Shipping rule tests the water, to see how muddy it is.
Shipping rule tests the water, to see how muddy it is. (Vol 88)
Overview.
On the 31 January 2018, Petrmonindo.com and Coal Asia magazine put on a conference to discuss the new Ministry of Trade (MOT) shipping regulation 82/2017. This regulation includes clauses that obliges coal exports to be made in ships belonging to Indonesian companies. The stated purpose behind the regulation is to support the development of Indonesia to become a significant international maritime shipping nation. This regulation shall become effective on 1 May 2018. The Petromindo.com conference was well attended by around 150 key industry players.
It is clear to everyone at the conference that this is a poorly developed regulation that has not been adequately discussed with the shipping and coal industries. Most shipping and coal players were sympathetic towards building up Indonesia’s shipping industry, but very clear that this regulation was not the way to do it. This regulation only leaves Indonesias as being embarrassed by its government, , and poses a catastrophic threat to the Indonesian coal industry.
Some key aspects brought out in the Conference.
Domestic more profitable – There was a clear message that domestic shipping is more profitable for Indonesian ships than international bulk shipping. It would seem the Indonesian ship owners are not so interested to go international.
Not enough ships – There are simply not enough coal bulk carrier ships to meet Indonesia’s export needs. Indonesian flagged vessels carried only around 1.17% of Indonesian coal exports last year. Last December 2017, only 9 Indonesian vessels carried export coal of 405,000 ton, as compared to December exports of 32 million ton. Indonesia has 17 vessels suited to the coal industry, whereas it is suggested Indonesian would need to increase that number to more than 220 vessels.
Not the right type of ships – Many (43%) of Indonesian flagged ships are more than 15 years old, and their old and varied construction design, and even their crew SOP often make them unacceptable to many of the discharging ports. In a some discharging ports, the ship specification is so restricted that only a few ships can dock at such ports.
No return cargo – Many international ships may pick up intermediate cargo runs on the way back to Indonesia. Should Indonesian owned ships follow this economic path, then the number of ships to support the coal industry may be much higher.
Fundamental cost disadvantage – Indonesian flagged ships are obliged to charge 10% VAT plus further imposed government taxes, including PPh pasal 15 of 1.2%, PPh 26 of 20% and 10% VAT on fuel cost plus regional taxes of 5 – 7.5%. Typically, Indonesian vessels are 35 to 50% more expensive than international ships. Certainly, the buyer will not want to pay such extra costs, and the coal seller can not afford such additional costs.
Not clear regulation – The regulation has a number of unclear aspects. One is that the regulation states that FOB or CIF can be used. However, one legal interpretation suggests that preceding laws (29/2017) may only permit CIF. Much was discussed about the clause allowing for exemptions to the rule if there were not the right ships available. It was very confusing and unsettling about how the implementing regulations may impact on this clause.
Running out of time – The implementing regulations are not yet developed, and it takes considerable time to book ships and schedule mine production to meet sales commitments. There were universal industry calls to postpone this regulation for 2 years.
International treaties – Concern was raised over the potential impact of this regulation on several international trade treaties, including the ASEAN free Trade Agreement (ATIGA chapter 4, articles 40,41,42), various international tax treaties (DTAAs Article 5 &8) and the Comprehensive Economic Partnership Agreements. This regulation may be reviewed through synchronization with a number of existing regulations (GR No.9 of 2012 & MoEMR Reg 7 of 2017). Appeals to the WTO and other international bodies may be lodged in relation to long-term coal contract sales agreement that form the bases for several nations electric power reliability and pricing. The MOT representative acknowledged that perhaps this regulations impact on various international treaties may not have been thoroughly looked at.
The potential for provoking reciprocal action. – Asian countries often follow one another’s trade patterns. There is concern reciprocal trade regulations may harm Indonesia. Will this regulation 82/2017 invite counter maneuvers from other vessel owning/importing nations such as Japan (Mitsui OSK Lines, NYK, K Line), China (China Cosco Shipping), Thailand (Thoresen Thai Agencies, Precious shipping), and Malaysia (Malaysian Bulk Carriers Berhard) by requiring importers of coal to use their national carriers? A careful evaluation might reveal the potential for trade disputes, which are best addressed through a multilateral consultative process rather than through a unilateral decision.
Cost benefit rules – It is understood that during the development of new rules, that a “cost benefit” study is to be undertaken, as regulated under Presidential Regulation 7 of 2017. The Indonesian Coal Mining Association was invited very late into the rule drafting process, wherein there is no evidence of such a “cost benefit” study having been undertaken or presently underway.
The use of local agents – The Ministry of Trade representative expressed concern that they did not want local agents simply to act as fronts for foreign vessels. There is concern that such agents may simply disappear if insurance claims are filed, or the government makes in depth tax enquiries.
