October 15, 2009

Mining Contribution to National Prosperity

A Personal Observation

Noke Kiroyan Managing Partner, Kiroyan Partners

Indonesian Mining Conference and Exhibition 2009 “Mining Indonesia: Unlocking Mineral Potential”

Jakarta, October 15, 2009

The mining industry brought me back to Indonesia in early September 1997 – and not a moment too soon, as things began to unfold the moment I arrived. The country was undergoing rapid transformation and I am fortunate to be on hand to witness history in the making. I was working overseas and just arrived that day twelve years ago with my boss to take up my job in Jakarta. He remarked to me that he found it strange that the rupiah that used to be stable at 2,200 to the US Dollar had dropped to 2,500. Having spent the past six years in industrialized countries I had lost the sense of what the “correct” relation between the two currencies should be, although I was aware that in those days the Rupiah had always been maintained at a stable rate to the US Dollar over lengthy periods. The rest is history.

It turned out that I came home just as what later is to be known as the “Asian Financial Crisis” was about to unleash its fury. Eventually it would engulf and bring down the political and economic edifice that President Soeharto had meticulously constructed over many decades. The president stepped down in May 1998 and slowly the political and economic situation began to unravel. What was a financial crisis in other countries became a cataclysmic event in Indonesia that brought about social change at a scale we have not seen in Indonesia for many years. The only two other events of similar magnitude in recent history were the attainment of independence and the first major regime change when President Soeharto succeeded the first president of the young nation in 1967, twenty-two years after our Declaration of Independence.

Of course we know all that with the benefit of hindsight. While we were going through the entire chain of events, after briefly wondering what it was all about, we all set out to resume what we have been doing previously. We were blissfully unaware that the Indonesian society was about to change while we were thinking of picking up just where we have left off in May 1998. The mining industry was no different from other industries, or society at large, for that matter. We resumed the struggle to gain acceptance of our view of how the 8th Generation of Contract of Work ought to look like. In proposals for a draft Mining Law we included all the improvements that we thought were needed to get the mining industry moving again after the downhill slide precipitated by the Busang Affair and all its

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ramifications. There is no doubt that in the late nineties the mining industry stood at ill repute, not only in Indonesia but practically all over the world.

Then came another change that we were totally unprepared for. The devolution of administrative powers to the regions that is popularly known as regional autonomy was ushered in by laws No. 22 and 25 of the year 1999. Again, we were aghast at this development and thought this was the biggest mistake the nation could collectively commit. True, the dark prognosis that the country was in danger of Balkanization if devolution was not instantly and rigorously implemented now seems like a bad dream, but regional autonomy is an undisputable fact. It is in everybody’s interest to make it work and strengthen the institutions to make it function even better.

We tried to coax the genie back into the bottle. Unperturbed, the irrevocable march toward greater autonomy of the regions continued relentlessly, unimpressed by all our admonitions about the dire consequences that may result from handing over authority to regions that had no capacity to nourish the mining industry. After rebuking the central government – albeit genly – for not having done enough to promote the mining industry, we suddenly discovered that central government was actually our biggest ally and tried desperately to convince everyone who would care to listen that it must have most of its powers restored.

So, a decade down the track, where are we at now in the mining industry? Actually, we are doing fine. According to noted Indonesian development economist and Fellow at the Australian National University, Budy Resosudarmo and his fellow researchers, the mining industry contributes 4% of Indonesia’s GDP. This is up by 1% after hovering at 3% or less for years on end. They expressed this view in a publication from the Henry L. Stimson Center this year titled “Exploiting Natural Resources.” Considering what the industry has gone through we are actually not doing too badly, after all. And, it is worth bearing in mind that the 4% is on the basis of an economy that has crossed the five-hundred billion US Dollar mark in 2008. Indonesia is now a member of G-20 and is gingerly settling in into its newly won status as a middle income country.

We are not very comfortable yet in this position after years of feeling somewhat inferior to other countries in the region, and being told that we have made a complete mess of the country in almost all respects. In due course Indonesia should assert itself in its new role. As The Economist put it in a recent Special Report, Indonesia is everybody’s friend that deserves a better image. Admittedly, we haven’t done much to improve our image. Looking at newspaper articles over the last ten years or so, we seem to indulge in self-flagellation rather than priming ourselves with a healthy dose of self-confidence. In short, we looked, and behaved, like losers, whereas we should be proud of the fact that we have entered the ranks of democratic countries after letting go of the shackles of authoritarian rule. Our democracy is not perfect yet, but I share none of the worries that Indonesia would ever revert to a dictatorship again.

Getting back to the mining industry, what we have witnessed over the years may to a certain extent be explained by a diagram I borrowed from Daniele Barberis in her book “Negotiating Mining Agreements” that I am going to show now. I talked about it for the first time at a Coaltrans conference in Bali four years ago, but the diagram has not lost its relevance as an analytical tool. What we perceived as vagaries of an uninformed few that

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happen to be part of the ruling elite is the result of what is called “political will” that is an outcome of ideology, public opinion, perception of the good of community and economic, social and political circumstances. Of the last mentioned component we have had more than our fair share. I will quote a passage of her book to put the diagram in context.

