Indonesian coal miners are digging in for a long siege. Besides weak global demand and volatile coal prices, the sector is dealing with domestic regulatory changes. The first mining license conversion under the new mining law, announced on Nov. 2, 2020, will offer some guidance to an evolving royalty, tax, and profit-sharing regime. Meanwhile, uncertainty remains over production quotas that were imposed due to COVID-19-related fallout.

A weak macroeconomic outlook is likely to keep demand muted and consequently the recovery of coal prices tepid over the next one to two years. S&P Global Ratings believes these challenges could weigh on Indonesian miners' cash flows and credit quality over the next one to two years, at least.

Meanwhile, capital is becoming increasingly scarce for the coal sector. We believe environment, social, and governance (ESG) factors will play a significant role in future investment decisions, as funding risk rises for the sector.

In this piece, we address investors' questions about the outlook for coal prices, production quotas, and royalties under the new mining law. We also look at long-term financing and related issues.

Frequently Asked Questions

Last week saw the first license conversion under Indonesia's new mining law. How will this issue affect business conditions?

License conversion is a key business risk.   We think the new regime threatens the operations and earnings of Indonesian miners mainly due to the complexity, likely frequent changes, and the lack of clarity on implementation.

The 2020 Mining Law, passed in June, has centralized license issuance under the Ministry of Energy and Mineral Resources and removed some regulatory hurdles for holders of Coal Contract of Work (CCOW) licenses. CCOW holders must convert their expiring licenses to Izin Usaha Pertambangan (IUP; granted to those operating in commercial mining business area) or Izin Usaha Pertambangan Khusus (IUPK; a special mining permit granted to those operating in a state reserve area) to retain their mining rights and apply for a 10-year extension.

On Nov. 2, the government issued a IUPK license to PT Arutmin Indonesia (Arutmin), the operating subsidiary of PT Bumi Resources Tbk., with expiry on Nov. 1, 2030. This marked the first conversion under the new law, and could set the standard for other Indonesian miners whose CCOW licenses are about to expire.

Arutmin's mining concession area has been reduced to 34,207 hectares from 57,107 hectares, but this does not impact on its 20-year production plan, given that the land returned to the government is largely post-mining. The company's royalty charges and tax schemes remain the same, with an addition of 10% profit sharing scheme to the government (6% to regional government and 4% to central government). We note that, there could be further changes to the company's royalties and tax scheme given the government is still considering adjustment to regulations related to the license, indicating such consultations may take time and be complex.

Despite the complications faced by Arutmin, we do not expect the new mining laws to be an immediate regulatory risk for Geo Energy Resources Ltd. (GERL) and PT Bayan Resources Tbk. GERL recently extended its IUP licenses for PT Sungai Danau Jaya and PT Tanah Bumbu Resources mining concessions with expiries in 2027 and 2028, respectively, from 2022. Bayan's Bara Tabang mine currently holds an IUP permit, with the earliest expiry falling in 2025 while the nearest expiry for Bayan's CCOW-bearing mines is in March, 2037. This provides some predictability of production quotas for the sector over the medium term, while allowing time for regulatory changes to be gradually implemented, in our view.

Other concessions expiring over the next five to six years include Bumi's PT Kaltim Prima Coal (KPC) in 2021 as well as those operated by unrated peers; licenses held by PT Adaro Indonesia Tbk. and PT Multi Harapan Utama will expire in 2022, PT Indika Energy Tbk.'s Kideco Jaya Agung expires in 2023, and PT Berau Coal Energy Tbk. in 2025, for example.

Any adverse regulatory developments would have the potential to further elevate refinancing risks within the sector, particularly given US$6.2 billion of maturing debt over the next three years (see chart 5 and table 3).

Will changes to royalties and the proposed profit-sharing scheme under the new mining law affect miners' profitability?

Since taxes and royalties from coal miners form an important part of Indonesia's state revenue, we believe that the overall economics of the mining law will not be significantly altered. That said, the implementation of new royalties and the proposed profit-sharing scheme under the new mining laws remains unclear.  

Miners who convert to IUP/IUPK licenses under the new mining laws could see lower income taxes and potential profit-sharing with the government, but with lower royalties if they engage in downstream activities.

Table 1

We note that the proposed changes remain subject to further consultation and are yet to be finalized. For example, the government is considering lower royalty charges, or even cancellation of such charges for new IUP/IUPK license convertors who participate in value-added downstream activities such as coal gasification projects. In addition, the application and implementation of the profit-sharing schemes have yet to be disclosed along with changes in royalties. Bumi anticipates more clarity by mid-December 2020. This uncertainty suggests more volatility ahead for Indonesian miners.

