Why Is It Rational For Rio To Sell Its Stake In the Grasberg Mine


Rio Tinto’s interest in selling its holding of the Grasberg mine in Indonesia indicates the growing unattractiveness of doing business in Indonesia. Given the increasing restrictions being imposed on foreign companies operating in the country, it makes sense for Rio to sell its 40% stake to the Indonesian government.

Rio’s Initial Framework of Agreement with Freeport

Rio came into a joint venture (JV) with Freeport-McMoRan in 1995 which provided the company a 40% share of the mine’s production above a specified threshold until 2021 and even greater production access post 2021. The disruption in Grasberg’s operations  due to the restrictions imposed by the Indonesian government since 2014 has led to a zero contribution of Grasberg to Rio’s gross revenue since 2015. This was primarily due to the fact that the mine’s total production couldn’t meet the threshold proposed for receiving its proportion of the production volume.

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However, on the contrary, Rio’s share of capital expenditure in the Indonesian mine has stayed intact. The expenditures were mainly attributed toward the Grasberg Block Cave, associated common infrastructure cost, and other costs. The below chart depicts the schedule of capital expenditure made by Rio and expected in 2017.

You can view our base case for Rio Tinto here and create different scenarios using our interactive platform.

Persistent Uncertainty Regarding Mining Operations in Indonesia

The Indonesian government since 2014 has discouraged the export of unprocessed minerals from the country in order to encourage smelter development within the country and export value added products. Although Freeport was able to gain access to a special mining rights which allowed the company to export a certain amount of its copper and gold production outside the country, these exports were subject to high royalty rates and the company’s operations were continuously disturbed by separatist violence.

The below graph depicts the fall in Indonesia’s exports to the rest of the world. Indonesia as a country, is rich in natural resources, however, even if the current restrictions on exports are lifted in the near future, gaining its market share from its competitor countries would be a difficult process.

Indonesia’s Export Volume to the Rest of the World

These pressing issues had led Newmont Mining to sell off its assets in Indonesia in order to operate in a more predictable environment. However, such an exit is not possible for Freeport as Indonesia contributes a significant proportion to its revenue. However, Rio’s stake in Grasberg is not as significant and the Indonesian government’s proposal to purchase its stake seems like an attractive medium for Rio to exit the Indonesian economy.

We have a $45 price estimate for Rio Tinto, which is 5% below the market.

Have more questions about Rio Tinto? See the links below.

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such 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 Rio Tinto