Energy, Natural Resources & Infrastructure

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1 Energy, Natural Resources & Infrastructure Indonesia Issue 3/2008 In this issue Special Issue: Bill On Mineral and Coal Mining 3.5 Years in the Making! Key Points from new Bill Summary Special Issue: Bill On Mineral and Coal Mining 3.5 Years in the Making! On 16 December 2008, the Bill on Mineral and Coal Mining was passed by the Indonesian Parliament, ending three and a half years of protracted debate between lawmakers and Government. Last minute dramatic walk-outs by various Indonesian political parties over disagreements as to whether existing Contracts of Work should be grandfathered has not halted the passing of the Bill, which now sits awaiting a Presidential signature. If the President has not signed the bill by 16 January 2009, it will automatically become effective on that date, and will form the new cornerstone for future development of Indonesia mining projects. We have attached a brief analysis of the Bill, providing an analysis of some of the key aspects of the Bill and its changes from its 1967 predecessor, and its likely effect on existing and future mining projects. We have focussed our review on the provisions applicable for coal and mineral mining, and have not addressed small scale community mining or the mining of non-metallic mineral mining (such as granite, limestone, etc.) The Indonesia Stock Exchange Building, Tower II, 21st Floor Sudirman Central Business District Jl. Jenderal Sudirman Kav Jakarta 12190, Indonesia Tel: /91/92/93 Fax: /45/50/55 One of the key practical issues is how quickly the Government can issue the required implementing regulation. Past precedents in relation to energy sector reforms have demonstrated that there is often a long lag time between the passing of the law, and the passing of the Government Regulation. For oil and gas, the 2001 law was followed by the key implementing regulation in For geothermal projects, it was only in 2007 that the implementing regulations This may qualify as Attorney Advertising requiring notice in some jurisdictions. Prior results do not guarantee a similar outcome.

2 Hadiputranto, Hadinoto & Partners were issued for the 2003 law. Whilst this Bill provides that the Government must issue the required implementing regulations within 1 year of the Bill becoming law, it remains to be seen whether this target can be met. Key Points from new Bill After long debate, no form of contractual-based concessions will be available for new mining projects 1. Abolition of new Contracts of Work After long debate, no form of contractual-based concessions will be available for new mining projects. All investors will be issued a form of licence (called an Izin Usaha Pertambangan or IUP), with the licence being issued by Regional, Provincial or Central Government depending on the geographical coverage of the mine and its infrastructure. There was much debate over whether a form of contract would remain for those mining areas declared by the Government as State Reserve Areas (being areas generally defined as those having high value to the State). Ultimately, those areas will also be exploited by a form of licence (called an Izin Usaha Pertambangan Khusus or IUPK), but with the difference being that an IUPK will be issued directly by the Central Government, regardless of the geographical coverage of the mine. 2. Tender requirements Under the new regime, the relevant Government issuing authority issues initially a mining business licence area (called a Wilayah Izin Usaha Pertambangan or WIUP), and then an IUP for the specific coal or mineral is issued. WIUPs for coal and minerals must be issued through a competitive tender process. The winner of that tender is then issued the IUP for the coal or mineral applied for. This is a marked departure from the system to date, which provided for direct grant of Kuasa Pertambangan (KPs) by the relevant issuing authority upon application. In the event other minerals are discovered, the relevant Government authority has authority to issue further IUPs for those different minerals to other parties on application, after taking into consideration the views of the founding IUP holder. This is a departure from the previous regime where the initial KP holder for an area had the priority right for the KPs for other minerals on the same area. IUPs/IUPKs can be held by foreign owned Indonesian companies 3. No restriction on foreign ownership Under the previous regime, it was generally accepted that KPs could not be held by Indonesian entities with foreign ownership or management. Under the new Bill, IUPs/IUPKs can be held by Indonesian legal entities (which is interpreted as including both domestically owned Indonesian companies, and foreign owned Indonesian companies). This accords with Indonesia's current Negative List on Investment, which provides that mining is 100% open for foreign investment. 2