Should the proposed changes occur, Bumi would most likely have to comply with the most demanding royalty and profit-sharing obligations to the state, given the company's limited financial capacity to invest in capital-intensive downstream projects. Based on current S&P Global Ratings price assumptions, our sensitivity analysis shows that under the most proposed stringent government scheme, Bumi's EBITDA per ton could decline by about 10% compared with under the current CCOW scheme. Dividends received from mining subsidiaries could also decline by about 10%.

Chart 1

In our view, an increase in royalties or change to a profit-sharing scheme is unlikely to affect mines currently holding IUP licenses, such as GERL and Bayan. Under the same price assumptions, we expect GERL's EBITDA per ton to be below US$5.0 in 2021-2022 and Bayan's to be below US$9.5 per ton in 2021, before recovering to above US$10.0 per ton in 2022.

When will the Indonesian government relax its limits on coal production?

Perhaps late next year, at the earliest.   We expect the 2021 production quota to remain close to the 550 MMT that expires on Dec. 31, 2020. This reflects the government's stance in supporting domestic coal prices, in light of a global recession that will continue to undermine demand and prevent recovery for coal prices for the remainder of 2020 and potentially well into 2021.

We anticipate Indonesian coal producers will likely adhere to the restrictions, given that coal producers could be penalized for non-compliance if they don't, likely by the government not approving their Work Plan and Budget (known as RKAB; Rencana Kerja dan Anggaran Biaya) in the subsequent years.

The quotas will likely reduce coal companies' production volume by 10%-15% on average in 2020, compared with 2019. GERL is an exception, with a likely increase, given the recent approval of its RKAB production quota to 12MMT from 8MMT.

Chart 2

In our view, demand for coal will recuperate from 2021 onwards as economic activity recovers. We forecast Indonesia's GDP will expand by 6.3% in 2021 after a contraction of 1.1% in 2020. This should support a gradual easing on production restrictions toward the end of 2021.

What's the global coal outlook and how will that feed through to recovery for Indonesian miners?

We view the medium-term dynamics as remaining supportive of thermal coal despite volatility and weakness for the next year.   This incorporates our assumptions for Newcastle benchmark coal prices to average US$60 per ton for the remainder of 2020 and 2021, before rising to US$70 per ton in 2022 and 2023, amid a global recession and suppressed hydrocarbon prices (see "S&P Global Ratings Lifts Price Assumptions For Most Metals," published on Sept. 24, 2020).

Chart 3

Indonesia is set to export 75%-80% of its production through 2025, securing its recent status as the world's largest thermal coal exporter. This will ensure steady exported volume for Indonesian coal miners. Nevertheless, a sustained recovery in coal prices, and hence miners' earnings, will hinge on the pace of economic recovery among the major coal importers. In particular, the markets of China and India will be key to supporting long-term demand for thermal coal.

We do not expect Indonesian coal miners to make a full recovery until 2022, at the earliest. This takes into account export demand, production quotas, and the regulatory changes in Indonesia.

What means do Indonesian coal miners have to withstand a weak market environment?

A number of factors should support rated coal companies' ability to withstand weaker market conditions. These include flexible production-cost structures, secured sale contracts, and for some miners such as Bumi, the benefit of higher average selling prices due to its high-quality coal reserves (5,200-6,250 kcal/kg of calorific value).  

Chart 4

Bumi's high-quality coal will help anchor the company's average selling price at about US$48 per ton in 2020 and US$50-US$55 in 2021-2022, in our view. In addition, license conversion at Arutmin and KPC--the latter in 2021--will allow Bumi to renegotiate the mining costs with its contractors, potentially reducing its production cash costs by about 7%-10% from 2021 onward. We therefore expect the company's cash cost, including royalties and selling and administration expenses, to be about US$40-US$41 per ton throughout 2021-2022, compared with US$42-US$44 per ton in 2018-2019.

Similarly, GERL has been proactively negotiating with its mining contractors to reduce mining costs and has managed to lower its cash cost by more than 20% from the average of US$26.86 in the first quarter. This was also attributable to GERL's flexible cost structure with contractual terms linked to index coal prices, allowing GERL to further flex its cost base amid a weak market environment. Our revised forecasts anticipate the company's EBITDA per ton to average above US$4 over the next two years, compared with US$1.8 in 2019.

Bayan's cash cost may fall toward US$30 in 2020 (2019: US$35 per ton) supported by higher sales volumes, lower overburden volumes, mining costs, and royalties, before rising toward US$33 per ton through 2022. We project Bayan's EBITDA per ton will fall to around US$8.50 to US$9.50 in 2020 and 2021 from US$12.6 in 2019, and subsequently recover above US$10 through 2022.

