The Current Status of Freeport’s Indonesian Stand-off

Freeport McMoran Copper & Gold Inc. (NYSE:FCX) has been involved in a stand-off with the Indonesian government over a tax on mineral exports for a while now. The Indonesian government had earlier banned unprocessed mineral exports from the country with effect from January 12. However, last minute changes to the law permitted both Freeport and Newmont Mining (NYSE:NEM) to export their copper concentrates, subject to new regulations, including an export tax. Both Freeport and Newmont had halted mineral exports from Indonesia as they did not have the necessary approvals under the new rules. Negotiations between the two companies and the Indonesian government have been ongoing for some time.

Newmont recently filed for international arbitration against the Government of Indonesia, seeking resumption of their mineral exports from the country. ((Arbitration Filed over Export Restrictions in Indonesia, Newmont Press Release)) However, Freeport continued negotiations with the government, seeking resolution of the situation. The company has reached an agreement with the government over a draft memorandum of understanding (MoU) on a contract renegotiation. However, the MoU has not been signed yet and there is still no concrete timeframe for resumption of mineral exports. ^[1]

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The Indonesian Situation

A law enacted in Indonesia in 2009, banned exports of unprocessed minerals from the country with effect from January 12, 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. However, last minute changes to the law deferred the ban on exports to 2017. Exports of copper concentrate were permitted, but under new rules. The government introduced new regulations in order to get an export permit and also imposed an export duty of 25%, which will rise progressively to 60% by 2016. Freeport contends that the export tax violates the terms of its investment agreement, or contract of work, 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 displayed some leniency in its stance on the tax issue, it has still not been resolved. ^[2]

Freeport was awarded registered exporter status by Indonesia’s Ministry of Trade in March. The company still needs a recommendation letter from the Mining Ministry in order to get an export permit, which would allow it to restart exports.((Freeport-McMoRan Copper & Gold Inc. Gets Export Certification In Indonesia; Permit Awaited, U.S. Trade Voice)) As reported by Reuters, the draft MoU between Freeport and the government is set to be finalized within two weeks. Under the terms of the draft MoU, Freeport is to divest 30% of its Indonesian unit, pay a royalty of 4% for copper sales and 3.75% for gold sales – up from 1% previously – and agree to build a smelter. The company is to pay a smelter construction bond of $115 million to the government, post which the Finance Ministry will sign a lower export tax regulation and allow exports to resume. ((Freeport says draft MoU agreed but not signed, no export timeframe, Reuters)) However, the Indonesian presidential election may cause a delay in the reaching of a deal.

Impact on Freeport

Indonesia accounts for around 22% of Freeport’s consolidated copper production and nearly 91% of its consolidated gold production. Prior to the imposition of export restrictions by the government, Freeport expected to sell around 40% of its copper concentrate production in Indonesia to PT Smelting, Indonesia’s only copper smelter and refinery, in which Freeport holds a 25% stake. The remaining copper concentrate produced in Indonesia was to be exported to international smelters. ((Freeport McMoran’s 2013 10-K, SEC))

As a result of the export restrictions, the company aligned its production rates in Indonesia with PT Smelting’s operating plans. As a result, Freeport’s milling rate averaged 118,000 tons of ore per day at its Indonesian operations, which is around half of  normal rates. This was reflected in its Q1 2014 sales figures. Freeport’s consolidated copper sales volumes decreased to 871 million pounds in Q1 2014, compared to 954 million pounds in Q1 2013. Consolidated gold sales volumes decreased to 187,000 ounces in Q1 2014, compared with 214,000 ounces in Q1 2013. Lower copper and gold sales volumes primarily reflected lower volumes from the company’s Indonesian operations as a result of the restrictions on concentrate exports from Indonesia. This resulted in a deferral of approximately 125 million pounds of copper and 140,000 ounces of gold shipments in Q1 2014. ^[3]

The Road Ahead

The delay in resumption of exports from Indonesia is expected to result in a deferral of approximately 50 million pounds of copper and 80,000 ounces of gold sales per month. To put this into context, Freeport expected 4.43 billion pounds and 1.75 million ounces of  copper and gold sales respectively in 2014, at the time of declaration of its Q4 2013 results. ((Freeport McMoran’s 2013 10-K, SEC)) Thus, any delay in the resolution of the stand-off in Indonesia will certainly have an impact upon Freeport’s results. However, the extent of the impact will depend upon the duration of time for which exports remain suspended. A quick resumption of normal operations in Indonesia is vital for the company’s business prospects in the region.

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1. Freeport says draft MoU agreed but not signed, no export timeframe, Reuters [↩]
2. Indonesian Government Relaxes Its Stance in Tax Dispute with Freeport and Newmont, Forbes [↩]
3. Freeport McMoran’s Q1 2014 10-Q, SEC [↩]