Introduction

Law No. 4 of 2009 on Mineral and Coal Mining (the "Minerba Law") was enacted in January 2009. The Minerba Law requires that implementing regulations be introduced prior to the first anniversary of its enactment in January 2010. While this target has not been met, recent developments suggest the Indonesian Government is aware of the passing of the prescribed date reflected in its enacting of several long-awaited implementing regulations.

On 12 February 2010 (but effective from 1 February 2010), the Government released two keys regulations: Government Regulation No. 22/2010 regarding Mining Areas, and Government Regulation No. 23/2010 regarding Conduct of Coal and Mineral Mining Business Activities (respectively "GR No. 22" and "GR No. 23").

It had been expected that GR No. 22 and GR No. 23 would provide more answers than they have. Unfortunately, in comparison to earlier drafts of GR No. 23, the enacted GR No. 23 is very general in some areas. The further detail needed appears to have been pushed down again to expected Ministerial regulations.

Grant of mining business licences

GR No. 23, however, does provide some important clarification surrounding the procedure to obtain new licences. While further guidance is required, it is hoped that a properly structured system for the grant of new mineral licences is a key objective of the current push to enact implementing regulations for the Minerba Law. Frustration among Regents (the heads of local governments and the principal grantors of mining licences) over the delay in establishing new licensing procedures has already led to some discord between the Ministry of Energy and Mineral Resources (the "Ministry") and the Regents. In our view, better coordination and interaction between the Regents and the central Government (which was almost non-existent under the previous law) is one of the biggest possible positives of the Minerba Law.

GR No. 23 provides a framework for a tender process applicable to entities wishing to obtain a mining business licence area (referred to as a "WIUP"). GR No. 23 does not provide all of the specific details you would wish to see for a tender process and stipulates that further details will be provided in Ministerial regulations. Once an entity wins the tender for a WIUP, it must then, within a short timeframe, apply separately for an IUP Exploration licence within that area. Failure to do so will result in a forfeiture of the WIUP and bid bond required for any tender bid. Further, and as expected, GR No. 23 makes it clear that foreign investors must use locally incorporated bid vehicles.

One major drawback in the process may be whether, and if so how, it can be used for larger scale mining projects. Whilst there does not appear to be an express restriction on the number of IUP licences which may be granted within one WIUP, the restrictions on acreage within the Minerba Law itself are linked to the WIUP and not the IUP licences granted. For example, for coal mining projects the maximum WIUP area size for exploration is 50,000 hectares, and for production operation, 15,000 hectares. Further, for metals projects the maximum WIUP area size for exploration is 100,000 hectares, and for production operation 25,000 hectares. In essence it will not matter how many IUP licences the entity holding the WIUP is granted as the same entity may only hold licences covering up to the maximum allowed WIUP acreage and may only hold one WIUP area. It appears only publicly listed companies may obtain multiple WIUPs and it is not clear whether there will be any procedure to enable multiple WIUPs to be linked when awarding.

There is a general right for holders of a WIUP to apply for an area outside their WIUP to “support” their mining business activities, however, there is no detail around what this extra area may be used for, how large it can be, what the application process entails, what the relevant government body's approval procedure is for the application and so on. It is unlikely that this right may be used to obtain further exploration/mining acreage without tender.

GR No. 23 also requires IUP licence holders to reduce the maximum WIUP area to 50,000 hectares (in the fourth year of the exploration phase) and 25,000 hectares (at the end of the exploration period or in the eighth year of the exploration phase) for metals and 25,000 hectares (at the fourth year of exploration phase) and 15,000 hectares (at the seventh year of the exploration phase) for coal mining, although this is not necessary in the production operation phase.

Reassurance for existing concessions

GR No. 23 formally deals with the transition from the old locally owned KP system to the new Minerba Law regime and confirms the position of existing KP holders. It provides that these must be swapped into IUP licences within a three month period. Detail of how this will occur remains to be specified.

As a general impression, GR No. 22 and GR No. 23 also appear to be attempting to provide more certainty regarding existing concessions, both for Contracts of Work ("COWs") and KPs. Uncertainty around COWs, which the Minerba Law stated would be honoured but were to be 'adjusted' within 12 months of enactment, has caused serious concern for investors. Local press, citing comments from a Director at the Ministry, portrays GR No. 23 as good news for COW holders, on the basis that it makes it clear that COWs would be honoured. GR No. 23 does not refer at all to the COW ‘adjustment’ concept from the Minerba Law and may be read as opening up the possibility that amendments to the terms and conditions will be dealt with after the expiry of existing COW periods. This is a theme that tentatively began to emerge from discussions (which are on-going) between COW holders and the Government in late 2009. Although a very positive development if it can be realised, this raises the issue as to whether GR No. 23, as subordinate legislation, can omit a matter contained in the principal Minerba Law.

