The Indonesia Factor, or… Can’t see the Forestry for the Greed
September 19, 2008
Beginning, middle, and ending. Every good story boasts at least one of each. The challenge in telling a story well is in the mixing and the matching of parts so as to leave the reader with some sense of a unified whole that both informs and entertains. This challenge is made all the greater with the realization that there are multiple options for each part. As children, we played with flip card combinations, choosing heads, bodies, and feet of diverse characters. This junior resource market is pretty much the same. With a growing list of possibilities, the story quickly becomes a permutation comedy… or nightmare, if you’re trying to distill simplicity from a complex situation. Now consider telling a story that remains open. The ending resides only in your imagination. Add the uncertainties of politics, geology, financial and commodity markets, fear, greed, and corruption (actually, these last three are quite certain)… and the number of potential outcomes rapidly becomes incalculable.
There you have it. I’ve already excused any inaccuracies to follow. One man’s fact is another man’s fiction. Even when we agree on the set of facts we face, our differing perspectives lead us to different conclusions. What follows, then, is not ‘the’ truth. It’s not even ‘my’ truth. These are only my observations, each event contributing to a continually unfolding story. This is not, as storytellers often claim, the definitive case. It’s just me, thinking out loud.
All things considered, a good place to start this story would be at the beginning. Of course, we are now beset with the need to identify this beginning. To be fair and full, we must include all of: timing; context; people; and purpose. Southern Arc Minerals Inc. was incorporated in August 2004. The Company went public in June 2005, assuming the symbol SA on the Canadian Venture Exchange. The beginning, however, takes us back to two major incidents in 1997 and 1998.
The 1997 financial crisis in Southeast Asia left Indonesia, among other nations in the region, in a state of high inflation, collapsing productivity, and fleeing foreign capital. Between 1997 and 2005, per capita income in Indonesia fell from US$4,600 to $3,700. High foreign debt, falling confidence in the economy, and increasing unrest with the Suharto regime left Indonesia in the late 90s primed for change.
In the face of this financial crisis, General Suharto, who had forcibly assumed unofficial power in 1965, and the presidency in 1967, found himself unable to beat down the rising protest against his authoritarian rule. Rife with corruption, his government had lost any semblance of legitimacy. Support from the West was also increasingly in doubt. The absence of communism was insufficient to offset a blatant absence of democracy. To make a long story short, Suharto was left with no option but to resign the presidency in May 1998.
This, then, was a period of great stress for Indonesia. A regional financial crisis in Southeast Asia, coupled with the fall of an authoritarian regime, left the country in a position of great uncertainty. Foreign investment was drying up, with no indication of improvement on the horizon. But there’s more. Now add the infamous ‘B’ word to the equation. Bre-X was a Calgary-based junior explorer operating in Busang on Borneo in 1992-97. Lab assays came back with extraordinary results for the Company, indicating progressively more and more gold in the ground. Each new assay raised estimates from the low millions of ounces to as much as 200 million ounces. Share price rocketed from 20 cents to more than $280 (pre-split). This project attracted interest from far and wide. It even touched former U.S. President George H.W. Bush and former Canadian Prime Minister Brian Mulroney, as advisors to Barrick Gold. After a long negotiation, by mid-February 1997, Freeport McMoRan, ended up slotted for a 15% interest, the Indonesian government and influential domestic interests holding 40%, and Bre-X retaining 45%. Only problem was that it was a fraud. Drill core was not being split (a generally accepted practice to allow secondary assays on the remaining half-core for verification of results). Whole core was instead crushed before getting to the lab, and was ‘salted’ with gold of a type that doesn’t come from hardrock ore. Less than six weeks after the deal was negotiated, share price had fallen to just $2.50. It remains unclear as to who the culprit was in this fraud. The effects, however, were very clear. Bre-X geologist (the key man on site), Michael de Guzman, either fell or was pushed to his death out of a helicopter after having been summoned to a meeting with Freeport McMoRan (after their tests found insignificant traces of gold on site). Not only did many retail investors lose a great deal of money (billions of dollars, in fact). The Canadian government introduced the National Instrument program – including: the NI 43-101 report, requiring strict core processing procedures; and the independent audit of resource estimates. This system was created to help restore investor confidence in a troubled junior exploration market. After this scandal broke, many people became skittish about placing hard-earned dollars into an environment subject to scams like Bre-X. Investor reluctance to support the junior exploration market was pervasive world-wide. As for Indonesia, don’t waste your breath. You couldn’t raise a dime for exploration there. Combined with the regional crisis and the domestic instability, Indonesia became an untouchable. Even today, investors shy away from the country, naming the “Indonesia Factor” as enough to justify staying away. No junior could attract the necessary financing to operate in Indonesia. Major mining companies found themselves without an exploration function altogether. Understand that majors don’t generally like to explore. That’s a role played by the juniors who take the risks, leaving the majors to scoop up projects that actually yield something worth advancing into production. The only choices left for the majors operating in Indonesia were either to become explorers, or to just forget about exploration in that country. Except for a few very small privately funded operators, exploration in Indonesia completely dried up.
