Indonesia: The Commodity Curse in the Green Transition
Indonesia has some of the world’s largest reserves of critical minerals and resources. Its natural endowment includes copious amounts of nickel (1.5 billion tons), copper (640 million tons), bauxite (927 million tons), and tin (1.2 billion tons). All these materials have roles of varying importance for the Green Economy. Nickel is used to power EV batteries. Copper is an essential element for renewable energy infrastructure due to its high degree of conductivity and non-corrosivity. Bauxite is processed to become aluminum, the preferred metal for vehicles due to its low density. Lastly, tin, an under-the-radar mineral, is a crucial component for electrical circuity used for green infrastructure. Following pro-active policies by the largest countries in the world (China with its EV developments, US with the Inflation Reduction Act), the Green Transition is well under way as it undergoes its implementation phase. Demand for green infrastructure, vehicles, and components will likely accelerate in coming years as countries seek to wean off reliance from fossil fuels and hit pre-determined targets, such as the 2015 Paris Accords.[1] Indonesia therefore faces an opportunity with its massive deposits. But to what extent can it capitalize on it in a sustainable manner and avoid near-sighted economic behavior which prioritizes short-term windfall profits?
In 2023, Indonesia’s mining sector contributed roughly 12% of its GDP.[2] This has increased from roughly 7% in 2016, and the growth rate is projected to accelerate further with greater sovereign incentives to achieve the green economy. As the world’s largest nickel producer, Indonesia dominates the global market, accounting for 51% of global nickel production. This makes nickel a cornerstone of the country’s economy.[3] While a large proportion of such nickel is used to fabricate stainless steel, recent state developments have heavily favored EV batteries.[4] [5]Viewed from a long-term perspective, the price of nickel has consistently risen, with a compound annual growth rate (CAGR) of 11% since 2016, underscoring the persistent gap between demand and supply.[6]
Fig 1. Nickel future prices have increased drastically—excluding the short squeeze in 2022—over the past 10 years. Source: Trading Economics
However, Indonesia must be careful to not fall into the “resource curse” which has become a byword for economic ruination in nations naturally endowed with precious commodities. While Indonesia has nickel, it might not fully profit from it. If its supply chain is majority-dominated by FDI, from mining to processing to exporting, then Indonesia will not receive any substantial economic benefits apart from land leases and value-add taxes (VAT). For example, the Democratic Republic of Congo possesses massive reserves of Cobalt, a precious transition metal for lithium-ion batteries, but 80% of its supply chain has been controlled by Chinese enterprises.[7] These companies are also vertically integrated. Many of them—such as China Molybdenum Co., Ltd. (CMOC) and Zhejiang Huayou Cobalt Co., Ltd.—have either on-site or off-site processing capacities that transform crude ore into ready-for-export cathodes that will be further assembled for diverse uses.[8]
But this is not Indonesia’s case. The government, under Joko Widodo, has been adamant about national sovereignty and the importance of capturing as much of the supply chain value as possible. The most prominent measure taken was an export ban on raw, unrefined natural resources. In 2020, the government moved to ban nickel, while in 2023, bauxite was added to the list.[9] [10] This is a primary step in capturing supply-chain value. Even if processing were to be done by foreign entities, it must be conducted on Indonesian soil, thereby benefiting Indonesians by creating employment, providing greater tax value, and encouraging the development of local infrastructure. These economic spillover effects would be significant. The continued success of the 2020 nickel ban was therefore a primary catalyst for the 2023 ban on bauxite, given that domestic copper production has exploded by more than 500,000 metric tons in 5 years.[11] [12]
