Status Of Freeport McMoran’s Indonesia Stand-Off

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Freeport McMoRan Copper (NYSE:FCX) has been in a stand-off with the Indonesian government over a new copper export tax for quite some time now. The government had banned export of copper concentrates beginning January 12 but tweaked the criteria later to allow Freeport and Newmont Mining to continue exporting subject to the new tax. Freeport had said at that time that it still hadn’t received formal approval to resume exports which the company had voluntarily halted in December owing to a lack of clarity on the new rules.

We had said in one of our earlier pieces that we would keep the readers updated with developments on this front and their impact. The latest development is that Freeport has been certified as a registered exporter by the ministry of trade. However, before investors start celebrating, there is a note of caution. The company still needs to obtain a recommendation letter from the mining ministry to get the export permit. Also, it is not clear if Freeport will still have to pay the export tax it has been protesting against. Therefore, despite the positive signs, we think that nothing has actually changed on the ground and it is still status quo. [1]

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See our full analysis for Freeport McMoran here

What Is The Export Ban All About?

A mining law enacted in 2009 prohibited export of unprocessed minerals from Indonesia after January 12, 2014. The purpose was to increase the value of commodity exports and encourage development of the local processing industry. On the designated date, this ban came into effect but the government used its discretionary powers to provide selective relaxation for some minerals and metals. The copper content in the ore exported has to be greater than 15%. Both Freeport and Newmont export copper concentrates with a higher percentage of the metal than the designated minimum and account for nearly 97% of Indonesia’s total copper exports. [2]

The problem mining companies like Freeport faced with the original ban is that there is a shortage of smelters in Indonesia even if they were ready to process all of their ore before exporting it. In addition, Freeport said that it ships its minerals under long-term contracts to international smelters and wishes to honor these contracts. It said that it entered into these contracts in the first place because its initial agreement with the Indonesian government allowed it to export concentrates without placing any restrictions. However, Freeport already processes about 40% of its ore mined in Indonesia at a smelter in East Java which is the only copper smelter in the country. While it has plans to get the rest of its copper ore processed in two upcoming local facilities, construction will be complete only around 2017. ((Indonesia trying to skirt its own ban on mineral exports, Reuters))

Newmont Mining, another major copper producer, currently smelts less than a quarter of its ore in Indonesia it produces at the Batu Hijau mine.

Leniency Was Shown Towards Copper…

Currently, Indonesia is struggling to cut a large current account deficit. As a result of the high deficit, confidence in its currency is being undermined which has been Asia’s weakest performing this year after falling around 20% relative to the U.S. dollar. Any cut in exports will results in bigger deficits and a further weakening of the currency. A weak currency makes imports costlier which in turn fuels inflation and angers the population. So far, the authorities have been deliberately slowing growth in an attempt to cut imports and the current account deficit but a reduction in exports may cause the deficit to widen to unmanageable proportions.

The exports of nickel and bauxite in 2012 amounted to a total of $2 billion which is relatively small so the Indonesian government has more room for acting tough there as compared to in the case of copper. [3]

…But The New Export Tax Is Now The Crux Of The Problem

While granting Freeport an exemption from the export ban, subject to smelting copper within Indonesia in the future, Indonesia nevertheless slapped a new export tax of 25% on copper concentrate exports. This is scheduled to rise progressively to 60% by end of 2016. According to Freeport, this tax violates the original agreement between the government and the company. In a recent regulatory filing, the company said that it might invoke the force majeure clause that would allow it to renege on supply commitments without paying penalty as the event triggering breach of commitment in this case was beyond its control. It also said that it may start laying off workers, defer capital expenditure plans and cut operating costs. The implication would be halting of copper concentrate exports which would impact the company’s revenues, keep the Indonesian government from realizing any expected income from taxes and royalties and job losses on a massive scale.

The government, perhaps realizing this, hinted at the beginning of this month that the export tax might be reduced. Freeport welcomed the statement but did not clarify if it would be ready to pay this reduced tax. This means that even if is given the recommendation letter by the mining ministry and obtains an export permit, the company may not resume exporting if it is not exempted from the new tax. Failure to resume Indonesian exports will result in an estimated $5 billion loss in revenues for Freeport in 2014. [4]

It is clear that the stand-off is far from over. We need to wait for the new conditions of the government as well as Freeport’s stance on the same. We will keep you updated on further developments on this front.

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Notes:
  1. Freeport McMoran Copper Permit Awaited, US Trade V []
  2. Here Are the Winners of Indonesia’s Ore Ban, Daily Finance []
  3. Indonesia bans mineral ore exports, but may allow Freeport shipments, Reuters []
  4. Indonesia May Cut Mineral-Concentrate Export Duty as Standoff With Miners Persists, WSJ []