Remember, though, that Indonesia is understood to be the fourth largest zone of mineralization in the world, created by a series of volcanoes that resulted in the precipitation of a great deal of gold and copper, not to mention a variety of other metals. If you look on a Google Earth map of the region, you can see its arc-like volcanic formation in a southern band. That’s a lot of metal not being explored. The late 90s, carrying over into the early years of this century, were the worst of times. Fortunately, life tends to expose itself in waves of good and bad. The trick, of course, is to know when the waves are about to change direction.
Here’s the good news. Much as for the current (2008) market crisis, difficult times in Indonesia began to set the stage for immense opportunity. Every crisis can be said to contain the seed for new opportunity… but only for those wise enough and courageous enough (or crazy enough) to seize the moment. Just as today’s market represents huge buying opportunities, with many stocks showing market capitalization close to cash in the bank (sometimes less), Indonesia presented opportunity to those willing to step up to the plate and take a swing.
Such a highly prospective area of mineralization will eventually be exploited. I take this as a given. The market will eventually make it so. The natural process of ebb and flow, and equilibration will make it so. Newton’s Third Law of Motion declares it so. From where I sit, it’s only a matter of time. Often, however, when one waits for the market to signal the right time, it’s too late. Only those willing to think outside of the box, and to step outside the circle, leaving the herd, will win big. While there’s never a guarantee, and while many of those who arrive too early will be punished for being too early (as funds dry up), this is where the real money can be made.
Back in 2003, a group led by Craig Dalziel of Vancouver tiptoed into post Bre-X Indonesia and started exploring. This Company, Sunda Mining Corporation, engaged a consulting geologist from New Zealand who had lived and worked in Indonesia then for many years. Importantly, he held many close ties to people inside the ‘system’. He understood the ‘beast’. Married to an Indonesian woman, he was well acculturated to the prevailing environment and customs, and in a comfortable position to steer local operations. His name… Hamish Campbell.
Come 2004 and John Proust enters the picture. With a reputation for thinking outside of the box, and a long record of fundraising achievements, Proust created Southern Arc Minerals Inc., taking over the Sunda Mining properties, and SA went public a year later. Hamish Campbell stayed on, and to the present day, leads the exploration effort for Southern Arc. With this move, Southern Arc led the way back into Indonesian exploration using publicly raised capital. Three years later, Southern Arc finds itself in the company of Rio Tinto, Barrick Gold, East Asia Minerals, and BHP Antam pursuing highly touted Contracts of Work (CoW) with the Indonesian governments (three levels, making it a true choreographic performance). This CoW concept is unlike what most in the West are familiar with in regard to permitting. It covers not just the rights to explore, or to drill out, or to exploit. It provides the entire working framework for the entire life of the operation, including employment, environmental reclamation, taxes, tailings, all the way to closure of the operation. It becomes an actual law, impervious to subsequent changes in legislation. For all the delaying difficulties offered by the Indonesian experience, no CoW has been abrogated in the more-than-forty years since the first iteration of CoWs was introduced. Disputes are specifically indicated to be settled, if necessary, by the International Court, rather than remaining subject to the whim of the regime-of-the-day. This was true even of the dictatorship years, setting Indonesia apart from other developing nations where no such protection exists.
Since the departure of Suharto, Indonesia has made great strides into functional democracy. In 2001, it was decided by parliament that the next president would be directly elected by the population. This first occurred in September 2004 with the election of Susilo Bambang Yudhoyono.
Significantly, Yudhoyono, or SBY as he is known domestically, served first in government as Minister of Mines and Energy. Actively involved in proposing and developing government reforms after Suharto, SBY came to be known as “The Thinking General”. With successful reforms, his popularity with the Indonesian people rose. Much traveled early in his military career, he received training abroad, including stints at Fort Benning, Fort Leavenworth, and a Master’s in Management in 1991 from Webster University. SBY was responsible in the mid 1970s for training troops in the English language. With a PhD in Agricultural Economics, and a co-authored book called The Challenges of Development, SBY was experimenting with democracy as far back as 1988.
Well into his first term as President, and with sustained popularity, SBY is expected by many to win a second term in next July’s presidential election. This expectation is placed in some doubt by the recent, and very unpopular, 30% rise in fuel prices. In the face of the rising world price of fuel, Indonesia’s domestic subsidization program will be increasingly difficult to maintain. Moreover, with a 50% rate of unemployment, victory at the polls is never assured. The current president is credited with containing risk of terror, and with continued efforts in reducing corruption (an ongoing, yet incomplete, process). This said, he’ll need to show significant gains (or at the very least, strong promise of significant gains) in economic quality of life for the general population.
