Freeport’s Understanding With Indonesian Government Should Secure Company’s Future In Uncertain Regulatory Environment

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Freeport-McMoRan Inc. (NYSE:FCX) has announced that the company management has received assurances from the Indonesian government over the long-term continuation of its mining operations in the country, on the same terms as it is currently operating on. [1] This is significant since the operations of several mining companies in Indonesia over the past couple of years, including Freeport, have been disrupted by regulatory changes affecting the mining sector. We feel that the latest understanding between Freeport and the Indonesian government would benefit the company’s operations by reducing the uncertainty surrounding Freeport’s mining operations in the country.

Freeport in Indonesia

Freeport’s copper and gold mining operations are located in the Grasberg minerals district of Indonesia. Freeport’s Indonesian operations account for around 28% of the company’s proven and probable copper reserves and nearly all of its gold reserves. [2]

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Freeport’s Indonesian operations were disrupted by regulatory changes last year. A law enacted in Indonesia in 2009 banned exports of unprocessed minerals from the country with effect from January 2014. The intent behind this law was to encourage the development of the Indonesian mineral processing industry and at the same time increase the value of the country’s commodity exports. However, last minute changes to the law deferred the ban on exports to 2017. These changes enabled the exports of copper concentrate from Indonesia, but under new rules. The Indonesian government introduced new rules in order to get an export permit and also imposed an export duty of 25%, which would have risen progressively to 60% by 2016. [3] As per Freeport, the imposition of export taxes violated the terms of its investment agreement, or contract of work, with the Indonesian government. The company halted its copper concentrate exports for around seven months last year, owing to the dispute with the Indonesian government over the regulatory changes.

The suspension of exports negatively impacted Freeport’s operations, since exports accounted for the bulk of the company’s copper sales from Indonesia. After months of negotiations, Freeport resumed its copper mining operations under revised rules, including the payment of higher royalties on mineral sales, the commitment to develop a copper smelter in Indonesia, the payment of export duties on copper sales (though the export duties were to be tapered off along with the progress of smelter construction), and the eventual divestment of up to a 30% stake in its Indonesian subsidiary to Indonesian nationals or the government. [4] Though these rule changes made Freeport’s Indonesian operations less profitable, they enabled the resumption of normal operations for the company in Indonesia.

Even after the resumption of Freeport’s operations last year, the company’s operations have been beset by worker unrest that has negatively impacted Freeport’s copper production in Indonesia. As a cumulative result of these disruptions, there was a drastic reduction in copper production at Freeport’s Indonesian operations in 2014. Despite accounting for around 28% of Freeport’s copper reserves, Indonesia accounted for only 16% of Freeport’s copper production in 2014. [2] In contrast, in case of a disruption free 2016, Indonesia is expected to account for 1.5 billion pounds, or roughly 28% of Freeport’s copper production. The following chart illustrates the potential copper production at Freeport’s Indonesia operations in the coming years.

Production at FCX’s Indonesian Operations, Source: FCX’s Q2 2015 Earnings Presentation

Indonesia has recently been characterized by a difficult regulatory environment for mining companies. Some of the mining companies operating in the country are still dealing with uncertainty pertaining to their operations. For example, Newmont Mining’s (NYSE:NEM) export permit, which expired in September, was not renewed by the Indonesian government. [5] Thus, given the important role that Indonesia plays in Freeport’s operations, and the difficult regulatory environment, securing the long-term future of its operations in Indonesia was a priority for the company. With this latest understanding between Freeport and the Indonesian government, the company may have done just that. Ensuring the government’s support for the long-term continuation of its mining operations in Indonesia will greatly lower the uncertainty surrounding Freeport’s Indonesian operations. It should ensure disruption free operations in Indonesia for Freeport, which would boost the company’s long-term prospects.

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Notes:
  1. PT Freeport Indonesia And The Government Of Indonesia Agree On Continuation Of Operations Of The Grasberg Mining Complex Beyond 2021, Freeport-McMoRan News Release []
  2. Freeport-McMoRan’s 2014 10-K, SEC [] []
  3. Indonesian Government Relaxes Its Stance in Tax Dispute with Freeport and Newmont, Forbes []
  4. Freeport-McMoRan Announces Resumption of Exports from Indonesian Subsidiary, Freeport-McMoRan Press Release []
  5. Newmont’s Indonesian copper export permit will not be renewed – govt officials, Reuters []