Indonesia seeks to get mining right

Despite being home to some of the world’s more robust gold deposits, mining in Indonesia is in a state of upheaval.

Amidst the introduction of a new mining law aimed at strengthening the industry, the country watched as gold production dropped off severely last year. For the first time in more than a decade, annual gold production fell to under 100 tonnes, coming in at just 95 tonnes — a 35% decrease from 2007 levels.

That reduction means Indonesia now ranks 8th amongst gold producing nations according to GFMS 2009 gold survey — a long ways off from the 183 tonnes it managed to produce 2001 when it was the world’s fourth largest gold producer.

Part of the blame for the drop off can be chalked up to technical problems. Because much of the country’s total gold production is tied to Freeport McMoRan’s (FCX-N) massive Grasberg mine a drop of 45 tonnes, or 55% in mining there took its toll on the overall tonnage.

That reduction came partly because of mine sequencing and a pit wall failure in third quarter of last year.

But questions around the new mining law aren’t doing much to help usher in a wave of investment that would in turn bolster production.

While the new law was passed three months ago, there is still much to be done on regulating how the new legislation will be implemented and many questions about how it will all play out.

Further complicating things is the fact the situation is unfolding within the context of fiercely contested legislative elections, which are to be held on April 9, and a presidential election slated for July.

With the role of big miners in the country being a hot political issue, there is concern that populism could interfere with sound mining legislation.

A clue to how serious the government is about polishing up its mining image will be found in its dealings with Newmont Mining (NEM-N, NMC-T).

A recent ruling from an international arbitrator came down on the side of government, saying that Newmont and its partner at the Batu Hijau project, Japan’s Sumitomo have 180 days to divest 17% of their interest in the jointly held subsidiary that holds the project.

The arbitration panel said Newmont and Sumitomo were in default of their contract by not meeting deadlines in 2006, 2007 and 2008, to sell 17% of the project to local buyers.

The Minister for Energy and Mineral Resources Purnomo Yusgiantoro, stepped in after the ruling and said that 10% of the project will be sold to local governments, with 7% going to the central government.

Investors will be watching closely to see if the divestment is done in a fair and transparent manner and what the future climate for major miners will be.

A recent survey by Price WaterHouse Coopers found that the majority of investors in the region felt that while the new law would encourage relatively small-scale investments, there was still uncertainty over large-scale projects like Batu Hijau.

Those concerns centered on the fact the new law fails to offer long-term protection of contracts granted under the previous system.

The new law, it is feared, will make old mining contracts with their 30 year guarantees, obsolete.

Companies with old contracts have one year to comply with the new system which will rely on arbitration in place of contracts in claim disputes.

The worry is that such arbitration cases will go before the Indonesian judiciary — one that is considered to be overly opaque.

The new law had its origins as a corrective measure for the failings of regional autonomy laws passed in 2001.

The shift to great regional authority was an operational nightmare for miners as regional authorities were allowed issue mining concessions that often were in conflict with centrally administered contracts.

The new law gives back more power to the state as it makes clear that the central ministry can suspend or revoke locally administered contracts if regulations are not followed — an improvement because local-level laws are renowned for their lack transparency.

Still, onlookers say the government has not yet given firm assurances on how it will deal with regional conflicts.

Of additional concern for investors is that there is still no one-stop solution for miners looking to secure the necessary permits and contracts.

While prior to 2001 centrally granted mining contracts were all a miner needed, companies now need a host of contracts from both the provincial and central governments.