An investment cycle is kicking off in the Indonesian nickel space. S&P Global Ratings anticipates nickel miners and processors will raise significant capital over the next two to three years to leverage on surging demand for materials used in electric vehicles. They will be joined by an array of battery firms and carmakers that are investing heavily in the country.

Given the steep costs of the investments, companies will likely have to turn to external financing. Nickel refining is capital intensive. Equity and debt markets should be important to funding, depending on the entities' place within the value chain.

Indonesia's Push Into Domestic Refining: Carrots And Sticks

Indonesia's miners have compelling reasons to develop onshore refining capacity. The government has banned the export of nickel ore since 2020. Nickel miners have to find a refiner onshore to buy its nickel ore. It makes sense to own some of this refining capacity, to avoid ceding too much pricing power to a handful of external refiners.

Chart 1

Meanwhile, rising demand for high-grade nickel for use in EVs is converging with new processing technology. Entities are now able to refine Indonesia's often low-grade ore into the battery-grade nickel used in EV batteries.

Companies have already announced about US$30 billion in investment in nickel refining and EV battery making in the country (see table 2). This encompasses Indonesian nickel mining companies such as PT Vale Indonesia Tbk. (PTVI; BB/Stable/--), Aneka Tambang Tbk. PT (Antam; B+/Positive/--), Nickel Industries Ltd., and Merdeka Copper Gold Tbk. PT, among others.

PTVI has already committed to investing in two downstream refining projects slated to come online by 2026. We project the firm to be in a net debt position in 2024 because of this. It is currently net cash.

Antam has not made any announcements about its own fixed-investments. However, it will also likely go down this path. While the entity is government backed (it is 65% state owned), the sheer size of its likely investment may prompt it to access debt markets.

More investments in Indonesian refining and the EV value chain could follow as the government continues discussions with EV automakers such BYD Co. and Tesla Inc.

Why vertical integration makes sense

Miners are pushing into refining, and so are the producers of EV batteries and electric cars. Refining is the sweet spot. It's where entities get to control the output and pricing of an increasingly in-demand commodity.

EV battery makers and automakers are turning to backward integration to secure supply of raw materials. This is aimed at improving cost control. There is little new supply of nickel. Most high-quality and easy-to-reach deposits have already been exploited.

The scramble for nickel (among other essential battery materials) in the EV sector has pushed nickel prices above US$20,000 per ton, levels not seen since 2012 (see chart 2).

Chart 2

An Industry On The Cusp Of Transformation

Indonesia's nickel refining story so far has been largely about making nickel pig iron to sell to Chinese producers of stainless steel. Nickel pig iron is a form of ferronickel. Helpfully, new processing technologies are emerging that can convert the country's vast reserves of low-grade ore into the high-grade nickel the EV sector needs.

More new nickel projects in Indonesia are making mixed hydroxide precipitate or mixed sulfate precipitate using high-pressure acid leaching (HPAL). Through acid leaching, firms can extract nickel and cobalt from lower-grade limonite ore, and then process the material into battery-grade nickel. Both metals are key to making EV batteries.

Indonesia has a lot of limonite ore, which has nickel content of less than 1.5%. The country's ferronickel-focused refining sector has had little use for this ore. But its applicability in the EV sector suddenly makes these reserves relevant. Moreover, Tsingshan announced that it could make nickel matte from laterite ore in March 2021.

Chart 3

What Is Changing?

There is an important development brewing, from a credit perspective. In 2021, Huayue Nickel Cobalt PT and Halmahera Persada Lygend PT built HPAL plants in Indonesia on time and on budget, sparking the launch of other HPAL projects over the past 15 months.

Project execution is a key credit risk when evaluating a greenfield project. This could encompass construction delays, cost overruns and delays in production ramp-up that may lengthen the lead time between capital outlay and earnings.

The HPAL method of processing nickel is not new, but it has only been recently adopted in Indonesia. This is because past projects that employed this technology faced steep cost overruns and frequent technical glitches. Some of these projects just shut down.