Limited funding to acquire ships – The recent OJK figures for 2017 show that Indonesian banks have excessive amounts of bad debts, and near bad debts, for the Indonesian mining and shipping sectors. Indonesian banks are keen to use the present profit cycle reduce their debt portfolio. There is little bank credit available for the purchase of ships. At present ships are relatively cheaply priced, wherein one estimate from the Indonesian shipping association suggested an initial investment of $700 million was urged to purchase 70 – 100 new vessels. There are very few Indonesian entities that may be able to make such undertakings. However, a good business outcome would be difficult given the uncompetitive tax structure for operating Indonesian vessels. Such a ship procurement would also require the significant development of crew manpower and improved SOP. Then, how to go about buying 100 – 200 coal ships in a few months – who will sell so many, and will the price of such ships increase upon such Indonesian buyers coming into the market?
Insurance Limitations – The Indonesian marine insurance association indicates that marine cargo insurance is relatively straight forward, with various international models to choose from in the market. However. the shippers are concerned if they will be able to get comparable products from local insurance agents at competitive prices. The producers are concerned that making a claim through an Indonesian insurer for incidents (ship sinking etc) outside Indonesian waters may take longer and be more difficult to conclude in Indonesia. Ship schedules often make substitutions just a few days before laycan starts, wherein the local insurance agents may not be able to handle this quick change of vessels, particularly the MOT trade representative and some lawyers suggested the nomination of ships & insurance may need to go through a tedious public tender system.
CIF and cash flow & Insurance – At present coal miners pay for mining, coal hauling, ship loading, cargo superintending plus royalty upon ship loading. Under the CIF coal sales agreement, the coal miner will also need to put up front costs of shipping and insurance, whereupon the miner does not get paid till after the ship is offloaded at the discharge port. This is a much larger and longer cash flow cycle. Furthermore, any disputes on coal offloaded would be settled in the country of the receiving port, making insurance claims more difficult (language & process), costly and much slower for the Indonesian insurer and coal seller.
Export may kill domestic shipping: – There is concern that if this rule is stringently bought in, then competition for the limited Indonesian ships will draw ships out of the inter-island domestic shipping routes, harming Indonesia’s domestic growth.
Trade business reputation; – At this conference I hear over coffee breaks that coal sellers are being told by their buyers that they will not buy from Indonesia unless they can load into ships of their choice. Many coal buyers have long standing relationships with certain preferred shippers, based on mutual understanding, competitive price and reliability. For Indonesian ships to break into this international market, they will also have to establish a performance reputation.
CIF games – With FOB, the cargo superintending is undertaken before the ship sales, and responsibility of the coal producer/seller ends with the ship sailing. However, with CIF it may be possible for some buyers to manipulate the offloading works and so create delays in laycan or disputes over coal quality in the foreign country. These activities place greater cost burdens on the coal miners / shippers – and sending someone to the destination port to sort it out takes more time, experience and cost. It is likely such disruption at the CIF discharge port may be resolved with a discount by the coal seller, and so create thinner margins or losses to the coal miner / shipper.
Rational.
This shipping regulation came as a big surprise to the coal industry. If the objective is to build up an Indonesian shipping industry, surely the regulation could have been directed at container shipping. Such container ships could then carry the much-vaunted drive to increase manufactured goods, and stimulate inter-island trade within Indonesia. Perhaps the new shipping rule could have been directed at oil, to support Pertamina’s objective to become a more vertically integrated business?
In other democratic countries the government often use an incentive scheme to stimulate an industry. Certainly, there is room for the government to develop incentives, particularly by removing the approximately 30% extra costs due to various government regulations on tax, duties and such on-export shipping. It is clear from this conference that Indonesian shipping companies prefer and make more profit from domestic shipping and are so disincentive to venture into the international shipping market. The history of this lack of competing on the international shipping market, and possibly lax local shipping regulations, has also led to aged and ill-equipped ships that may be unacceptable to international ports. Stimulating the Indonesian international shipping industry may need a wide review of the shipping industry.
The concept of “value adding” is uppermost in the present governments political push to further develop Indonesia. In the nickel and aluminium mining industry, we saw the termination of raw ore exports as a driver to incentivise the building of smelters. Some early reviews suggest this has had a strong initial negative impact upon the broader economy, but we can “wait and see”, and hope. There were earlier attempts to value add to the coal industry in the promotion of mine mount power plants. Indeed, this triggered much exploration and many applications, but these applications were gradually withdrawn due to the government changing the proposed project terms. This left many of the projects with no return on their exploration and application costs. Perhaps this shipping regulation could be looked at as another political attempt to add value to the coal industry, buy obliging the export of coal to use Indonesian ships. One difference to the smelter value adding program, is that the ESDM had negotiated with a number of foreign parties (Russia, China) to step-into the smelter business once the regulations had been passed. The smelter value adding regulation was incentivised through regulations to “protect” the smelter investors. In this shipping value adding program, there is no sign yet of some foreign or Indonesian wealthy parties to promptly step in and support this regulation.
