Indonesia Commodities Sector Heads for Trouble

The folly of Indonesian nationalist posturing on natural resources extraction is coming home to roost even faster than even pessimists might have expected a few months ago.

The first place to look for this evidence is the price of thermal coal, of which Indonesia is the world’s largest exporter. This has collapsed from US$135 a tonne in late 2011 to around US$85 today. Nor is there much prospect of more than a brief bounce. The reasons are very simple. Firstly the massive expansion of gas production in the US has forced US coal producers to seek markets in Asia. Secondly, Indonesian output has been rising thanks to the stimulus of previously sky-high prices.

Now Indonesia thinks it wants to conserve its coal and is threatening to tax exports. But its coal resources are so large and the commitments to new production are so well advanced that there seems little chance that exports won’t continue to grow in volume, keeping the price depressed. In theory it would better if more were used to generate power at home. But that is an issue of investment in power stations not coal mines and the country has poor record of attracting private capital into this sector.

Meanwhile the longer-term outlook for global coal looks poor given its pollution costs and the prospect of rising LNG output from Australia, Qatar and other sources and further output from fracking in the US and in future in Australia and elsewhere. China seems unlikely to benefit much from fracking due to its coal geology and shortages of the vast amounts of water required to extract gas. However advances in gasification techniques for low-grade Chinese coal could be a further blow to Indonesia’s thermal coal exports.

Market disillusion with Indonesia, until recently viewed as a bright star at a time when the shine was coming off China and India, has been reflected in a steep fall in the rupiah, from a peak of Rp8,500 to the dollar to Rp9,400 today. The reasons appear to be both a direct reflection of a deteriorating export outlook, dissatisfaction with government policies which are seen to be erratic as well as nationalistic, and concern that the central bank was unwilling to raise interest rates for political reasons, instead resorting to controls on lending to rein in consumer credit.

More immediately hurt by government policy are nickel exports. Although those from major miners are not yet affected by plans to enforce local processing, those of many smaller mines selling nickel ore to refineries in China and Japan have been hit. In the short term, Indonesian policy may even have helped the global nickel price fall less quickly than otherwise would have been the case. But the policy has done nothing either for bauxite or copper prices. It remains to be seen how far copper mining investment is damaged by the new rules.

Gold is less affected because processing to concentrates is always done at mine site due to the volume of material required to yield a single ounce of gold. However as copper and gold are often found together the new rules are sure to deter investment.

Indonesia’s desire to extract the maximum value from its resources is natural enough. But policies which are erratic and driven by domestic politics rather than devised in full knowledge of the forces at work in the marketplace are already undermining its attractions just at a time when the outlook for most commodity prices has deteriorated.