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A Taxing Result for Freeport-McMoRan Copper & Gold Inc. in Indonesia

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Gold and copper miner Freeport-McMoRan (NYSE: FCX  ) may have ducked under the export ban Indonesia imposed on unprocessed ore, but it and fellow miner Newmont Mining (NYSE: NEM  ) can't avoid paying a new export tax the government sprung on them at the last moment.

It seems Indonesia is determined to get its pound of flesh one way or the other, but the miner has said it will defend itself against the imposition, which it charges violates the contract it signed with the country in 1991 that it would not be subject to any new taxes, duties, or fees. Newmont says it is similarly exempt.

Indonesia is engaging in a bit of resource nationalism, and first proposed banning unprocessed ore in 2009 as a means of giving domestic processors a boost. Yet there is little infrastructure in place to carry the current load, and though Freeport has two smelters under construction that are due to come online in 2015, it's also said smelter construction costs have tripled, and while it processes about 40% of its ore at an existing facility, building another one would be cost prohibitive. Newmont's Batu Hijau copper mine only processes about 20% or so of its copper concentrate at Indonesia's only copper smelter.

Grasberg mine, Indonesia. Source: Freeport-McMoRan.

Moreover, not every metal is so economically viable that it deserves its own smelter. Nickel, for example, has fallen from about $8 per pound a year ago to $6.66 per pound today, a near-20% decline brought on by rising global supplies amid slower economic growth, and analysts don't expect it to recover before 2015. There's an oversupply in other metals, too, including bauxite, tin, gold, and silver, and China, where much of the minerals mined are destined, has been sourcing them from other countries like Australia and Malaysia at an accelerated pace in anticipation of the export ban going into effect and stockpiles have been rising globally.

Vale (NYSE: VALE  ) , the world's second-largest nickel producer, says the policies shouldn't impact it at all since it already processes its ore at its smelter in Soroako. And because the new export taxes relate to the export of copper concentrates, it won't be affected by them, either.

Freeport is suffering from the collapse in commodity pricing as it caused profits to tumble to $707 million, or $0.68 per share, from $743 million, or $0.78 per share, a year ago. While revenue jumped from $4.5 billion to $5.9 billion, the increase came as a result of the miner's recent oil and gas acquisitions

Last year, it paid $9 billion for Plains Exploration & Production and McMoRan Exploration, two oil and natural gas companies in which it already had substantial stakes. At the time, investors were furious it was diversifying away from its mining core, arguing they had bought a miner, not a driller, but in truth it was returning to its roots as a resources company. It spun McMoRan Exploration off in 1994 and since its repurchase, copper prices have  collapsed making the oil and gas activities Freeport's saving grace.

It was a prescient buy, so management deserves credit for the move and opper globally has become more difficult to mine. Indonesia also has been rattling its saber over wanting to renegotiate Freeport's contract to allow the government to extract more taxes from it, and so far the miner has been able to smooth over ruffled feathers with them. It's once again offering placating words in hopes it can work out the differences this time, too, but it says it's willing to defend itself if necessary, though going to international arbitration is an option of last resort. 

Freeport faces the possibility of having to pay $5 billion in new taxes so it is planning to defer production of about 40 million pounds of copper and 80,000 ounces of gold per month until the issue is settled. It produces almost three-quarters of Indonesia's copper, which in turn accounts for almost 20% of the miner's revenues. Newmont is responsible for almost all the rest of the country's copper output.

Even as the mining union has come out against the new export policies as has the country's trade association, estimating as many as 800,000 jobs could be affected, Indonesia trying to back door the expropriation of wealth from the miners themselves won't do much to create the impression it is a country open for business.

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  • Report this Comment On January 25, 2014, at 6:29 AM, CopperBaron wrote:

    The imposition of a 25% export tax on Indonesian copper concentrate revenues rises on a sliding scale to 60% by 2016 and this is on top of income tax which is charged at 35%. One has to question the wisdom of these imposts given that a company like Freeport still needs to spend billions of dollars on further underground mine development to replace its ageing Grasberg open pit which is due to be depleted in 2017.

    It would appear that both Freeport's and Batu's Contracts of Work clearly set out the levels of taxes that can be imposed over the life of these contracts (Freeport's expires in 2021 and Batu's several years later). Although it is unlikely that either company would wish to do so, they may be forced to enter into litigation if the current regime rejects the validity of these contracts (the timing of this new legislation is not ideal with regional elections scheduled for April 2014 and a presidential election due in July).

    Mention is made in the article that Freeport is building two smelters that are due to come on stream in 2015. I am not a Freeport nor a PTNNT employee, nor do I hold any of their stock, but this is not my understanding - there are currently three smelter projects proposed in Indonesia (PT Indosmelt, PT Nusantara and PT Indovasi) but none of these involve equity participation from either Freeport or PTNNT, although both companies state that they would be willing to supply concentrates to these projects at market rates. Freeport and PTNNT are thought to be looking at the economics of building a smelter in Indonesia and are undertaking feasibility studies. Building a copper smelter is expensive (potentially two billion dollars for a plant of a similar scale to the existing smelter in Indonesia) and the returns are usually minimal or negative. This is because the revenue split on copper between miner and smelter is around 92%:8%. A large proportion of a smelter's revenue comes from the treatment charges paid by the miner for these smelting services. It has been estimated that a smelter project outside of China would require long-run treatment charges of more than double the prevailing rates. Meanwhile in China, smelter projects benefit from significant subsidies from provincial governments who often provide land in industrial parks as well as power, water, port facilities etc. thereby significantly reducing the overall construction costs. This means that Chinese smelter projects are often viable at significantly lower treatment charges than elsewhere in the world. This is one key reason why the majority of new smelters are being built in China, while smelter builds outside of China (and India) are extremely rare. Little wonder then that the last custom smelter built next to tidal water outside of these two countries was over 20 years ago.

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Rich Duprey

Rich has been a Fool since 1998 and writing for the site since 2004. After 20 years of patrolling the mean streets of suburbia, he hung up his badge and gun to take up a pen full time.

Having made the streets safe for Truth, Justice and Krispy Kreme donuts, he now patrols the markets looking for companies he can lock up as long-term holdings in a portfolio. So follow me on Facebook and Twitter for the most important industry news in retail and consumer products and other great stories.


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