Freeport Earnings Preview: Low Copper Prices and Indonesian Export Restrictions to Weigh on Results

by Trefis Team
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Freeport McMoran Copper
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Freeport McMoran Copper and Gold (NYSE:FCX) will report its second quarter results and conduct a conference call with analysts on July 23. Lower copper prices in Q2 2014, as compared to the corresponding period a year ago, and stalled mineral exports from Indonesia will weigh on the company’s results. Freeport had acquired oil and gas assets in Q2 2013. The company started reporting revenues from its oil and gas business only from June 2013 onwards. Thus, an apples to apples comparison between revenues of the oil and gas division in Q2 2014 with the corresponding period a year ago is not possible.

See our complete analysis for Freeport McMoran Copper and Gold

Copper Prices

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 around 40% of the world consumption of copper. The prices of the metal are to a large extent influenced by Chinese demand for it. A slowdown in Chinese economic growth and fears over unwinding of financing deals using copper as collateral led to a fall in copper prices earlier on in the year. According to data from China’s National Bureau of Statistics, growth in investment, factory output and retail sales slowed to multi-year lows in the first two months of the year.((China Premier Warns On Economic Slowdown As Data Fans Stimulus Talk, Reuters)) Further, the Chinese leadership has proposed structural reforms of the economy, shifting the emphasis from 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. In addition to weak demand, the expansion in production by major copper mining companies has resulted in an oversupply situation. With a wave of new projects adding to global output, a supply glut will put pressure on prices. [1]

Copper is also used as collateral for financing deals by Chinese firms. 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, which would add to the oversupply situation. The country’s first domestic bond default by Chaori Solar earlier on in the year, heightened fears of such an eventuality. This triggered a dramatic drop in copper prices. ((China Fears Trigger Dramatic Drop In Copper, Financial Times))

As a result of these factors, London Metal Exchange (LME) copper prices were lower in Q2 2014, as compared to the corresponding period a year ago. Spot prices averaged $6,800 per ton in Q2 2014, as compared to $7,100 per ton in Q2 2013. ((LME Copper Prices, LME)) Lower copper prices will impact Freeport’s copper revenues, which constitute the bulk of its revenues.

Copper prices have recovered recently, driven by improved macroeconomic data from China and the U.S. China’s National Bureau of Statistics reported earlier on in the month that the factory sector grew at its fastest pace in six months. [2] However, for a sustained recovery in copper prices, demand will have to catch up with increased global copper supply.

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. [3]

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)) The company has recently 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. 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))

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. [4]

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. ((Freeport McMoran’s Q1 2014 10-Q, SEC)) 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, Freeport’s second quarter results will certainly be affected.

Other Developments

The company restructured its oil and gas portfolio in the second quarter, with the sale of its Eagle Ford Shale assets to a subsidiary of Encana Corporation for $3.1 billion. The company simultaneously purchased some of Apache Corporation’s interests in the Deepwater Gulf of Mexico (GOM) for $1.4 billion. The focus of these transactions was to use the net proceeds to reduce the company’s debt. [5]

Expectations from Conference Call

It will be interesting to note whether the company’s management maintains its copper shipment guidance for the year, considering that the company has suspended exports from Indonesia for much of the year. We would also like the management to give an update regarding its negotiations with the Indonesian government and if any timeframe for resumption of exports has been set. This would throw some light on the road ahead for Freeport.

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Notes:
  1. Copper Miners Forecast Years Of Surplus, The Financial Times []
  2. Copper confounds bears with strong gains, Financial Times []
  3. Indonesian Government Relaxes Its Stance in Tax Dispute with Freeport and Newmont, Forbes []
  4. Freeport McMoran’s Q1 2014 10-Q, SEC []
  5. Freeport Restructures Oil And Gas Portfolio Primarily To Reduce Debt, Trefis []
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