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The Real Cost of Indonesia’s Commodity Export Restrictions

The Indonesian government has geared up its efforts to limit raw commodity exports. Although the policy measures are applicable to all sectors — coal, gas, liquefied natural gas (LNG) and minerals — the instruments used and the intensity of the curtailment vary across commodities. 

The government’s aspiration to move up the industry value chain and secure long-term supplies for the domestic market are the main drivers behind these initiatives. 

While policies may yield benefits for Indonesia in the longer term, they also bring many near-term challenges. The trade balance could further deteriorate from shrinking export revenues. As a result, both investor confidence and economic growth could suffer. 

To recap, a raw mineral export ban has been applied to nickel, bauxite, chromium, gold, silver and tin. Under a progressive export tax until 2017, exemptions were given to copper concentrates, iron ores, manganese, lead and zinc. 

In the coal mining sector, additional requirements were imposed from August 2014 for coal producers to obtain registered licenses as a condition to export. 

For gas, domestic market obligations are on the rise, with LNG exports cut to allow more volume to go to domestic consumers. In April 2015, the use of letters of credit for export payment for key commodities, excluding oil and gas, was also made mandatory. 

This move is expected to spur the development of domestic processing industries and associated infrastructure, creating new job opportunities and revenue streams in the country. 

The industrial sector is important to consider because it accounts for 47 percent of current GDP, and the government is seeking to prioritize the sector’s development, shifting away from agriculture. 

Indonesia’s energy consumption is expected to nearly double from 226 million tons of oil equivalent (mtoe) in 2015 to 418 mtoe in 2035, so substantial investment in the energy sector will also be required. 

Additionally, export restriction also aims to secure resources for domestic use. The government anticipates growing energy requirements from the domestic market, particularly in the electricity sector, as the country ramps up the development of new power plant projects, which will be fuelled mainly by coal and gas. 

Electricity will be a key component particularly given per capita electricity consumption in Indonesia is extremely low, at just 782 kilowatts per hour. 

In fact, close to 23 percent (60 million) of the population does not have regular access to electricity. But there will be a delay before the new power plants are up and running, with great uncertainty as to whether they can be delivered on time.

The short-term implications for Indonesia’s trade balance are already being felt. Energy and mining commodities form a significant part of export revenues, with coal and gas the largest contributors, accounting for 27 percent of total export revenue. Copper, nickel and bauxite ores and concentrates are also in the top ten contributors to export revenue. 

For these reasons, Indonesia’s trade position is highly sensitive to these commodities, which are the primary focus of the government’s policies. They experienced a combined loss of US$6.4 billion in export revenue. 

Indonesia’s trade balance has been deteriorating since 2012 as a result of shrinking export revenues, but the recent softening of commodity prices has exacerbated this. 

Such losses in export revenue could also affect the current account and position of the rupiah. Indirectly, both investor confidence and economic growth could suffer.

At the moment, there is a mismatch between the pace of policy implementation and market readiness. So far, development of domestic smelters and related support infrastructure has been quite limited. 

At the same time, for mineral producers, such as nickel and bauxite, the combination of outright export ban and lack of domestic processing plants further reduces market options for these domestically produced commodities. 

This results in mine closures, reduced activities and suppressed production.

In the gas sector, aside from lost export revenues, domestically allocated LNG cargoes in 2014 were not fully absorbed by local off-takers following lower demand and infrastructure constraints. 

The LNG export approval process hasn’t been quick or flexible enough to send the stranded cargoes to the international market in a timely manner.

Last year, this led to production curtailment from the Offshore Mahakam and Sanga-sanga areas in East Kalimantan and Vorwata in West Papua. If this is not mitigated properly, we could see a similar scenario repeated in the future, which will result in more production losses. 

The production curtailment may also affect the future performance of gas fields — immediate shutdowns of gas production will negatively impact reservoir performance and, in the future, require further investment to restart these gas fields.

On the coal front, the market has been less affected by the recent measures, mainly because current production is still way above the allocated domestic market obligation. 

But the impact has been felt by illegal miners, who do not pay royalties to the government. That said, as domestic coal demand continues to grow, the measures could expand in the future.

If it is to handle short-term pain and achieve its aspirations of encouraging foreign investment and securing domestic supply, Indonesia must still overcome obstacles in its commodities export restrictions. 

First, there is a clear urgency to develop domestic mineral-processing facilities. An export ban alone won’t deliver this. Concerted efforts are also required to mobilize funding, simplify permit requirements and develop support infrastructure, such as port facilities and power supply. If this does not occur, activities in the mining sector will not recover.

Second, making more supply available to the domestic market won’t necessarily lead to increased demand, given demand is also influenced by infrastructure availability and the market’s ability to pay. 

Third, there is a need for more regulatory certainty. This is evident from the fact that there was little progress in the development of domestic processing facilities between the formulation of the new mining law in 2009 and its effective implementation in January 2014. 

An ambiguous policy will not encourage market players to comply. Instead, the possibility of regulatory reversals will cause the market to take a wait-and-see approach, hoping for decisions to be reversed. 

Regulations that are firm but well planned and carefully thought through, on the other hand, will be effective in most cases.

To successfully achieve its objectives, the government needs to make a strong push in spurring and promoting domestic demand and developing new infrastructure, instead of simply focusing on cutting exports. Concerted efforts are required but seem to be missing elements from the overall experience thus far.