Resumption Of Exports From Indonesia Provides A Boost To Freeport McMoran

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Freeport McMoran Inc (NYSE:FCX) has resumed exports of copper concentrate from Indonesia. [1] This ends an almost seven-month  suspension of Freeport’s mineral exports from the country. The company had been negotiating with the Indonesian government over new regulations governing mineral exports from the country that came into effect in January. The resumption of exports, albeit under new regulations, is extremely significant for Freeport  as Indonesia was expected to account for 24% and 94% of the company’s consolidated copper and gold shipments in 2014, respectively, at the time of release of its 2013 annual results. ((Freeport McMoran’s 2013 10-K, SEC))

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The Indonesian Situation

A law enacted in Indonesia in 2009 banned exports of unprocessed minerals from the country starting 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 was of the view that the export tax violates the terms of its investment agreement, or contract of work (COW), with the Indonesian government. The company halted its exports from Indonesia in January pending negotiations with the government over these regulatory changes. [2]

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Freeport recently entered into a memorandum of understanding (MOU) with the Government of Indonesia under which the two parties will negotiate an amended COW to address various dimensions of Freeport’s operations in Indonesia. The negotiations over the amended COW are expected to be completed over a period of six months. Along with the signing of the MOU, Freeport has agreed to provide a $115 million assurance bond to support its commitment for smelter development in Indonesia and to pay higher royalties of 4.0% for copper and 3.75% for gold, up from the current rates of 3.5% and 1% respectively. Freeport will now pay a revised duty of 7.5% on its copper concentrate exports, which will decline to 5% when smelter development progress exceeds 7.5%, and 0% when development progress exceeds 30%. ((Freeport-McMoRan Announces Resumption of Exports from Indonesian Subsidiary, Freeport Press Release)) The negotiations for the amended COW will also address the sharing of costs between Freeport, the government and any other partners involved in the project for smelter development, the terms for continuation of Freeport’s operations post-2021 including legal and fiscal guarantees, as well as the divestment of up to a 30% stake in its Indonesian subsidiary to Indonesian nationals or the government. [3]

Impact on Freeport

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. [4] This was reflected in its Q2 2014 sales figures. Consolidated copper sales for the second quarter stood at 968 million pounds, as compared to the company’s April estimate of 1.1 billion pounds of copper shipments, which assumed a resumption in exports from Indonesia in May. ((Freeport McMoran’s Q2 2014 Earnings Release, SEC)) Consolidated gold shipments in the second quarter this year stood at 159,000 ounces, lower than the company’s estimate of 320,000 ounces, which also assumed a resumption in exports in May. [5] Lower copper and gold sales volumes primarily reflect lower volumes from the company’s Indonesian operations as a result of the restrictions on mineral exports. This resulted in a deferral of approximately 275 million pounds of copper and 380,000 ounces of gold shipments in the first half of 2014. [5]

As per Freeport’s mine plan for its Indonesian operations, consolidated copper sales are expected to rise sharply from 0.7 billion pounds in 2014 to 1.6 billion pounds in 2016 and gold sales from 1.3 million ounces in 2014 to 3 million ounces over the same period, before moderating as a result of lower output. ((Freeport’s Q2 2014 Earnings Presentation, Freeport Website)) Indonesia is clearly a critical part of Freeport’s plans going forward, so the resumption of exports from the country is very good  news for the company.

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Notes:
  1. Freeport Indonesia says copper exports resumed as tax dispute ends, Reuters []
  2. Indonesian Government Relaxes Its Stance in Tax Dispute with Freeport and Newmont, Forbes []
  3. Freeport-McMoRan Announces Resumption of Exports from Indonesian Subsidiary, Freeport Press Release []
  4. Freeport McMoran’s Q1 2014 10-Q, SEC []
  5. Freeport McMoran’s Q2 2014 Earnings Release, SEC [] []