Localisation divestment obligations

The need to bring local shareholders into projects during production has been one of the most fraught areas for foreign investors in Indonesian mining projects over the last decade. Disputes over compliance with localisation obligations in COWs and added political difficulties about how, and to whom, this divestment should be done have been an unfortunate part of the mining industry environment for a number of major international companies in the mining sector. GR No. 23 contains some good and some not such good news on this topic. Positively, the percentage of local ownership required through a divestment is now fixed at 20%, making it potentially much more manageable than the 51% localisation required in many earlier COWs. Holding 80% of shares will enable foreign investors to retain a level of control that should provide much comfort. The not so good news is the pyramid of entities with a succession of first call rights over divestment shares - the Government, Government owned entities and local Government owned entities. This list is similar to that featured in other contexts and experience suggests that these entities are often not equipped to deal with the matter expeditiously or financially. Furthermore, GR No. 23 provides that if the offer to divest is not successful in the first year, then it must be repeated in the second year, and so on. Prolonged confusion, uncertainty and the inability to finalise matters when foreign investors’ offers to divest have not been taken up has been a problem in the past.

Our recommendation is that parties should give very serious consideration to locking in a local shareholder at 20% from the outset or at least in the first years of production. The specific statement contained in an earlier draft of GR No. 23 that in this situation no further localisation would be needed has been removed. The reading, however, of the localisation obligation - to sell shares such that there is a 20% Indonesian shareholder - would seem to mean it could not sensibly apply where there is at least 20% Indonesian shareholding at the date the divestment obligation would otherwise commence. Further details on share divestment procedures and share price mechanism will hopefully be provided in Ministerial Regulations although precedent and comparison to the oil and gas regime suggest much may be left vague.

New business opportunities?

The Minerba Law imposes an obligation on all mining companies to undertake processing or refining of their production by 2014. GR No. 23 provides that if a holder of a Production Operation IUP does not carry out processing, refinery, sale and transportation activities itself, the licence holder may engage another party to perform those activities, subject to licensing requirements. This presents a significant new business opportunity to perform mineral processing, refining, sale and transportation activities for companies that do not have such capabilities through a separate stand-alone business entity. The potential stakeholders and owners of this stand-alone business can be other than mining concession holders eg. technology owners. Previously these activities could in general only be undertaken by the licensed mining companies themselves.

Domestic Market Obligations

GR No. 23 provides that holders of Production Operation IUPs and Production Operation IUPKs must prioritise domestic needs for minerals and/or coal. The holders of Production Operation IUPs and Production Operation IUPKs may export minerals and/or coal after the domestic needs for minerals and coal have been fulfilled. Further details on the procedures for the prioritisation of minerals and coal for domestic needs are regulated by the recent Ministerial Regulation No.34 of 2009 regarding Prioritisation of Domestic Mineral and Coal Supplies (“Regulation No. 34”). Regulation No. 34 requires producers of coal and minerals in Indonesia to allocate a proportion of their annual production output to the domestic Indonesian market (although GR No. 23 does provide for an approved increase of production to cover DMO shortfall due to existing export commitments), or face sanctions. The allocation is to be based on an annual work programme and budget concept. Notably, the aspiration of the Government seems to be that both export demand and domestic demand can be accommodated within production and figures for 2009 tend to suggest this can be achieved. It therefore remains to be seen how much of an issue DMO is in reality.

Regulation No. 34 does contain some interesting provisions that may provide more flexibility for producers in the future. These include: the possibility that DMO will be satisfied by sale to an onshore entity carrying out added value processes (e.g. coal upgrade); that a party can buy coal to fulfill its DMO requirement; and that a producer who exceeds the minimum percentage can transfer the credit for the excess to another producer. These are all potentially innovative approaches if they can be made to work.

Under Regulation No. 34 and GR No. 23 the annual production output required for the domestic Indonesian market will be set by the Minister based on the estimate of annual demand proposed by potential domestic buyers in the previous year. Further, the price of metals and coal allocated for the domestic market will refer to a prescribed mineral benchmark price and a coal benchmark price. The mineral benchmark price refers to a prescribed prevailing international index or market price. The coal benchmark price refers to the international index.

Summary

There are number of key areas in which GR No. 22 and GR No. 23 are still lacking useful specific detail. Of particular note is the continuing lack of clarity on detail regarding the new minimum pricing system for sales of coal and other minerals and how it will be applied in practice. Broader pricing and contracting controls was an area mapped out in the previous draft of GR No. 23. There was, however, little express basis for this in the Minerba Law. While not detailed in GR No. 23, it is unclear whether it may be in subsequent regulations. The regime proposed in the earlier draft looked potentially cumbersome and complex to meet and restrictive on commercial conduct. More recent comments from Ministry officials suggested that price controls on sales pricing may only relate to the price upon which tax and royalty revenue is to be calculated, and not putting commercial deals in a straightjacket of approvals and reporting. This would be good news but will need to wait for Ministry regulations to see if this is borne out.

Nevertheless, the focus on the new licensing system does indicate a drive to get the Minerba Law IUP system up and running this year. Although the one year deadline for new regulations was not met, the change in the system is quite a far-reaching one and those with previous experience of Indonesia (e.g. comparison to the shift to the ‘new’ Oil and Gas Law) will appreciate that the timeframe for these regulations remains a positive one. We look forward to grappling with further details as the system starts to function and facilitate new investment - often a more effective way to move matters forward.