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FEATURE-Unrest tarnishes drive to tap Indonesia's gold riches

* Social unrest, illegal mining hurt Indonesia's gold production potential

* G-Resources, latest miner to be hit by protests, halts operations

* Indonesia gold output seen to fall in 2012, but to recover to 2011 level in 2013

By Michael Taylor and Rujun Shen

JAKARTA/SINGAPORE, Oct 3 (Reuters) - When Hong Kong-listed G-Resources Ltd opened its $1 billion Indonesian gold mine in July, six months behind schedule, it had high hopes it would be hitting its annual output target of 250,000 ounces by next year.

Less than three months later the company halted operations after hundreds of protesters blocked the entrances to the Martabe mine, in the north of Sumatra island, in a dispute over the installation of a water discharge pipe.

It began laying off the 2,000-strong workforce at the mine, the company's sole asset, this week.

"There is misinformation being spread, relating to poisoning of waters and other issues relating to the river," Peter Albert, chief executive at G-Resources told Reuters.

With the world's fifth-largest gold reserves, estimated at 3,000 tonnes, Indonesia is eager to ramp up exploration and production as it pursues its ambitious target of becoming a top 10 global economy by 2025.

But illegal mining, politicking between central and regional government and a spate of demonstrations and violent attacks against junior gold miners are hampering development of the sector and could deprive it of crucial foreign investment.

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"It is the first major mining investment of this size in Indonesia for more than 10 years," said G-Resource's Albert, whose company is backed by investment firms Mount Kellett Capital and BlackRock Inc . "Inevitably this will put gold miners off. Investors are going to look at this and ask if this is the right environment, that's a fact."

FAIR SHARE

The push to open up new deposits is bringing miners into conflict with local communities, who complain of environmental damage and loss of livelihoods and say they are not sharing in the mineral wealth being extracted from the land in their areas.

"They feel that they did not get anything beneficial from it and thus they reject the plan from the company," Energy and Mineral Resources Minister Jero Wacik told reporters, according to a report on the Martabe dispute in the Jakarta Post. "Therefore, the company must improve its approach to the community."

G-Resources is not alone. At least six gold miners have had similar problems over the past 18 months.

Two people died when villagers and students in the town of Bima on Sumbawa island rioted earlier this year - forcing the government to revoke an exploration permit for a joint venture of Arc Exploration Limited , a small Australian-listed firm.

Back in north Sumatra, security guards could only stand and watch as hundreds of protesters burned buildings at a project run by Sihayo Gold , another Australian company.

"No specific demands - rather that 'we want you to leave the area'," said Sihayo Chief Executive Paul Willis, adding that illegal miners had stirred up the trouble.

"It wasn't anything out of the horror movies. It's a challenge that you just have to deal with. It's best described as: that's Indonesia."

LAND DISPUTES

With spot gold prices rising from about $300 an ounce 10 years ago to more than $1,700 an ounce today, mining the precious metal in Indonesia should still be a very attractive prospect, despite the risks involved.

Indonesia is already the world's seventh largest gold producer, with foreign-owned miner currently responsible for the majority of the country's annual output of 111 tonnes in 2011.

But land disputes are common in the world's fourth most populous country, where the mining industry now accounts for around 12 percent of GDP.

"There is a challenge faced by all mining companies in Indonesia - rising anti-mine or pro-environment sentiment," said Anton Alifandi, analyst for Southeast Asia at business risk consultancy Control Risks. "With foreign mining companies there is an extra layer in that sometimes people or stakeholders play the nationalist card."

Many Indonesians who live on or near mine sites believe they have a right to plunder the land for minerals.

Although the central government has banned small-scale gold mining, local officials and police often have interests or turn a blind eye to the practice, which provides a livelihood for thousands of otherwise impoverished families but poses a major threat to their health and the environment.

Thirty-year-old Taofic began his career as a gold miner earlier this year, on the edge of a vast Borneo rainforest.

"I came here to look for quick money," he said, sitting on a motorcycle that, like many other miners, he uses to roam a sandy, moon-like landscape about two-thirds the size of Manhattan. "But the work is much harder than rice farming at home and the income is very uncertain."

FALLING PRODUCTION

Indonesia produced 45.8 tonnes of gold in the first half of 2012, down 23 percent on the year due to output disruptions and lower ore grades at key gold mines, according to Thomson Reuters GFMS, a metals consultancy.

Gold production in 2012 is likely to fall 14 percent year-on-year, but is expected to rebound back to 2011 levels next year, GFMS added. Global gold output was 2,818 tonnes last year.

Indonesia's overall gold output figures are mostly due to larger miners such as Newcrest Mining , Newmont Mining Corp and Freeport McMoRan Copper & Gold Inc's giant Grasberg gold and copper mine in west Papua.

Freeport McMoRan, like a number of the bigger operators in Indonesia, has spent millions of dollars on development projects such as building roads and schools, but has frequently been embroiled in local disputes.

The Grasberg mine, which holds the world's biggest gold reserves, suffered a months-long strike over pay last year and the Arizona-based miner also has to cope with a separatist movement that has long pushed for a greater share of resources.

The company estimates that as many as 6,000 people, both Papuans and Indonesians from other parts of the country, are panning gold along the tailing river near its mine or living around the site.

"(It is) the residue coming out of our mill, so it's residue that we cannot extract anymore," Riza Pratama, corporate social responsibility officer told Reuters on the sidelines of a conference on illegal mining in Jakarta earlier this year.

"They sell to gold shops in Timika, so some of those gold shops are probably making money. It is very well organised."

For the smaller players, the risks posed by uncertain regulation, illegal mining and local unrest are making it harder to sustain their operations, as G-Resources problems show.

"Even though geologically it is quite an attractive place to produce, each of these risks essentially increases the cost of doing business, and the risk of sustaining the operations," said Mike Elliot, global mining & metals leader at Ernst & Young.

(Editing by Alex Richardson)

((rujun.shen@thomsonreuters.com)(+65-6870-3726)(Reuters

Messaging: rujun.shen.thomsonreuters.com@reuters.net))

Keywords: INDONESIA MINING/GOLD

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