It is undisputable that our Constitution is the fountainhead of ideology. All discourse on natural resources – including mining – will have to refer to what the constitution meant to say or is interpreted as expressing the views of our Founding Fathers about this matter. The constitution has gone through a few amendments, but Article 33 remains unchanged. This particular article is understood as ordaining that all natural resources must be controlled by the state and utilized to the greatest benefit of the people. The legal construct that is known as the Contract of Work was devised to accommodate this view and simultaneously allowing foreign mining companies to operate mining companies, however not on their own right but on behalf of the state as its appointed contractors. The good of the

“In order to understand how host-country governments formulate mining policy it is helpful to consider the nature of policy-making in general. Policy-making at a national level is a complex process involving many factors and reflecting many influences. It requires a state within whose boundaries the process will take place and a government to formulate and implement policy. At the heart of the process lies the national political will.”

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community as the ultimate goal of the national policy-making process was to be achieved by the economic contribution of the mines working for the Indonesian state as contractors..

As we know now, the upheaval in 1998 and the resulting social change caused public opinion and the concept of the good of community to undergo a thorough revision. With the onset of regional autonomy the kabupatens and to some extent provinces as well, developed their own newly-found aspirations regarding the riches in their regions. And theirs is a powerful voice that cannot be ignored. Nobody can prohibit the regional governments from thinking that their best interest is best served by having direct stakes in mining companies. But viewed from the other side – from our side in the mining industry – certainty about divestiture and other issues dear to our hearts like forestry and unambiguous licensing procedures still needs to be addressed.

Law No. 4/2009 on Minerals and Coal Mining was issued earlier this year. While to some extent providing the much yearned for legal certainty, this is still a work in progress, as several important matters like divestment requirements are yet to be formulated in implementing regulations. Ultimately, everything boils down to dollars and cents. If, after taking into account all the risks associated with mining in this country are quantified and measures have been taken to control them, and a mining company still sees the opportunity of doing reasonable business, it will carry on. Quite a few have done so. I am glad to say, that I have observed companies from traditional mining countries entering the market again for exploration and productive utilization of minerals.

I stated earlier on that the contribution of mining to the national economy – and thus national prosperity – has risen to 4%. While the direct economic benefits are an outcome of the business purpose of conducting mining operations, there is another aspect that may contribute to prosperity and is one that mining companies in general have the competence and expertise to do well. I am talking about Corporate Social Responsibility, commonly abbreviated to CSR and one of its most common manifestations in the mining industry:. Community Development..

The mining industry has taken CSR seriously long before others even started thinking about it. As far back as September 1997, the Center for Rural and Regional Studies of the Gadjah Mada University in Yogyakarta under its visionary Head, the late Prof. Loekman Soetrisno, conducted a two-day workshop on “Finding Solution Models for the Relations between the Mining Industry and Surrounding Communities.” The workshop was attended by representatives of all major mining companies in Indonesia at the time. The first recommendation that was mentioned in the workshop proceedings addressed the issue of Corporate Social Responsibility and it specifically mentioned three objectives to be achieved in this respect: 1) Empowerment of the communities, 2) Regional development, and 3) Nurturing the nation’s unity.

On the part of the mining authorities, numerous speeches in 1998 and 1999 by the then Director General of Mines, Dr. Rozik Soetjipto on the new generation of Contract of Work mention the need for community and regional development to be part of mining company operations.

It is no coincidence that most of the initiatives in the mining industry during the late nineties to practice CSR were driven by subsidiaries of international mining companies. The

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international mining world in those years began to respond positively to pressures from NGOs and local communities. At the same time, theories about CSR began to coalesce around the concept of sustainable development that gives equal weight to the three components for development to be called sustainable. i.e. the economic, social and environmental aspects. The sustainable development movement has found fertile ground in the mining world that was adopting a new way of responding to societal issues after years of contentious relationships between mining companies and many of their stakeholders.

The nine largest mining companies in 1999 decided to set in motion the Global Mining Initiative that among other things was tasked with unearthing the root cause of many of the issues faced by the industry. The International Institute for Environment and Development (IIED) was commissioned to undertake an independent study for this purpose, and the whole process was called the Mining, Minerals and Sustainable Development Project (MMSD) that took two years to complete involving a tremendous amount of efforts and resources.

In the meantime the concept of CSR has evolved further and efforts are currently underway to achieve a common platform on what social responsibility constitutes, as depicted in the diagram below.