Due to the long lead time, the project owners face an increased sensitivity to nickel price volatility during construction phase. The construction time for HPAL and RKEF facilities can take between two and three years. The process of ramping up production may take a further six months to one year.

Nevertheless, growing worldwide production of electric vehicles is creating new demand for the type of high-grade nickel these facilities produce.

Investment into nickel processing will likely accelerate as new production technology takes hold. Once a technology is proven to be viable, firms will rapidly apply it. For example, other entities quickly adopted the RKEF technology after it was successfully deployed by Tsingshan Holding Group Co. Ltd. close to a decade ago. Most of Indonesia's primary nickel production now uses this process.

Fundraising will rise in lockstep with increased investment.  Firms will likely need external financing. Indonesia's nickel mining and refining sector are expanding quickly, and this should be capital intensive.

Established downstream players such as EV battery makers and battery-components producers have been among the first to raise funding for such ventures (see table 1). Meanwhile, automakers are pledging a larger portion of their capex to invest in EVs, utilizing internal financing.

We believe the Indonesian miners will access debt markets, given the projects in their pipelines. Such entities may tap into capital redirected from brown sectors such as coal, toward other commodities that have an energy-transition theme.

This may or may not include Indonesian nickel. Investors have yet to determine if the environmental benefits of the wider electrification of mobility are worth the costs of refining nickel in the country. Nickel refining in Indonesia is carbon intensive, and the HPAL process produces chemically treated byproducts.

As their investment accelerates, Indonesian miners may utilize the dollar bond market. The dollar bond market provides diverse funding at long tenors, and are a natural hedge for entities dollar-based cash flows. However, Indonesian miners have been well funded by domestic banks and the domestic bond market.

We expect the merits of such investments and an expected appetite for capital raising could drive transactions when the market opportunity returns. Capital markets have been tenuous of late, particularly for high-yield issuers, as a result of continuing rate hikes, slower global growth, and rising geopolitical tensions.

Table 1

Joint ventures, the way to go

With miners looking to move down the value chain and EV battery manufacturers looking to secure supply, parties are converging on nickel refining. This creates ideal conditions for joint ventures (JVs).

JVs let entities share significant capital costs, as well as the sharing of greenfield development risk. An example would be Antam's planned partnership with Indonesia Battery Corp., LG Energy Solution, and CATL to invest in nickel refining projects. We generally view such arrangements to be positive for credit. This assumes the risk sharing is effective, and the counterparty risk is manageable.

JVs give miners more visibility over the offtake of their nickel ore. They also get exposure to technological expertise. This is in keeping with the government's goal to immerse the country more deeply into EV supply chains.

Some of the projects that have successfully applied the HPAL technologies are also JVs. For example, Huayue Nickel Cobalt PT is a JV involving Tsingshan, Zhejiang Huayou Cobalt Co. Ltd., and CMOC Group Ltd.

Halmahera Persada Lygend PT involves Ningbo Lygend Mining Co. Ltd., and Indonesia's Harita Group PT.

Increasing vertical integration also allows nickel miners to participate in the profits of the downstream sector, which typically posts higher absolute profits per unit of nickel output.

Battery makers and EV manufacturers for their part secure supply of battery-grade nickel, which gives them more control over their battery costs, the biggest cost component of an EV.

Chart 4

What really matters is bargaining power.  JVs also help parties manage a contest for bargaining power. The ventures merge the needs of nickel-ore suppliers and parties that refine nickel or require nickel for their downstream operations.

Offtake agreement may be a fraught arrangement for miners outside of JVs, particularly if they are selling almost all their output to a single, private buyer.

An imbalance of bargaining power between counterparties may move offtake prices substantially away from market benchmarks. Moreover, a lack of transparency about the private counterparty's finances and creditworthiness may present counterparty risk.

Miners And JVs: Minority Reports

When Indonesian miners venture downstream they typically do so as part of a JV, we have observed. They then need to decide whether to take a minority position in the venture, or a controlling one.

For example, miners such as Antam and PTVI have taken minority stakes in downstream nickel ventures. In such arrangements, the miner's capital outlay is lower, and the miner does not consolidate onto its balance sheet any project financing debt of the venture. These debts are generally kept off-balance sheet, at least from an accounting perspective.