3 Energy, Natural Resources & Infrastructure However the Bill does contain obligations on IUP /IUPK holders who have foreign shareholders, to implement a divestment program after 5 years of production start. The detail of how extensive this divestment obligation will be is to be set out in further regulations. 4. State Reserve Areas As mentioned above, the Government has the ability to declare certain areas as State Reserve Area. The IUPKs granted to develop these areas are offered first to State/Regional Owned Companies, but in the event they are not taken up, are then offered to private sector interests via a tender process. IUPKs are only applicable for coal, copper, lead, gold, iron, nickel and bauxite. 5. Term and size of IUPs The maximum sizes, and the terms, of IUPs for coal and metals are: Coal Metals Exploration - 7 years (1 general survey, 2 yr exploration , 2yr feasibility study) - Maximum area 50,000 Ha - 8 years (1 general survey, 3 yr exploration , 1yr feasibility study + 1) - Maximum area 100,000 Ha Production Operation - 20 years (inc. 2 yr construction) Maximum area 15,000 Ha - 20 years (inc. 2 yr construction) Maximum area 25,000 Ha 6. Royalties All holders of IUP/IUPK will be required to pay production royalties in an amount to be further set by regulation. Currently, a range of percentages applies for the different types of coal and mineral mining, and it is expected that such an arrangement will continue under the new law. for State Reserve Areas, the holders will be required to pay an additional royalty of 10% of production However, for State Reserve Areas, the holders will be required to pay an additional royalty of 10% of production, with 4% going to the Central Government, and 6% being shared between the relevant Province and Regencies. 7. Onshore processing obligation of minerals All mineral based projects are required to process their ore in Indonesia. The only guidance as to what processing is, is that it is a process which increases the value of the relevant commodity. For existing Contract of Work holders who are already in the production phase, there is a five year grace period applicable before they have to comply with this obligation. 3

4 Hadiputranto, Hadinoto & Partners 8. Further regulation of Mining Contractors Mine owners are prohibited from using their affiliates to carry out mining operations, unless Ministry approval is obtained. Such approval will only be granted where there is an unavailability of other contract mining options. Similarly, all mining companies must use local or national mining contractors. Again, if no such local companies are available, foreign mining contractors may be used. 9. Production and Sale Controls The Bill contains a reference to further Government Regulations being issued to implement the domestic market obligation, but provides no further detail at this stage. The production level control presents significant risk for investors More importantly, for the first time, the Bill gives the Central Government power to determine production levels for each commodity in each year on a Province by Province basis. The production level control presents significant risk for investors. 10. Grandfathering The most hotly debated provision of the Bill was the provision relating to how existing Coal Contracts of Work/Contract of Work were to be treated. The final Bill provides that existing contracts will continue to be valid until their expiry, but the contract terms must be modified within one year to bring them into line with the new law. The Bill expressly states that the provisions of these existing contracts regarding State revenues (e.g. royalties, etc.) will not be amended. It is not at all clear to which provisions of the new Bill these existing contracts must conform. The range of changes could include alignment with the new law s provisions on divestment obligations, re-sizing of the mining areas, reduced production periods, prohibition on using affiliated mining contractors and the like. It is hoped that the implementing Government Regulation may specify in more detail with which provisions of the new law these existing contracts must be aligned. The Bill is completely silent as to the treatment of KPs. Previous drafts of the law had provision for KPs to be transitioned to IUPs, however those provisions do not appear in the final Bill. Do the existing KPs remain in their current form until expiry (i.e. with their continued foreign ownership restrictions)? Are they now automatically reduced in size to comply with the new maximum area requirements of the new law? Or are they to be treated as if they are IUPs (and therefore foreign ownership is allowed)? 4

5 Energy, Natural Resources & Infrastructure Contact Information: Luke Devine Foreign Legal Consultant Tel: Norman Bissett Foreign Legal Consultant Tel: Daniel Ginting Partner Tel: Muhammad Karnova Associate Tel: Liza Tantri Associate Tel: Summary The new Bill leaves much of the detail to be dealt with by the implementing Government Regulation. What seems clear is a theme running through the Bill relating to the promotion of national interests, and it is clear that the Parliament has not accommodated the requests of the major foreign mining houses to preserve a contract of work system going forward. It is expected that these majors would remain on the sidelines as far as new project development is concerned, as they perceive the licensing system presents far too many regulatory risks. For the regional and mid-tier/junior miners who have been willing to work with the existing domestic KP structure with all of its risks over the last decade, the new Bill can be seen as a step forward in terms of adding certainty to their ownership structures. However, we now eagerly await the devil which will inevitably rear its head in the detail of the implementing Government Regulations. December 2008 Hadiputranto, Hadinoto & Partners is a member of Baker & McKenzie International, a Swiss Verein with member law firms around the world. In accordance with the common terminology used in professional service organizations, reference to a partner means a person who is a partner, or equivalent, in such a law firm. Similarly, reference to an office means an office of any such law firm Hadiputranto, Hadinoto & Partners All rights reserved. 5