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Last week, the Indonesian Ministry of Finance announced a punitive tax on the export of ore concentrate mined within its country. Considering Freeport-McMoRan (NYSE: FCX ) operates a massive mining facility in the country that produces substantial copper and gold ore, the impact is very concerning to the bottom line for shareholders. The decree also impacts mining operations of Newmont Mining (NYSE: NEM ) so Freeport-McMoRan will have some extra help in lobbying for a reprisal of the proposed new law.
For numerous reasons highlighted in the recent earnings conference call, investors shouldn't be so quick to dump the stock. Jefferies recently named Freeport-McMoRan a top franchise pick, and this the type of scenario where investors can pick up long-term winners at bargain prices.
Already 40% compliant
The purpose of the new law is to require more valued added work be completed in Indonesia, instead of shipping the work to other parts of Asia. In the case of Freeport-McMoRan, it already processes 40% of the copper concentrates at a Mitsubishi joint venture smelter in the country. The ruling would only impact up to 60% of the copper produced in Indonesia.
The joint venture smelter built back in the 1990s only costs $750 million to build and would cost up to three times the amount at this time. Not to mention, the fees received for processing the copper ore haven't changed much over the years. This unattractive cost-benefit ratio provides Freeport-McMoRan with some leverage in negotiating with the government.
Focused on mining in the Americas
While the Grasberg mine is one of the largest in the world, Freeport-McMoRan produces more copper in both North America and South America than it does in Indonesia. In fact, the 2013 sales in North America equaled 1,422 million pounds and South America sold 1,325 million pounds. Combined, the two regions produced triple the copper mined in Indonesia at 888 million pounds.
The biggest wildcard is that Indonesia is the only major source of gold production, having produced 1.1 million ounces in 2013. Of more concern is the 1.6 million ounces expected for production in 2014.
The Tenke mine in Africa provides another source of copper that helps reduce any impact from Indonesia. In addition, Freeport-McMoRan has three brownfield projects outside of Indonesia that should add roughly 1 billion pounds per annum in increased production by 2016.
Newmont Mining is less affected with roughly 7% of the company's revenue coming from the Batu Hijau mine in Indonesia. The company doesn't plan to export copper concentrate until later this quarter after having already completed the a scheduled shipment in early January.
History with government
Before investors get too scared by the new decree that would add a 25% export tax in 2014 that expands to 60% in 2016, one needs to remember that Freeport-McMoRan has a long history of working with the government in that country. Similar to the U.S., members of parliament and high-ranking government officials can make statements in order to win political favor. These officials may have no intention in following through with the suggested punitive tax.
Freeport-McMoRan already has a working contract that specifically stipulates no export tax. With the company estimating that it already pays over $1 billion annually in the various taxes including a 30% income tax, it appears unlikely that the government would continue to push a tax that would shut down operations at the massive Grasberg mine.
Since operations at the Batu Hijau mine began in 2000, Newmont estimates it has spent more than $3 billion in taxes and royalties.
Improving copper demand in the U.S. combined with a recovering Europe could provide a strong backdrop for copper demand, especially if the Chinese economy holds on to current demand. The large drop in shares of Freeport-McMoRan appears irrational considering the likelihood that a reasonable compromise will be reached in Indonesia. The lack of available smelter capacity in the country makes it impossible to meet the government targets or continue production at the proposed export duty. Both parties have every reason to reach a compromise that limits the impact to Freeport-McMoRan and Newmont Mining.
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