China Feels Pinch of Indonesian Ore Ban

Four months after Indonesia cut off nickel exports in an effort to drive domestic investment in downstream processing, distribution pipelines to China have begun to break down, with prices surging and both supply and demand shrinking, according to Chinese media.

The Indonesian ban, in tandem with Ukrainian unrest that has cut further into production, has driven nickel prices on the London metal exchange to a 15 month high. Chinese importers, already anticipating a ban, began importing much greater amounts of nickel prior to the January cutoff. However, nickel pig iron producers have finally run down their stockpiles. They are said to be operating at just 30 percent of their design capacity

The price could bounce as much as another US$1,000 per tonne to as high as US$23,000 per tonne, traders said. Nickel pig iron, an alloy of iron and nickel, is used in stainless steel production. Some stainless steel makers are now turning back to refined nickel and scrap metal to feed production instead of the cheaper nickel pig iron.

The nickel ban is part of a broader ban on unprocessed ore shipments driven by a wave of economic nationalism that continues to shape Indonesian politics. The Indonesian ore ban is a heavy-handed way to force investors to put smelters in place by 2017 at the latest. Exceptions for some minerals are possible but an additional tax penalty has been levied on those shipments that companies say make exports uneconomical.

US mining giant Newmont said last week that it may halt production at its Batu Hijau gold and copper mine and lay off 8,000 workers because of the ban on the export of copper concentrate, its major product.

Indonesia’s action has attracted widespread criticism for its short time span for the development of a downstream industry, with many observers pointing out the difficulty of developing international standard smelters overnight. In the short term, the critics said in January, the ban had the potential to be catastrophic for mining companies. That concern appears to be coming true as predicted

The situation doesn’t bode well for Indonesia’s economy either. Exports have been a key driver of economic growth, according to World Bank figures, contributing 24 percent of Indonesia’s gross domestic product in 2012. Its principal exports are coal briquettes, petroleum, palm oil, rubber, and crude. A more stringent cutback on exports could do real damage.

Chinese news services said the situation is unlikely to change until at least October as economic nationalism drives presidential politics in Indonesia, a concern widely shared in other countries and investment sectors.

Both China and Japan are said to be turning to Africa and the Philippines. In the latter, virtually all of the nickel being mined is said to be smuggled out of the country, according to a study last year by Pacific Strategies & Assessments, a Manila-based country risk consultancy, with as little as 5 percent passing through government channels for the assessment of excise duties.

The shortage is a slow-moving crisis that has been predicted ever since Indonesia, against the advice of the World Bank, investors and others, in January activated the four-year old plan to ban the export of raw ores.

The ban, which also covers bauxite and many other minerals, was enacted to seek to encourage mining companies to add value to their products by developing downstream industries and processing minerals locally. But despite a four-year window to put a smelting industry in place, the domestic industry remains woefully inadequate. The enormous power needs for smelting plants has meant that Indonesia’s energy grid is unable to deliver enough energy to far-flung areas where the smelting plants would be needed.

A World Bank economist told Reuters in March that the negative impact on net trade could be as much as US$12.5 billion between 2014 and 2017, when supposedly enough domestic smelting capacity could come on line to handle the export flows. The World Bank estimated that for the period 2014-2017, the potential cost in lost fiscal revenues, including royalties and export taxes, could be $6.5 billion, with the possibility that if the many proposed smelting projects don't kick in by 2017, the negative impact could go well beyond that time.

That doesn’t seem to concern the Indonesian government. R. Sukyar, the director general for minerals and coal, R. Sukyar, told reporters on May 5 that China will be looking to Africa and the Philippines for additional nickel supplies, but that would only provide about 40 percent of China’s needs.

China, he said, will continue to invest in smelters in Indonesia, since the country is China’s biggest supplier. However, the World Bank warned that the ban may only prompt a short-term increase in smelter investment as the Chinese diversify away from Indonesia and move away from nickel pig iron producers to other, more expensive products to produce stainless steel.

The World Bank report also suggests that for copper, lead and zinc, additional investment in processing appears unlikely to be economically viable in current conditions given low margins from global overcapacity in smelting and refining.

According to the World Bank, Indonesia accounted for less than 2 percent of global production of copper, lead and zinc in 2012. Without an Indonesian import cushion, Chinese importers are looking elsewhere, raising the possibility that they could abandon the Indonesian field completely if adequate supplies can be found elsewhere and economical supply chains can be put in place.