We may ask, why this regulation is directed at the very selected bulk cargo exports of CPO and Coal, plus a few imports? In the coal mining game, it is common practice to develop a multi user coal haulage road, and then charge other users highly profitable user road fees. We have seen similarities in the nickel industry where smelters set low ore purchase prices because the government will not let the miners export to a free market. Perhaps only a very few companies are strong enough to purchase a number of ships and so corner the government imposed restrictive market. Is this new shipping regulation an extension of the few getting more control over an entire coal export industry? Will there be effective shipping price competition? Under this shipping regulation the small coal exporters may be gobbled up, such that the big coal companies get bigger and fewer.
A more fanciful look behind the scenes.
Is there simplistic thinking from the MOT of “lets target these big industries?” as the MOT can-not lift its performance in other fields, such as trade treaties etc.
Mission creep is a well understood term where a country may first involve itself in a publicly acceptable police action in some foreign country, but then mission creep can slowly divert this police action into a full-scale war, and so dupe the public into an unacceptable action. I wonder if this regulation will also see “regulation creep” whereby the initial soft appearance of “Indonesian controlled ship’ will creep into Indonesian flagged ship. Furthermore, the permitted option of FOB and CIF may become only CIF, or that the exclusion clause will become tighter and eventually close altogether. Note that the initial mining regulations on divestment were set at 20%, but then creeped to 40% open pit and 30% for underground, and finally jumped to 51% for all PMA companies.
The KCMI code is now widely practiced professional reporting code amongst geological and mining professionals. The legal, accounting and even environmental professions have reporting codes. In the light of the issues raised by the Petromindo.com conference, it would be of great interest to know what professional codes the Ministry of Trade technocrats comply with in preparing regulations. I was impressed with President Jokowi’s campaign concept of “mental revolution”. I fear that the MOT technocrats may find it difficult to influence their politically motivated peers in order to bring about good workable regulations. This would suggest a return to the Suharto “Guided Democracy” approach, wherein a few political elite dream up a scheme and implement it without sufficient professional scrutiny and control by responsible technocrats.
If this regulation proceeds as it is, then we may expect significant disruption around the 1 May 2018. Coal producers will need to get exemptions. Note that the cabotage example suggests 5 days to process exemptions, but this exemption could be longer. Upon the implementation date of this regulation there could be almost no cargoes exported for a week or a month, with dire consequences for producers and world trade. Those coal exporters first out of the exemption system will get peak prices. Paper traders and speculators such as George Soros, Noble or Glencore may make a killing over speculation of this disruption. However, the short term public perception may include conspiracy theories of favours to well connected parties. This can not be good for the broader public perception of a fair and professional coal and shipping industry.
Possible solutions.
The fear of possible reciprocal trade restrictions is quite real, wherein working out a trade sharing agreement is one option. As one person at the conference mentioned that perhaps the goals of the regulation may be adjusted to comply with unwritten UN rules of 40% home country, 40% trading partner and 20% independent. Indeed, such a balance may assist in maintaining a competitive free market for shipping and insurance. Perhaps the MOT could look to other models, such as the free sky policy for airlines, where reciprocal flight routes and landing rights are worked out between trading partners.
I wonder why the MOT chose to impose their ambitions of a grand national fleet upon the industries that provide the cargo. Perhaps they mistakenly think that these hard-working successful industries can achieve the MOT goals as the Indonesian shippers cannot perform such expansion by themselves. A within-one-industry approach could take the shape of imposing regulations on shipping companies to direct a certain percentage of their operations to the export market, and then gradually increase that export component. Indonesian shippers performing these export duties, should be incentivized along with penalties. Weak firms may drop out, allowing consolidation of the shipping firms that could become stronger, and so develop the export shipping industry through increased business competition.
Finally.
Some very senior government people were scheduled to give presentations to this conference. However, the usual excuses of sudden important alternative meetings were given, and underlings sent to read prepared statements, and sometimes struggled to answer questions. This new regulation has the potential to kill Indonesia’s second and third largest export industries, leading to hundreds of thousand out of work, and may threaten banks with excessive bad debts. I did not hear that Holland had re-invaded Surabaya? So, what could be so important to draw such senior people away from this pressing conference to explain, and calm the fears of the leaders of the coal and shipping industries? Perhaps the answer may lie with the return to Suharto style “guided democracy” where senior figure simply leads, and not much else.
A common perception is that this regulation may only be “testing the water’, and public reaction may lead to the regulation being postponed, altered or withdrawn. However, this short-sighted “testing the water” approach carries the potential to significantly disrupt Indonesia’s second (CPO) and third (Coal) largest exports. Certainly, Indonesia’s reputation for a stable and competitive business climate is sucked deeper into the mud.
Conclusion.
The clear sentiment of this meeting was empathy towards building a national shipping industry. However, this regulation needs significant further input from business, cross checking on international trade rules, and must be immediately postponed for at least two years. Some industry groups are looking into challenging this regulation through the courts.