Special Report: Grasberg mine talks signal Indonesia’s strengthening resolve

Special Report: Grasberg mine talks signal Indonesia’s strengthening resolve

Despite some issues concerning the Indonesian government’s divestment plans for the province of Papua’s Grasberg mine, there are growing signs that Indonesia will get its way. Nevertheless, Indonesia’s ruthless treatment of Freeport will alert future investors.

This year has been unforgiving to Freeport McMoRan Inc, an invaluable player in Indonesia’s mining sector. On August 29, after months of tense negotiations, Freeport agreed to relinquish a 51% share in Grasberg, the world’s second-largest gold and copper mine, to the Indonesian government. Having acquired Grasberg early in the Suharto era, American corporation Freeport has since transformed it into a ‘super mine’. Grasberg produced 500,000 tonnes of copper and 1.1m ounces of gold in 2016 – over 25% of Freeport’s worldwide output.

Though Freeport’s mining activities have brought some economic development to Papua, Freeport’s operations have been accused of fuelling unrest in the region. Foreign ownership over natural resources has become an increasingly contentious issue in Indonesia, most noticeably reflected in this year’s Grasberg protests.

The government’s acquisition of a majority share of Grasberg suggests it is attempting to alleviate these populist concerns. Under the agreement, new mining rules that were introduced last January will be implemented, requiring Freeport’s 30-year contract to be replaced by a new mining permit, renewable every six months.

The issue is far from settled though, as sticking points remain over this divestment concerning valuation, timescale, payment structure, and tax and royalty payments. Further, these lingering concerns are evidence of deeper fractures between multinationals and the Indonesian state. They raise questions on ownership, sustainability and the shifting role of foreign investment in Southeast Asia’s largest economy.

Grasberg signals new aggressive Indonesia

Freeport initially reacted in a hostile manner, arguing that the new laws breached its current contract, which was slated to end in 2021. Freeport further branded the new regulations ‘a form of expropriation’ and threatening to request an arbitration hearing. It proceeded to suspend its operations, leading to loss of revenue and falling share prices.

Freeport’s eventual compliance was a reflection of the strong negotiating duo chosen by Indonesian President Joko ‘Jokowi’ Widodo: Energy and Mineral Resources Minister Ignasius Jonan, a formidable statesman, as well as Finance Minister Sri Mulyani Indrawati, a powerful technocrat and past managing director of the World Bank. The pair represented Indonesia well, reflecting a government unwilling to fold. Indonesia’s willingness to play hardball showed Freeport was no longer to be given special treatment, but to be treated ‘like any other company’.

The new agreement requires Freeport to build a new smelter, reflecting Indonesia’s long-term ambition to turn copper extraction from an export industry into a local, value-added industry. Freeport also committed to developing Grasberg’s underground mining facilities, (as open-pit resources are nearing depletion), investing $17bn-$20bn by 2031. Although Freeport hopes to retain control over Grasberg mining operations and governance, Maritime Affairs Minister Luhut Pandjaitan expressed Indonesia’s desire to assume overall control.

Indonesia has been deliberately aggressive on a number of fronts, attempting to place Freeport on the defensive. Whereas Freeport wants the full divestment to be completed progressively over several years, the government has expressed interest in taking its shares as early as December, 2018.

In addition, the government wants Freeport to pay more taxes and royalties, though the exact figure is yet to be determined. Freeport insists it is not subject to any taxes, royalties, or government fees, except those stipulated in the current contract. However, Indonesia likely views their quarrel through a more historical lens, reflecting a belief that past government administrations have been too lenient with Freeport.

This uncompromising stance has been driven by intense public pressure. It reflects Jokowi’s determination to balance foreign investment and economic growth against national and regional (Papuan) self-determination. Jokowi believes that fighting for a greater role for Indonesians, and particularly Papuans, in the mining sector, will gain him favour with influential Muslim civic organisations before the next election.

Unprepared to take over a major asset?

Despite the legal power behind Freeport’s negotiating team, Indonesia is in a strong position, as it technically owns the mineral reserve. According to Article 33(3) of the Constitution, ‘the land, the waters and the natural resources within shall be under the powers of the State’. Freeport’s team will attempt to argue otherwise, further delaying and disrupting negotiations.

The Indonesian Chamber of Commerce and Industry (Kadin) advised the government to defend its position on the current agreement. Indonesia is confident of its long-term prospects, driven by a growing middle class that accounts for two-thirds of its GDP and is a key driver of domestic resource demand. Yet, even though Indonesia has the political clout to control its own resources, it may not be equipped to take over such a major asset such as Grasberg.

Regarding the distribution of shares, it remains unclear which levels of government and which government agencies will benefit. The government wants the Ministry of State-Owned Enterprises to handle the transaction, yet Indonesia has a dearth of well-run state-owned mining companies. Should Indonesian SOEs buy up the shares, corruption problems may prevent a trickle-down of profits – as intended.

But Indonesia is not swearing off Freeport altogether. In fact, it has shown some signs of compromise, allowing Freeport to continue exporting under its current contract, according to a statement by the ministry – as long as Freeport makes progress developing the new smelter. The government understands that without Freeport’s investment it would be left with poorer infrastructure and a lack of skilled workers.

Impact on investment climate

Jakarta’s intent behind its tough stance stance is to regain control of one of its best resource assets by progressively circumscribing foreigners’ legal rights over their operations – which will alert other players in the extractives industries. The Freeport talks may prove to be a bellwether of how much investors have to compromise under new contracts in Indonesia.

Whatever the result of the Freeport dispute, the government’s actions will undermine Jokowi’s business-friendly reputation. This would come on top of a ten-year-low investment in Indonesian mining last year, notes David Fickling. Net investment has been negative so far this year. Wavering confidence and uncertainty surrounding Indonesia’s mining policies could begin to affect other industrial sectors.

Growing resource nationalism raises questions about future governments’ willingness to protect and fairly compensate foreign companies’ property rights. Though Jokowi is a favourite for re-election in 2019, a more Islamic and/or protectionist alternative may be even less accommodating.

About Author

Alexander Macleod

Alex is a Manchester-based Analyst specializing in Southeast Asian political and security risk. He holds a PhD in Politics and Geography from the University of Newcastle, where he examined the role that online media play in promoting and sustaining Malaysia's racialized political landscape during general elections. Alex also freelances as a social media manager for a digital marketing consultancy. He blogs at https://seaofrisk.wordpress.com/