SBY’s greatest political threat is posed by his predecessor, Megawati Sukarnoputri, president from 2001-2004, and daughter of the country’s founding president, Sukarno (1945-1967). During her term as president, Megawati is characterized to have achieved little in advancing reforms, opting to serve as a figurehead of stability, perhaps in a measure of nostalgia for her father’s long period of leadership. For foreign investment, a return to power for Megawati would not likely bode nearly as well as the continued leadership of SBY.
This is just me wondering out loud, but I wonder if Southern Arc’s continued challenges in completing the Contract of Work (CoW) process are connected in the back room to Megawati’s hopes to unseat SBY in next July’s election. SBY needs the CoWs to show evidence of moving forward, and to offer hope for employment to a largely unemployed population. Renewed foreign investment in mining represents significant potential for new employment. If the multiple CoW negotiations now underway can be stalled until next summer, Megawati stands a much better chance of being the next Indonesian president.
Apparently, the only remaining sticking point for the four CoWs now on the table comes from the Ministry of Forestry. SBY has been surprisingly successful in cutting out the influence of corruption in many areas of government dealings over such a short period of time. This program is not yet complete, however, with a few Suharto hangers-on still hanging on. It’s a new world but perhaps the Forestry folks haven’t yet gotten the message. In any event, somebody high up in that Ministry wants to retain the right to declare any of the mining properties as ‘protected’ lands, without time limitation, and without regard to whether or not there are any trees on the property in question. When you think about this for a good long millisecond, it’s unmistakably clear that such a dark cloud hovering overhead would entirely eliminate the potential flows of any new foreign investment in mining into Indonesia.
Now, let’s back up a step or two and ask why any government agency hoping to advance the interests of the people would do such a thing. Maybe they’re concerned with the environment. Maybe they’re concerned with preserving future economic opportunities in the business of forestry. Or maybe there’s something else at work. Certainly, they cannot be contemplating an opportunity down the road for extorting mining companies for the privilege of continued operations. This couldn’t happen because, if this sticking point does not become unstuck soon, there will be no new mining projects available to extort.
So, what’s going on? My guess, and that’s all it is, has somebody in the Ministry looking for something to happen NOW to make this obstacle ‘go away’. As to what that trigger might be, I’m not in a position to say. Suffice to say that what happens next will be an important test for the central government in Indonesia. Does SBY have the political clout to shut this obstacle down? Do Southern Arc and the other CoW applicants have the strength and connections to turn the key? As always, time will tell.
The outcome from work in the weeks ahead represents a watershed opportunity for the country of Indonesia. If successful in steering these CoWs to safe landing, the path will be clear for many more of the same. Precedent in Indonesian dealings is very important. Once the Taliwang CoW for Southern Arc is secured… and it will happen, I have no doubt (just don’t ask me when)… the Lombok CoW will amble into the barn, ringing a bell, close on its heels.
What I don’t know is the dynamic between SBY and the leadership of the Ministry of Forestry (I believe sourced from a different political party).
What I don’t know is who wields the power to say what happens next.
What I don’t know is what Southern Arc can do to help move this process along.
What I don’t know is what the Canadian government might be willing and/or able to do to help.
What I do know, on the other hand, is that this scenario pretty much captures the thrust of what people refer to as ‘the Indonesia Factor’. Until and unless this Factor is addressed head-on and and properly set aside, nothing will move. This Factor represents (historically, and to this day) the most significant impediment to attracting foreign investment into the country, and in turn, the greatest obstacle to Southern Arc’s forward movement, both in operations and in share price gains. It was believed almost a year ago that the first CoW (Taliwang) would be in hand by the end of January 2008. Then the weather intervened. Then something else, and again, and again. A casual observer can be forgiven for losing faith in the process.
At the same time, success (sooner rather than later) in securing the first CoW for Southern Arc will mark a significant step forward for the Company. Operations will be opened up. Negotiations with potential partners will begin… or perhaps conclude, as I suspect that there’s much more going on behind the curtain than we see. New CoWs will be forthcoming in rapid-fire sequence in advance of next summer’s presidential election. A new era for doing business in Indonesia will be launched, and the rewards for those arriving early on the scene will begin to flow.
As suggested at the outset, this is not a conclusive story line with any great certainty. Many more questions remain to be asked and answered. Many factors not examined here will come to bear on potential outcomes for Southern Arc in Indonesia. In the end, most of us will just have to sit and wait and see. Some won’t wait. Some have already jumped ship. Others have hung on, riding share price all the way down. Perhaps the only certainty one can assign to this story is that, when the dust finally settles, someone will have regrets. Too soon to say whether these will be the jumpers or the holders.
As always, time judges all.
Best,
Kevin Graham (holder)
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The sole intention of this report is to provide investment-related information and opinions. The writer holds a position in the featured security and may increase or decrease such position without prior notice. All content presented in this report is obtained from sources deemed reliable, but its accuracy is not guaranteed. Use of this information is at the risk of the reader, without responsibility on the part of the writer. The writer is not a licensed investment advisor, nor a geologist and does not offer personalized investment advice. Please do your own due diligence.