How will COVID-19 and the current market environment affect Indonesian coal miners' creditworthiness?

In our view, the credit quality of rated coal producers will hinge primarily on Indonesia's production quota and the pace of recovery of the global demand and prices. The knock-on impact to ratings will depend on each miner's individual cost structure, balance sheet strength, and liquidity.  

We consider Bayan to be the most resilient among the rated Indonesian coal companies, given its strong balance sheet position relative to its peers. Notably, Bayan suspended activities at two of its mines for about seven weeks from March to May this year. Yet, the company's sizable inventory stockpile and better barging conditions have sustained its sales volume. In fact, for the first nine months of 2020, sales volumes was 10% higher at 26MMT, compared with the same period last year. Nonetheless, we remain watchful of the company's impending refinancing plan on its maturing bond in 2023, which may be protracted under a prolonged industry recovery.

Bumi's creditworthiness depends on the dividends received from Arutmin and KPC to fulfill the company's debt obligations. If benchmark coal prices fail to recover to US$70 per ton in 2022, the company may generate insufficient cash flows to repay its tranche A and tranche B debt maturing in December 2022, consequently jeopardizing Bumi's credit quality.

We believe GERL's higher production quota together with its variable cost structure puts it in a better position to weather the current challenging operating environment. In addition, GERL's bond repurchases have improved GERL's balance sheet strength. Nevertheless, we believe the company's liquidity remains vulnerable and predicated on the evolution of its ability to fulfil conditions on its put option on April 4, 2021. On March 19, 2020, we downgraded GERL to 'SD' following the company's bond repurchases, which we regarded as tantamount to a distressed exchange.

Table 2

What is your view on funding risk, given growing ESG concerns, and how will this affect Indonesian coal miners?

We recognize an increasing funding risk for the thermal coal sector, as access to capital becomes increasingly scrutinized due to environmental, social, and governance (ESG) factors. However, we believe thermal coal will have a long-term role to play as part of the ongoing global energy transition  (see "The Energy Transition And COVID-19: A Pivotal Moment For Climate Policies And Energy Companies," Oct. 8, 2020). As coal demand in the U.S., Europe, and elsewhere in the OECD are projected to decline over the next decade, excess supply will likely be absorbed by Asia, where coal will remain an economical electricity source.

In our view, continued support from Indonesian domestic banks, investors, and shareholders will also prove critical in addressing the refinancing risk for the sector's US$6.2 billion of debt in 2021-2023.

Chart 5

In light of growing investor concern and a more selective funding appetite for the sector, refinancing risk will likely be most pronounced for miners with financing concentrated to bank funding as alternative financing options become increasingly limited.

For some Indonesian coal miners who are either frequent issuers or have an established market track record, bond market access may still be a viable option, albeit at a higher cost of funding for some issuers.

In January 2020, Bayan managed to tap U.S.-dollar bond markets in raising US$400 million at a fixed rate of 6.125%, as compared with LIBOR plus 4% to 6.75%% in its previous debt. Unrated coal miner Indika recently raised, in two separate bond issuances, US$675 million five-year senior secured bonds at 8.25%, reinforcing market access for Indonesian miners. Nevertheless, Indika's higher coupon compared with the existing issuances of 5.875%-6.875% infers a price premium, highlighting the rising cost of funding for the coal sector, which we expect to likely continue.

We also expect a flight-to-quality for the coal sector. Thermal coal players with stronger fundamentals, including lower cost position and higher quality coal will increasingly be better placed to withstand upcoming refinancing risk within the sector. For example, companies that generate positive free operating cash flow, such as Adaro and Bayan, are less exposed, in our view, given the flexibility to divert cash flows to debt servicing should market conditions tighten even further.

Conversely, first time issuers or thermal coal companies without an established market track record, weak business fundamentals, or a highly leveraged balance sheet, are likely to face increased financial difficulty as capital becomes increasingly scarce in the sector.

Going forward, the ability of thermal coal players to access offshore capital will increasingly call upon companies to demonstrate their ESG credentials and conformity to global best practice, in addition to their ability to control cash costs and generate future cash flows.

Table 3

ESG considerations form part of S&P Global Ratings' underlying corporate criteria because they could affect our opinion on the creditworthiness of a corporate entity.

Related Research

• S&P Global Ratings Lifts Price Assumptions For Most Metals, Sept. 24, 2020
• The Energy Transition And COVID-19: A Pivotal Moment For Climate Policies And Energy Companies, Oct. 8, 2020)
• Geo Energy Downgraded To 'SD', Senior Unsecured Notes Lowered To 'D' Following Sizable Debt Buyback At Less Than Par, March 19, 2020.