Indonesian Regulation on Benchmark Pricing - My views

The Indonesian regulation for benchmarking of coal prices for all transactions was proposed based on the new mining law of 2010, and the implementation is likely to be effective September 2011. The key features of this regulation are that the minimum prices for coal are to be set by the Minister for Energy and Minerals. A Standard Price will be fixed monthly and adjusted back for non-FOB vessel sales. The coal Standard Price will be fixed by reference to a number of indices. IUP holders (mining leaseholders) that sell mining materials below the Standard Prices may be subjected to administrative sanctions including (i) written warnings, (ii) suspension of part or all of the activities of exploration or production operation, and/or (iii) revocation of the IUP/IUPK. All contracts (term and spot) must be submitted to the Minister and there are substantial reporting obligations in relation to price, volume, quality and point of sale, including invoice, bill of lading and certificate of quality. There are also mandatory rules for use of letters of credit, which are likely to affect existing financing structures and require parties to renegotiate their terms of payment for off-take contracts.

For those Indian power producers who have been importing coal from Indonesia, and do not own mines, or own minority stakes with no preferential pricing, there is unlikely any impact as prices of coal are linked to global indices in any case.

For those, who own stakes in mines, the Indonesian rule will force such companies to transact at market prices, which may be seen as raising the cost of delivered coal in India. This is true but is not fatal. When companies invest in Indonesia, they tend to have the intent to sell coal at cost so that Indonesian business unit remained at no or negligible profits. This in a sense cannibalizes the Indonesian coal business unit for the power plant unit in India. Taking a holistic view, however, the cash flows in an integrated Indonesian coal mining and Indian power generation unit after this regulation will continue to be similar (albeit a little lower, obviously), except that royalty and income taxes will be paid in Indonesia, and the cash flows will need to be brought on the books on Indian power project after paying taxes in Indonesia through appropriate and innovative business structuring.

Many Indian companies that have established business structures and have holding companies for coal mining assets abroad and have only an ultimate parent level connection between the Indonesian coal company and Indian power generation company will end up making losses in the Indian power company if the power generation was envisaged and bid for based on cost plus approach to coal procurements from Indonesia.