seems to forget the recent extended period of very low coal prices, where many coal mines had to work on negative margins, to mothball or close. Having closed coal mines brings in zero royalty, and more importantly closed or mothballed mines hurts the local people and their economies. If the rational of the royalty discussions is to be serious about local and national economic recovery, then the royalty needs to be adjusted to ensure the survival of mines during hard economic times. Therein we may hope the discussions may entertain the concept of royalty rates being lower than present during very low HBA price periods, thereby giving relief to the hard-working mining communities.

Should the new royalty be only about increases, then we might expect aspirational local politicians to re-open demands for an increase in their share of royalties. This can-of-worms may be more easily diverted should the new royalty rate be seen to have a fairer give-and-take bases that includes lower royalties in hard time to keep the local mines from closing.

Industry Risk Perceptions.

The simple act of discussing a royalty hike is well within the rights of government, but all industries (not limited to the coal sector) will associate any talk of increasing government compliance costs as an increase in regulatory risk. Therein refinancing, expansion and the national desired growth is now more fragile, as it is accompanied by a greater country risk profile.

Any increase in cost of royalty for the coal mining sector shall be responded to by miners seeking to cut costs. The coal industry has achieved many costs of production efficiencies, but ultimately the most significant cost cutting option is to reduce the mining Strip Ratio (in metal mining it would be to reduce mine grade). Reducing Strip Ratio will reduce residual reserves, being contrary to other Mines Department objectives to expand reserves. Reduced Reserves can have a flow on effect to shorter mine life, in turn possibly impacting on ability to repay debt, refinance, and to stunt growth. An increase in royalty may see a flutter of Indonesian Stock Exchange mining companies being revalued, and cause wider market fragility. The options to start new mines may need to be re-evaluated, placing new growth at risk.

A reduction in reserves ultimately means placing the long term national economical recovery at risk, and taking opportunity away from the next generation of would-be miners and their co-dependents.

Underground Vs Open Pit.

The growing trend of the Environment, Social and Governance [ESG] factors in the mining industry is to be commended. However, we might expect the larger footprint of open pit mines to have a growing financial burden going forward, compared to underground coal mines. The earlier concept of attributing a discount royalty to underground mines was in recognition of higher start up and mining operation costs, and the need for a sustainable coal industry.

Lack of Exploration

This present review of “Hunting in the Zoo” for more government income is a clear reflection of the unsuccessful exploration industry to expand the subsequent mining industry. Perhaps now is the time for industry and government to work together to look for significant breakthroughs to provide meaningful stimulus to the exploration industry. Indonesia needs perhaps 200 new exploration tenements each year for the next 5 years, to generate a steady small stream of new mines in the next 10 years. If the exploration industry (including all minerals, coal and rocks) cannot grow significantly, then this government’s income crisis will only grow worse with a shrinking mining industry.