Special from Indonesia News

Investment and restructuring pay off for Indonesian nickel mine Soroako, Sulawesi — home to P.T. International Nickel Indonesia (In co), the largest foreign mining investment in Indonesia — is finally living up to its promise.

Initiated in the mid-1960s by Canadian nickel giant Inco Ltd. (TSE), during an era of buoyant worldwide metal markets, the Soroako mine saw it fortunes take a drastic tumble from the moment it opened its doors in 1978 as result of falling commodity prices. Last year, after nine consecutive years of financial losses, P.T. Inco turned a profit for the first time and this year appears firmly launched on a course of solid recovery.

The tale of Inco’s Indonesian nickel mine during its years of adversity — along with its rise to economic health — provides an illuminating case study of a foreign investor determined to outlast cyclical business setbacks through a rigorous program to improve efficiency and cut operating costs. Although Inco’s turnaround hinges largely on the recent surge in worldwide nickel prices — a factor outside its control — the company can also take credit for sweeping internal changes that turned the Soroako operation into the lowest-cost producer of its type in the world today.

Located amidst mountainous jungles in a remote corner of Indonesia’s Sulawesi island, and straddling a rich deposit of laterite nickel ore, P.T. Inco was constructed more than 10 years in the face of enormous technical challenges to become the fourth largest nickel mining operation in the world.

Because laterite nickel is found in surface deposits, in contrast to the hardrock nickel sulphide ore mined by Inco in Canada, Soroako’s open pit mining and downstream smelting operations require sharply different technologies and cost structures from those applied successfully at the company’s existing Sudbury and Thompson mines.

Demonstrating a flexible approach to technical problems from the earliest planning stages, Inco’s engineers recognized the high fuel component required in the laterite smelting process, and responded to the jarring 1973 rise in world oil prices by scrapping oil-fired generators — already partially constructed — in favor of hydroelectric power. The change was costly, but gave Inco 165 megawatts of reliable and inexpensive power.

More expensive, and challenging, was the task of creating a total industrial complex, with the infrastructure necessary to support it, at the site of what was then little more than a tiny traditional village in forbidding jungle terrain. More than 50 miles inland from the ocean shipping corridors by which its nickel could be sold, with no connecting roads, Soroako had to be built from scratch.

It wasn’t just a matter of the mine and the nickel ore smelter. Pipelines, roads, airports, schools, hospitals, municipal services and housing for nearly 4,000 initial employees were also Inco’s responsibility and had to be in place before a single pound or ore could be shipped.

It took 10 years and an enormous capital investment — more than $1 billion — to complete. In 1978, when Soroako’s gleaming new facilities were at last ready for start-up, Inco had succeeded in carving from the Sulawesi jungle one of the most modern and amenity-filled small communities in Southeast Asia. What Inco had not expected was that the 1978 start-up was also just in time for the longest and most severe stagnation in worldwide metals markets in recent history.

The “contract of work” signed between Inco and the government in 1968 — among Indonesia’s first major foreign investment commitments following the modernization of its foreign investment laws in 1967 — provided attractive terms both to the government and the company in key areas such as taxation, royalty payments, depreciation and import of capital goods.

What the contract could not do, however, was to solve the company’s immediate, and seemingly insoluble dilemma: The worldwide slump in commodity markets had driven the price of nickel below Inco’s cost of production, and the high interest rates of the late 1970s and early 1980s added a heavy burden to the company’s growing portfolio of debt.

It was a long and depressing cycle. For nine consecutive years, P.T. Inco Indonesia was able to operate the mine and smelter, maintain the town of Soroako and tend to the welfare of its 4,000 employees only with the aid of massive infusions of cash from the parent company in Canada. By the end of 1986, P.T. Inco had mounted cumulative losses exceeding $400 million.

“It was a rough ride,” says Beni Wahju, P.T. Inco’s vice president of operations. “Everyone knows the mining business goes in cycles, but a lot of other investors might have thrown in the towel under circumstances such as ours.”

In fact, faced with similar circumstances, a number of marginal nickel producers in other parts of the world did close down operations completely during this difficult period.

Inco took a different route. It couldn’t raise the selling price of nickel, but it could take steps to improve its own operations. In a sweeping effort to pare costs and improve efficiency, Inco embarked on a 4-pronged program aimed at becoming the lowest cost producer of laterite nickel in the world:

— Technical innovation: By reducing the mix of energy and sulphur in its smelter operations, the company achieved a significant reduction in fuel consumption, its largest single operating expense.

— Manpower and training: By steadily upgrading its Indonesian work force, Inco succeeded in reducing its expatriate advisors from nearly 200 to fewer than 30. At the same time, improved operating efficiencies allowed the over- all work force to be pared from 4,000 to 2,500.