While economic benefits are manifest, the adoption of core technologies by local companies to achieve technological self-sufficiency is the only method for a reliable revenue source. This key concept seems to have been relatively well digested by the Indonesian government with its 2020 revision on Foreign Ownership Limit (FOL) in mining companies A more flexible law was implemented, which allows for 100% foreign ownership of a domestic mining company, but with divestment requirements: majority domestic ownership must occur by the 20th year after the issuance of an IUP-OP, a license which permits mine construction after the completion of exploration activities.[13] This is a significant improvement from the previously inflexible FOL limit in 2012, which caps foreign ownership stake at 49% after 10 years.[14] Complete initial ownership is important in an industry like mining, where high Capex volumes and cyclical demand are crucial for ensuring an Internal Rate of Return (IRR) which justifies the project. At the same time, the new regulation stipulates the active role that ministers must play in ensuring mining technology transfer and the prioritization of employing local suppliers/workforce for mining operations.[15] For example, the utilization of the High-Pressure Acid Leach (HPAL) technique by Chinese firms for cobalt-mining in joint Indonesian ventures has led to the first HPAL plant to be built in Indonesia by the Harita Group, a domestic mining firm.[16] Recent developments in smelter-grade bauxite refineries by Antam and Inalum also testify the gradual success of the government’s policy-directed efforts to bolster the technological competitiveness of domestic firms.[17]
However, significant impediments prevent a more attractive ecosystem for FDI. The lack of coordination between government agencies and bureaucratic red tape is persistent. Constant tussles of power exist between local and central authorities in the 4th most populous country in the world, creating complicated regulations that are frequently applicable to only one authority.[18] Government efforts in decentralization to better manage country-level finances since the early 2000s have only worsened transparency in doing business.[19] This has resulted in a complicated environment to invest in, despite the huge potential that the island-country offers. For example, average development times from discovery to production were some of the highest in Indonesia, at 25 years.[20] Additionally, despite efforts to increase foreign investment, the ease-of-doing business index in Indonesia remains dismally low. The country ranked 73rd out of 190 countries in 2023, a position that has remained relatively stable.[21]
The most immediate consideration that the Indonesian government is dealing with is geopolitics. Increasing Chinese influence in the mining industry leaves Indonesia vulnerable to over-concentrated risk accumulation. Reducing Chinese participation also possibly qualifies Indonesia for tax breaks in its copper exports under the Inflation Reduction Act (IRA) under the Biden administration.[22] Under the Inflation Reduction Act (IRA), tax incentives will be provided for electric vehicle (EV) components produced by companies in which Chinese entities hold less than a 25% controlling interest. However, such decoupling measures might lead to a temporary decrease in performance given the high technological prowess and cost-cutting capacities of Chinese companies.[23] Short-term transitionary pain will thus be expected as Indonesia pivots away from the Asian giant to other foreign investors from Australia, U.S, Korea, and Japan.
Fig 2. Explosion in domestic Nickel supply after the export ban in 2020. Source: Statista
From an economic standpoint, these export bans have benefited Indonesia, but at the expense of other countries. An immediate reduction in raw copper supply will push up their prices, spilling over to refined products and other products downstream. However, greater FDI in Indonesia has increased domestic supply, thereby reducing operational costs by refineries and smelters. With ready access to cheap primary resources, these firms can earn higher profit margins, thereby undercutting competition and creating more value-add to the domestic supply chain.[24] However, this narrative is subject to many conditional restraints. The bauxite and copper ban in 2023 seemed to do little to reverse a decline in export value-add. This can be attributed to decreasing global demand in a high-interest rate environment, slowing demand in China—a large player in renewable energy and real-estate infrastructure—and supply bottlenecks that Indonesia was facing.
Fig 3. GDP contribution of mining and quarrying activities in Indonesia: A rather turbulent past few years since 2020. Source: LSEG Workspace
While it is sensible to price in the boom-and-bust nature of the mining industry, it is equally important to note internal imbalances in demand and supply which led to a reduction in mining sector activity. Indonesia surfed the nickel wave in 2022 and produced massive amounts of nickel ore. This was further buoyed by sky-high prices due to speculatory activities and a rebound in global demand following the end of the pandemic.