Mining companies operating in remote and economically less developed regions as is the case with most operations in Indonesia are very familiar with the topic of community development since more than a decade ago, as the workshop in Yogyakarta attests. As we can see in the diagram, it is part of the core subjects of ISO 2006 that has yet to reach its

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final stage and be launched in 2010 after several delays. As we know, ISO 26000 attempts to find a common platform for social responsibility among all organizations, business corporations, government institutions, not-for-profit entities and practically all organized human activity. The point I wish to make at this juncture is, that the mining industry played a very crucial and pioneering role in developing the concept of CSR – and rightly so.

In her book, “Corporate Social Responsibility in the Mining Industries,” Cardiff University scholar Natalia Yakovleva mentioned four industry-specific reasons for mining companies to consider CSR an important business issue:

• Public opinion of the mining industry is generally negative • Pressure groups have consistently targeted the mining sector at local and

international levels • Maintaining ‘a license to operate’ is a constant challenge • CSR is especially important for mining companies as they often operate in

remote areas, which are often economically underdeveloped and lack provision of social welfare services

She goes on to say that CSR is important to mining companies as a form of response to address concerns of its stakeholders, among others shareholders, employees, customers, local communities and the general public. Local communities are often the most important stakeholders in the context of CSR as they are significantly affected by mining operations in terms of economic and social welfare and by virtue of mining impacts on the natural environment. How true this rings for us in Indonesia.

It should be very clear by now that CSR is very much ingrained in the operations of mining companies. Conducting CSR initiatives is part of the way we do business in the mining industry because social responsibility is an integral part of running mining operations, Dissociating CSR from operations would create a disconnect between the two. Not only would there be divergent interests between the people conducting the respective functions, but it will be wasteful as well.

The much-used term in the resources industries “beyond the fence issues” is an expression of the view that mining operations ought to be secluded from social and political issues and influences. It cannot. No fence is strong or high enough to separate company operations from the communities. Integrating CSR and operations eliminates the need for an artificial fence that is unsustainable in the first place. We should be comfortable in dealing with social issues as we are with technical ones because the two are inseparable. What we used to deem as purely technical issues have an impact on the environment and communities. Competence in both areas needs to be developed if we are to run mining operations well these days, which is not too say that such competence would preclude social issues from occurring. However, they will be foreseeable and to a degree manageable, provided we actively try to find out how we are perceived and why various groupings that have an interest – a stake - in our company view us in different ways that shape their attitude toward and expectation from us.

This brings me to the final point of my presentation, namely stakeholder management. As touched upon above, knowing our stakeholders and their stakes will give us greater peace of mind as we are not caught unawares by developments that make us

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lurch from one crisis to another. Today we are facing a road block by disgruntled local business people that brings to a halt all supplies of fuel, food supplies, spare parts and all the material needed for daily operations, tomorrow the bupati demands that we put our community development funds at his disposal, and soon after that one of the ethnic groups stages demonstrations protesting unfair treatment in the company’s hiring policy and another one submits additional claims for land compensation that was reportedly resolved two years ago. The list goes on and on, and I am sure every mining executive is familiar with them.

Without knowing who our stakeholders are we would not know how they perceive the company and relate to it, so before anything else we need to identify them. Having identified our stakeholders the next issue to resolve is, what their stakes are, and by extension, what opportunities and challenges do our stakeholders present as the first step to manage their expectations. Finally, we need to engage our stakeholders which means that we have to communicate and interact with them. We will not be able to deal with these issues effectively by imagining there is a fence behind which we can retreat when there is an external threat because what we perceive as threats will always be there and we need to be able to deal with them confidently. A diagram to describe these steps in a systematic and much simplified manner is shown below.

I mentioned CSR earlier, and to deliver our CSR programs effectively and efficiently we need to know our stakeholders and construct our initiatives around the needs of the stakeholders and the company, A particular aspect of CSR that is closely associated to mining operations is community development, which is not about doling out company largesse as some people, also within the industry, believe. There is a way to combine business aspects with CSR directly to generate greater prosperity around mining companies in a systematic way.

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I will conclude by sharing with you my direct experience in attempting to directly link a mine’s economic activity with community development, a few years ago when I was directly involved in managing a major mining operation. At the time I initiated an economic impact analysis by a reputable scientific institution to ascertain the contribution of the mine to the local and regional economy from a macroeconomic standpoint. I believe that this is the only way to measure true economic impact objectively, and the resulting multiplier effect may be traced, critiqued and replicated by others using the appropriate scientific tools.

My thinking was to gear community development efforts in the direction that generates economic growth in the communities by supporting programs proposed by the various stakeholders in a meaningful way. After a few years a similar economic measurement should be conducted to ensure that the company is indeed stimulating growth, and by analyzing the components of regional growth it would be possible to quantify the impact of community development. It should be possible to isolate those specific areas of growth and align them with the regional plans for economic development, thereby achieving synergies between regional government and mining companies.

That line of thought was still at an embryonic stage then, and I would welcome a discourse with scientific institutions and the mining industry to find better ways of contributing to the local communities, enhancing their prosperity and sustainability of the operations concomitantly. By extension the national prosperity will be increased, and the contribution of the mining industry to GDP may grow beyond 4% over time.