There are limitations. Taking minority stakes reduces the miner's claims on the JV's cash flows, capping upside to the miner. Dividend payments to the partners are subordinate to the servicing of any project finance debt. Due to their minority status, Antam and PTVI may have less say in determining the JV's offtake counterparty.

Chart 5

Entities such as Merdeka Copper & Gold and Nickel Industries have acquired majority stakes in downstream JVs. As such, they have a stronger claim on cash generated at the operating level. These JVs are with Tsingshan Group Holding and are typically subject to shareholder agreements within the JV.

The stakeholders of these entities also get better visibility on the financial statements. The holding companies would have to report operating statistics and provide regular updates on the asset. The debt undertaken by the JV would usually be fully consolidated.

Nickel supply could remain tight if firms get exclusive claims on any incremental nickel supply.  The rise of refining JVs does have its downsides. The pricing of the base metal could remain volatile on metal exchanges should increasing amounts of the metal transact bilaterally. Increasing vertical integration would mean any incremental supply of nickel would be exclusively offered as offtake to a counterparty.

Miners not in such partnerships would find it harder to sell their output. They would be at a disadvantage. Price volatility in key pricing benchmarks would make life difficult for market participants, buyers, and sellers.

We saw such volatility on the London Metal Exchange in March 2022, when the stainless-steel producer Tsingshan had amassed a large short position on nickel.

Why Indonesia?

According to S&P Global Market Intelligence, Indonesia will contribute at least half of the world's incremental primary nickel production.

Chart 6

Moreover, the government's focus on developing the downstream leg of its metals and mining industry in 2023 has driven increasingly large flows of investment into the country's metal refining sectors over the past few years. This is bearing fruit for commodities beyond nickel.

For example, Freeport Indonesia PT's copper smelter and Amman Mineral Indonesia PT's copper smelter are slated to be operational in the next two to three years. Copper is also a key component of electric vehicle manufacturing, given its use in batteries, wiring, and charging.

Government policies will remain key to shaping Indonesia's downstream nickel sector.  This is apparent in the government's efforts to entice EV manufacturers to set up factories in Indonesia, so that entities up the value chain would follow suit.

This playbook is not new. It attracted a wave of investment into nickel smelting after 2014. The country first banned the export of unprocessed nickel ore in 2014, forcing miners and stainless-steel producers to invest in onshore processing capacity. Concurrently, the government also offered tax-holidays on refiners' profits.

Indonesia's primary nickel production has more than doubled since.

Chart 7

Indonesia has bolstered its external account by exporting higher value-added nickel products, as opposed to unprocessed ore. We expect this trend to continue as the next wave of EV-related nickel products starts production, which has the potential to increase export values multiple times.

In November 2021, President Joko Widodo said Indonesia could generate about US$35 billion of added value annually by refining more nickel domestically instead of exporting.

Chart 8

To ensure the continued development of the nickel downstream sector, the government is contemplating an export duty for intermediate nickel products such as ferronickel and nickel pig iron.

The introduction of such an export levy, while detrimental to ferronickel and nickel pig iron exports, demonstrates the government's desire to develop the downstream nickel industry.

In our view, this adds more incentive for increased vertical integration within the industry. Players want to demonstrate they are adding value, and to protect themselves against regulatory actions.

The government has to strike a delicate balance between developing the downstream nickel industry and taxing existing domestic players, in our view.

Frequent regulatory changes that hit miners' and processors' cash flows may inhibit investor confidence and, consequently, the ability of these entities' to fund. That said, in pushing for greater production of EV batteries and battery components, Indonesia is seizing an opportunity. The country wants to be much more than a supplier of vast amounts of ore.

This is setting off many chained events. Miners are investing in refining. This is pushing them into JVs, which is giving the country greater access to processing technologies, making more of the Indonesian ore suitable for EV battery making. Companies will expand, create jobs, raise debt, and increase leverage. Along the way, Indonesia may become a significant EV player.

Appendix

Table 2

Writer: Jasper Moiseiwitsch

Digital designer: Evy Cheung

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