Why Indonesia Remains A Source Of Uncertainty For Freeport Despite Latest Agreement With Government

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Freeport-McMoRan has reached a temporary agreement with the Indonesian government to resume the export of copper concentrate from the country. [1] The company had stopped exports from Indonesia in January in the wake of changes to the country’s mining regime. As smelting capacity within Indonesia is limited, with the ban on exports of copper concentrate coming into effect earlier on in the year, Freeport was forced to lower production levels at its Indonesian facilities by around 60%. [2] As a result, the company’s shipments from Indonesia could miss its original guidance for the year. We expect Freeport to make up for lost shipments over the rest of the year, with our forecasts for the company’s 2017 Indonesian copper shipments and its gold shipments around 10% lower than its original guidance for the year.

The temporary agreement signed by Freeport with the Indonesian government allows the company to continue to export copper concentrate till October 10, by which time the company has to sign a longer term agreement with the Indonesian government. [1] The changes to Indonesia’s mining regime require Freeport to switch from its existing long term investment agreement or Contract of Work (COW) to a special mining license. The special mining license would considerably change the terms of Freeport’s COW, requiring the company to divest up to 51% of its Indonesian operations to Indonesian nationals and build additional smelting capacity within the country. [1] The Indonesian government had previously changed regulations pertaining to its mining industry in 2014, which had resulted in a seven-month standoff between major international mining companies, such as Freeport, and the government, before a deal was reached. Among the terms of the deal reached between Freeport and the government in 2014, the company was expected to pay higher royalties on exports, divest a 30% stake in its Indonesian operations to locals over a period of time, and invest in creating domestic smelting capacity. [3] Freeport is engaged in negotiations with the government in order to safeguard its long term presence in Indonesia on terms similar to those in its COW.

Frequent regulatory changes In Indonesia have created uncertainty for international mining companies pertaining to the continuance of their operations on favorable terms. Newmont Mining divested its Indonesian operations last year, in order to focus on its operations in more predictable regulatory jurisdictions. [4] However, Indonesia accounts for a substantial portion of Freeport’s business and the company is looking to continue operating in the country. Around 31% of Freeport’s consolidated copper reserves and nearly all (99%) of its consolidated gold reserves are located in Indonesia. [5] Thus, it is critical for the company management to reach a conclusive long term agreement with the Indonesian government on favorable terms. Given the checkered history of the company’s Indonesian operations, a favorable long term deal is not a foregone conclusion. Thus, until a long term deal is struck on favorable terms,  Freeport’s business in Indonesia will continue to be dogged by uncertainty.

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Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com
2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for Freeport-McMoRan

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Notes:

  1. Indonesia Allows Exports From Freeport Mine in Stop-Gap Deal, Bloomberg [] [] []
  2. Freeport-McMoRan Updates Status Of PT Freeport Indonesia Operations, Freeport-McMoRan News Release []
  3. Freeport Expects to Reach Indonesia Export Deal ‘Imminently’, Bloomberg []
  4. Newmont Exiting Indonesia in $1.3 Billion Sale to Local Firm, Bloomberg []
  5. Freeport’s 2016 10-K, SEC []