Investing in Indonesian Energy & Natural Resources

By Mohamed Idwan Ganie

Posted: 16th July 2013 08:17

Indonesia has been a favourite investment destination of natural resource companies for a significant amount of time, with ample undeveloped resources that span the archipelago being available to this day.  Combined with the growth of Asian manufacturing demand for raw materials in the recent past, in light of Indonesia’s proximity to such manufacturing centres as China, Japan and South Korea, this has resulted in an ever-increasing interest in Indonesian natural resource projects.
 
Lately, Indonesia is also beginning to transition from being merely a source of the raw materials to securing a place as a manufacturing base in its own right, with the associated domestic resource and energy demands often driving both growth as well as domestic and foreign investment.
 
Framework Overview
 
The Indonesian mining industry currently operates under a dual framework: legacy Contracts of Work (CoW) and post-2009 mining licenses (IUP).  The CoWs are contracts between a mining company and the Republic of Indonesia, and contain all the key terms of the mining rights that have been granted (duration, royalty, divestment obligations if any, etc.).  IUPs operate under a license regime that defines their key aspects through regulations, and are therefore subject to a wider range of regulatory changes.
 
For example, the IUPs were originally subject to a 20% divestment obligation (to Indonesian-owned entities) after 5 years of operation, which has since been changed to a 51% divestment obligation after 10 years (staged, starting at five years).  Similarly the 2009 introduction of the licensing regime saw the introduction of a domestic processing obligation that was set to apply from 2014, but was amended to come into effect early along with an introduction of an alternative to domestic processing in the form of a 20% export tax.
 
Oil and gas operates under a production sharing contract (PSC) framework, which had been overseen by an independent state agency (BP Migas) until a Constitutional Court decision essentially held that BP Migas should be under the Ministry of Energy and Natural Resources.  As a result a revision of the oil and gas law is expected in the coming year, with a potential shift to a regime that introduces more license-based features than the existing contractual-based PSC framework.
 
Such regulatory changes are becoming increasingly more prevalent in the Indonesian energy and natural resources sectors.  And, as such, their impact on the business community needs to be carefully considered and any developments kept abreast of by prospective and current investors.
 
Government Incentives
 
In order to encourage foreign investment the Indonesian government has created a number of incentives that investors can take advantage of when committing funds to the Indonesian market.  The incentives include income tax holidays for strategic and innovative industries, value added tax and customs duty reductions and exemptions, and the upcoming benefits that will become available to ASEAN investors under the soon to come into force ASEAN Comprehensive Investment Agreement (ACIA).
 
Income tax holidays are available to large investments that are seen as introducing new technologies or having a strategic value to the Indonesian economy, which can include both power projects and certain mining operations, and are provided for a period of between 5 and 10 years.  The goal behind the provision of such a substantial incentive structure is to diversify from and complement the natural resource industries that have traditionally seen the bulk of foreign investment.
 
Customs duties and value added tax reductions and exemptions are available for the import of capital machinery, certain goods and materials, and select services; with varying durations of applicability following the commencement of the investment. 
 
In the context of infrastructure development, which includes energy projects, with its typically larger and longer term investments, the government has also sought to facilitate such ventures by developing a legal framework for structured guarantees that provide coverage for select commercial and political risks faced by the projects.  Such guarantees are generally available to public private partnership (PPP) projects, under the state owned Indonesia Infrastructure Guarantee Fund (IIGF), and to select non-PPP projects under more specific schemes that are designed to encourage the development of the energy industry, through the Ministry of Finance.
 
Investment Practicalities
 
There are a number of business types spanning several sectors that are either closed to foreign investment or require foreign investors to enter into a joint venture with an Indonesian partner.  Such restrictions are set out in the Negative Investment List, as currently contained in Presidential Regulation No. 36 of 2010 and certain sector-specific laws and regulations.  The restrictions, however, are quite dynamic, and are periodically reviewed by the government, which generally seeks to further liberalise investment policies, while at the same time balancing the necessity of protecting certain domestic industries that are seen as being socially or strategically important.
 
Foreign investments should be incorporated as an Indonesian legal entity and domiciled in Indonesia.  The investments are made in the form of a limited liability company (termed a PMA company in case of foreign ownership) although a preliminary market presence could also be established via a representative office (with certain limitations on the permitted business activities).  With regard to the percentage of foreign ownership, foreign direct investment can be established in one of two ways (with certain restrictions depending on the business area): 100% foreign-owned, or through a joint venture, of which the Indonesian partner has to own at least 5%.  In practice, the local knowledge, as well as invaluable market experience and connections that can be offered by an Indonesian partner are often a deciding factor in foreign investors opting for a joint venture structure.
 
What may come as a surprise to investors with limited prior experience in Indonesia is the at times lengthy and administratively complex process of fulfilling the formalities involved in entering the Indonesian market.  For instance, it can take as long as six months to complete the registration of a limited liability company in Indonesia, with just the first BKPM approval taking 1-2 months in some cases, compared with some neighbouring jurisdictions, where the minimal incorporation formalities can be completed in a matter of days.  This means that investors looking to enter Indonesia have to have accurate and realistic expectations concerning the market entry process, and, so as to ensure that the process is completed as expediently and smoothly as possible, select trusted and reputable counsel that has a well-established presence in Indonesia.
 
Another legislative feature that is important to note, and become familiar with, is the Indonesian labour law regime.  For instance, investors without prior experience of operating in Indonesia may find the Indonesian labour legislation much more protective of workers than the labour laws that apply in many other jurisdictions.
 
The final matter that foreign investors should keep in mind when structuring their investment is the dispute resolution process; should a conflict emerge in the context of a joint venture, or under a contract with an Indonesian counterparty.  Due to a number of peculiarities of the Indonesian legislative regime, and some notable differences from the legislative regimes that foreign investors may be more familiar with, it is essential to involve counsel with Indonesian commercial dispute resolution experience in the course of the drafting of any contracts involving an Indonesian party.
 
Mohamed Idwan (‘Kiki’) Ganie is the Managing Partner of Lubis Ganie Surowidjojo (LGS).  He graduated from the Faculty of Law of the University of Indonesia and holds a PhD in Law from the University of Hamburg, Germany.  Dr. Ganie has more than 30 years of legal experience, and specialises in commercial transactions and commercial litigation, including alternative dispute resolution and has acted as an expert in a number court and arbitration proceedings.  His expertise covers general corporate/company law, banking law, finance, bankruptcy and restructuring, mining, investment, acquisitions, infrastructure projects/project finance, antitrust, and shipping/aviation, with a particular focus on corporate governance and compliance.
 
Mohamed can be contacted by phone on +62 21831-5005, 831-5025 or alternatively via email at ganie@lgslaw.co.id

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