Post-Busang syndrome affects new mining deals

Post-Busang syndrome affects new mining deals

Mining analysts and foreign investors have criticized the
Indonesian government's recent move to change the terms of the
seventh generation contracts of work (COW) which were initialed
last year. Hartojo Wignjowijoto, a senior economist and president
of Asian Pacific Economic Consultancy Indonesia, explains why the
policy changes are ill-timed and could be counterproductive.

JAKARTA (JP): The Indonesian government seems to be suffering
from a post-Busang syndrome at the moment, as indicated by the 16
points of change recently offered by the Directorate General of
Mining to foreign contractors applying for the seventh generation
Contracts of Work (COW).

The drafts of the seventh generation COWs have been
initialized by both the government and the mining companies and
are now on the way to the House of Representatives.

But a heated controversy arose after the government suddenly
moved to enter the 16 points to the seventh generation COWs to
develop a leverage and improve its bargaining position. This was
in anticipation of political pressure for the government to
better control foreign mining companies.

There are two points which especially drew strong reactions
from the mining companies. One is related to the demand for the
contractor to give the government a 10 percent share for free
even before the mine is built. The other is the right for the
government to share in the capital gains from share issuance
overseas.

Foreign companies have been so outraged by the demand that
they have threatened to leave the country and forget about the
Indonesian geological potential. If this took place, mining
activities would adversely be affected.

Foreign mining companies argue that what they need is
transparent ground rules to play the investment game in the high
risk mining sector so that once the companies commit their risky
money, they can plan and implement it in an orderly manner.

They see the proposed changes in the contracts as additional
uncertainty in the mining investment climate. At the same time,
the government has felt compelled to strengthen its bargaining
position because of its bitter experience with the Busang gold
scam.

The Busang gold scam refers to what was claimed by contractor
Bre-X Mineral Resources of Canada to be the world's largest gold
find in the Busang area in East Kalimantan. But independent
audits in April discovered that the claim was the biggest hoax of
the century, causing an embarrasment and losses of billions of
dollars to investors around the world.

Foreign mining companies objected for the simple reason that
if one was caught in a criminal or gold scam, it does not mean
the rest of the foreign mining companies here are all crooks.

This chaotic situation will have a significant impact on the
forthcoming investment flows to Indonesia. According to a recent
survey by the Indonesian Mining Association, almost US$100
million is about to leave Indonesia due to the new uncertainty
caused by changes proposed for the seventh generation COWs.

The question then is to what extent long-term investors still
believe in Indonesia's geological potential and to what extent
the potential long-term investors believe in overcoming
Indonesia's institutional problems.

In my opinion, if potential mining investors are long-term
oriented they will leave the short-term institutional problems to
the government. This means they will leave the political problems
to the politicians and will focus on long-term mineral
development and its associated regional economic development.

The government has already acknowledged that COW is the best
scheme to accommodate article 33 of the Indonesia constitution,
whereby the government is still in control of mineral resources.

The government contracts the exploitation of natural
resources out to foreign mining companies which have the
technology, equity capital and the ability to attract high risk
capital.

Why has the government suddenly asked mining companies for a
10 percent free share? Is it not enough to collect up to 60
percent of mining contractors' revenues through royalties, a 30
percent income tax, and other indirect taxes?

The government has to consider several factors in deciding to
amend the seventh generation COW. These include the alternative
option for investors in other countries in the emerging mining
countries, the urgent need to accelerate mineral-based regional
economic development.

Above all, since the government and contractors have already
mutually agreed upon the seventh generation COWs, the amendment
should be directed to the eighth generation COW.

The government should carefully examine the structure of the
incentives offered to foreign investors, the cost and benefits of
foreign investment in the mining sector and the national value-
added generated from mining activities.

I believe the House debates on the 16 points of changes
proposed to the seventh generation COWs will create a lot of
political uncertainties for foreign investors and cause a
negative image on the credibility of the government's policy.

The middle of the road solution would be to reschedule the
proposed changes for the next generation COW.

But before changes are entered into negotiations the
government should again review the socioeconomic, financial and
political cost-benefits of the new terms, focusing on the role of
the capital inflow (including the development of infrastructure)
for regional development.

The present day mining sector in Indonesia is facing new types
of uncertainties. The completion of the full cycle of one COW
generation and the institutional problems are currently reaching
a crisis of confidence.

Even though the fundamental geological properties are strong,
as long as the fundamental institutional problems are not
overcome in the next cabinet, there will be a long setback to the
well-known COW.