Problems In Indonesia And Low Copper Prices To Weigh On Freeport’s Q1 Results

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Freeport McMoRan Copper (NYSE:FCX) will announce its first quarter earnings on Thursday, April 24. The company had acquired oil and gas assets in the second quarter of 2013. Thus an apples to apples comparison between its quarterly revenue with the year ago period is not possible. However, the company derives a majority of its revenue from its copper mining business. Lower copper prices as compared to the corresponding period last year and problems in Indonesia are expected to negatively impact Freeport’s reported quarterly revenue. [1]

You can check out our full analysis for Freeport McMoran Copper here:

Copper Prices

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Copper has diverse applications in industry. It is widely used in the manufacturing, power and infrastructure sectors. Thus, its consumption is broadly correlated with industrial growth. China is the largest consumer of copper in the world, accounting for nearly 40% of the total world consumption of copper. The prices of the metal are to a large extent influenced by Chinese demand for it. Slower economic growth in China has led to a moderation in copper prices. According to data from China’s National Bureau of Statistics growth in investment, factory output and retail sales has slowed to multi-year lows in the first two months of the year. Further, the Chinese leadership has proposed structural reforms of the economy, shifting the emphasis from an investment and export driven growth to services and consumption led growth. Such a transformation of the Chinese economy may negatively impact Chinese demand for copper in the long run. [2]

Copper is also used as collateral for financing deals by Chinese firms. Various types of such deals are prevalent in China. In one type of deal, traders use copper as collateral to obtain US Dollar financing at low interest rates. The proceeds are then invested in higher yielding assets in China or lent to the shadow banking sector for better returns. Some firms take advantage of interest rate arbitrage opportunities. Smelters, refiners and fabricators have been using copper inventory as collateral to obtain financing. It is estimated that up to a third of China’s copper imports may be tied up in financing deals. Thus an unwinding of these deals could result in large quantities of copper being dumped in the market. This could worsen the oversupply situation already existing because of falling demand and further depress prices .The country’s first domestic bond default by Chaori Solar last month has heightened fears of such an eventuality. The uncertainty regarding the financial health of Chinese firms and falling copper prices are forcing banks to demand more collateral from borrowers. This is forcing borrowers to sell their copper stocks in order to meet these obligations. In some cases the banks themselves are selling copper in order to recover their money. This is creating an oversupply situation which will keep downward pressure on copper prices. [3]

Copper prices have fallen sharply over the last one year. LME spot prices have fallen from around $8,000 per tonne to around $6,500 per tonne at the end of Q1 2014. This is expected to result in lower year over year revenues from copper mining operations for Freeport in this quarter. The results of a recent survey by Thomson Reuters have revealed expectations of low copper prices for the rest of the year. The main reasons cited were the uncertainties over Chinese demand for copper and the sustainability of the copper financing trade. Further, the survey expects copper prices to remain in the range of $6,000-$7,000/tonne for the rest of the year. [4]

The Indonesian Situation

A law enacted in Indonesia in 2009 banned exports of unprocessed minerals from the country with effect from 12 January 2014. The intent behind this law was to provide a boost to the development of the Indonesian mineral processing industry and simultaneously increase the value of the country’s commodity exports. Though last minute changes to the export ban permitted Freeport’s copper concentrate exports, the government also imposed an export duty of 25% which will rise to 60% by 2016. Freeport contends that this violates its agreement with the Indonesian government. The company halted its exports from Indonesia in January pending negotiations with the government over these regulatory changes. Though the Indonesian government has recently displayed some leniency in its stance on the tax issue, it has still not been resolved. Freeport is yet to resume its exports of copper concentrate. Indonesia accounted for over 20% of Freeport’s consolidated copper production in 2013. Thus, the suspension of exports from Indonesia will result in a significant fall in quarterly copper concentrate shipments as compared with the year ago period. [5]

The suspension of exports from Indonesia will also severely impact Freeport’s gold shipment volumes. Indonesia accounted for over 90% of Freeport’s consolidated gold production in 2013. Thus quarterly gold shipment volumes will plummet compared to the corresponding period last year. However, gold accounted for only 8% of Freeport’s consolidated revenues in 2013 as compared to 69% for copper. Thus, the decline in gold shipments will not impact revenues to the same extent as the decline in copper shipments. [6]

What To Watch Out For

It will be interesting to note whether the management maintains its production and sales estimates for copper and gold for the whole year in view of the prevailing prices. We will also be looking out for further updates from the management regarding the issue of export taxes levied by the Indonesian government on copper exports. A satisfactory resolution of this issue is critical for the resumption of Freeport’s exports from Indonesia and its business prospects going forward.

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Notes:
  1. LME Copper Prices, LME []
  2. China Premier Warns On Economic Slowdown As Data Fans Stimulus Talk, Reuters []
  3. China Fears Trigger Dramatic Drop In Copper, Financial Times []
  4. Copper Prices May Fall Below $7000/Tonne On Oversupply, The Economic Times []
  5. Indonesian Government Relaxes Its Stance in Tax Dispute with Freeport and Newmont, Forbes []
  6. Freeport McMoran Copper 2013 10-K, SEC []