Downstream processing and refining facilities reacted rapidly, but perhaps too much. The number of nickel smelters skyrocketed in 2022 to 62 from 15 in 2018, with roughly 20 more planned for 2023.[25] [26] However, the exhaustion of nickel ore following intensive harvesting has resulted in record imports of nickel ore from Australia and The Philippines. This is an ironic twist to a policy meant to ensure the sustainability of Indonesian nickel supply.[27] [28] More critically, the nickel ore shortage has driven up operating costs for nickel smelters, further exacerbated by slim profit margins due to an oversupply of refined Indonesian nickel products flooding the market in previous years. Demand-side problems are also more manifest with high global interest rates and weak consumption growth in China. In essence, there was an awkward scenario of both demand-side and supply-side problems which weighed on the sector’s profitability. To counter this problem, the government has been trying to rein in production, citing company profitability and the depletion of nickel ore reserves to be the main drivers.[29] [30]
To what extent can the motto “resource nationalization” be really implemented in practice? Indonesia recognizes the dangers of resource exploitation and avoids being the next DRC or Nigeria. Concurrently, well-intentioned measures such as export bans and foreign ownership controls seem to lose effectiveness once carried out in practice. Systemic issues exist, such as poor regulatory infrastructure, incomplete technological capacities in refining and processing, and strategic missteps in ensuring stable demand and supply dynamics in the local market. It is evident that Indonesia seeks to leap over the “Middle-Income Trap” which has characterized so many emerging economies with rich natural resources. Its efforts bleed with such intention. However, their success requires more than logically sound policies, but useful ones as well. More importantly, the key lies in streamlining processes, improving the business environment, and maintaining a fine balance between FDI attraction and local enterprise development in core technologies. These will be the building blocks for successful commodity-driven economic growth.
References
[1] United Nations Framework Convention on Climate Change. (n.d.). The Paris Agreement.
[2] Business Indonesia. (2023, May 26). Indonesia’s downstreaming policy gives its mining sector significant room for growth.
[3] Peh, G. (2024, October 24). Indonesia’s nickel companies: The need for renewable energy amid increasing production. Institute for Energy Economics and Financial Analysis.
[4] East Asia Forum. (2023, December 7). Indonesia doubles down on nickel export bans and downstreaming.
[5] Ibid.
[6] Statista. (n.d.). Monthly price of nickel at LME.
[7] Institute for Strategic Studies. (2024, October 18). China in the Democratic Republic of the Congo: A new dynamic in critical minerals.
[8] China Molybdenum Co., Ltd. (2021, April 11). CMOC’s contribution to the cobalt supply chain and new energy industry.
[9] Setkab. (2023, February 20). Gov’t committed to stop raw material exports.
[10] ASEAN Briefing. (2023, February 15). Indonesia to ban bauxite export from June 2023: An explainer.
[11] Huang, E. (2023, June 25). Indonesia stands by bauxite ore ban, but can it replicate nickel success? South China Morning Post.
[12] Reuters. (2024, May 29). LME brand approval cements Indonesian nickel ascendancy.
[13] Sriro, A. (2022, May 24). Foreign mining divestment requirements.
[14] Reuters. (2012, March 7). Indonesia’s mining ministry proposes export tax on coal and base metals.
[15] Government of Indonesia. (2020). Law No. 3 of 2020 on Amendments to Law No. 4 of 2009 on Mineral and Coal Mining. Jakarta: Ministry of Law and Human Rights.
[16] Harita Nickel. (2023, February 3). Harita Nickel expands its HPAL plant phase III with investment value of IDR 16 trillion.
[17] Mining.com. (2024, September 24). Indonesia launches $941 million smelter-grade alumina refinery.
[18] Indonesia Investments. (2014, May 13). Weak governance in Indonesian mining sector: Overlapping mining areas.
[19] Kadjatmiko, W. (2014). Decentralization and mining in Indonesia: Regional autonomy and its discontents. In C. E. Manning & P. van Diermen (Eds.), Indonesia in Transition: Social Aspects of Reformasi and Crisis (pp. 157-174).
[20] S&P Global Market Intelligence. (2024, June). Development times for US mines in perspective.
[21] KADIN Indonesia. (n.d.). Profil ekonomi Indonesia.
[22] Pfeifer, S. (2023, June 20). Indonesia’s bauxite export ban risks foreign projects. Financial Times.
[23] Bloomberg News. (2022, December 15). Chinese companies are flocking to Indonesia for its nickel.
[24] East Asia Forum. (2023, December 7). Indonesia doubles down on nickel export bans and downstreaming.
[25] MineralPrices.com. (2023, June 12). Nickel surplus seen widening in 2023 as Indonesian output soars.
[26] Indonesia Miner. (2023, February 3). Government ensures 17 smelters to be built in 2023.
[27] Reuters. (2024, December 19). Indonesia weighs deep cuts to nickel mining to boost prices, Bloomberg reports.
[28] Ibid
[29] IBAI. (2024, December 19). Indonesia to restrict nickel production to stabilize global prices.
[30] Indonesia Business Post. (2023, February 3). Indonesia's nickel reserves may end in 4 to 5 years.