— Costs and accounting: Tightened inventory management, more efficient vehicle usage procedures and a wide range of other procedural improvements brought measurable reductions in operating overhead.

— Productivity: Rigorous training programs and intensified job-site discipline led to significant gains in productivity.

In the five years from 1982 to 1987, Inco achieved an impressive 42% reduction in operating costs, succeeding in its goal of becoming the world’s most cost-efficient producer of nickel “matte”, the grey powder, 75% nickel, that serves as Inco’s final product. Industry analysts believe P.T. Inco’s closest rival, Societe des Nickel, a larger producer in New Caledonia, operates with costs as much as 30% higher.

By 1987, however, a new development, even more auspicious was beginning to affect the fortunes of P.T. Inco in Soroako. The price of nickel suddenly began to climb. In a 6-month burst starting in the third quarter of 1987, world nickel prices shot upward by more than 400%, from below $2 a pound where they had been languishing for most of the 1980s to a peak of nearly $10 a pound earlier this year.

Attributed to three concurring factors — strikes and shutdowns at several leading producers, reduced flow from East European nickel producers and increased demand for stainless steel, nickel’s leading by-product — the pricing peak of early 1988 was not expected to last. Prices in 1988 are now cl oser to $6.50 a pound and analysts are predicting a further decline to around $3 a pound during 1989.

“We’ve been waiting a long time for this cycle, ” says Hitler Singawinata, former executive vice president of P.T. Inco and now senior advisor to the president.

“At this price level, we are at last able to run a profitable operation without, at the same time, encouraging nickel consumers to seek substitutes.”

Hence “profitability” has now formally entered the P.T. Inco vocabulary. In 1987, Inco Indonesia officially went into the black for the first time, registering a profit — albeit modest — of about $500,000.

This year, Inco officials say, the results will be considerably more dramatic. With the first quarter net profits exceeding $13 million and second quarter results almost the same, the company is predicting net earnings exceeding $40 million during 1988.

Inco’s rapid change in fortunes has brought with it an equally decisive response in company operating strategy. During the second quarter, Inco announced a 2-year, $60 million expansion program to increase production from its present capacity of 80 million lb to 105 million lb annually.

At the same time, Inco announced it will sell a 20% equity share, valued at $100 million, to Sumitomo Metal Mining Co. of Japan. Sumitomo — a major purchaser of Inco’s nickel matte output — is part of a consortium of five Japanese metal producers that formerly held a combined 2% equity interest in the Indonesian firm. By raising its ownership stake, Sumitomo has agreed not only to provide an infusion of cash, but also to purchase 20% of P.T. Inco’s output under long-term contractual agreements.

Inco’s Singawinata says the company now commands a strategically important 30% share of the Japanese nickel market and the Sumitomo agreement will likely further consolidate and expand this key position. As Inco’s entire output is sold to buyers in Japan, the expansion, he says, is certain to increase Inco’s grip on this important market.

The infusion of new capital, along with the sharp improvement in Inco’s operating prospects, may also see a change in attitude on the part of Indonesian investment officials. As part of its Contract of Work agreement, Inco has offered a 2% equity interest every year to the Indonesian government to a maximum of 20%. So far, this option has not been exercised.

While no investment has yet been made, government mining officials say they are impressed with Inco’s sound operations in Indonesia. Drawing particular commendation are Inco’s record of employment and manpower training and its programs of environmental management, which include more than $10 million invested in scrubbers and precipitators and full systems for water treatment.

“We regard Inco as a responsible employer and a strong contributor to Indonesia’s mining sector,” says Soetaryo Sigit, director-general of mines. “They have made a major contribution in training a new generation of Indonesian mining engineers.”

For their part, Inco officials say Indonesia’s regulatory environment, especially the reliability provided to mining investors under the contract-of-work system, gives Indonesia an attractive climate for business.

“The rules-of-the-game for mining investors are pretty fair here in Indonesia,” says Inco’s Wahju. “Even more important for planning purposes, the contract-of-work system ensures that the rules aren’t constantly changing.”

Inco officials, like miners everywhere, are well aware that price cycles in the metal and commodity markets are subject to constant shifts and swings. They recognize Inco’s present good fortune as merely a turn of the same wheel that held back the Soroako mine during the previous cycle. They know also that the present turn will not last forever.

If this is so, the P.T. Inco of today is better equipped to face future price swings than it has ever been before.

Even the most conservative forecasters are calling for a minimum of two years of firm prices in international nickel markets. That would go a long way to establishing P.T. Inco on a sound, debt-free financial footing. This, combined with its striking success in reducing costs and its growing presence in the important Japanese nickel market, should give Inco Indonesia all the momentum it needs to press forward during the several decades still remaining before the proven nickel reserves deep in those Sulawesi hills are exhausted.