Latest News from Indonesia Puts More Pressure on These Miners

The proposed smelter cash guarantee shows that Indonesian government continues to implement its recent copper export initiatives.

Feb 10, 2014 at 10:13AM

As if there weren't already enough difficulties with copper concentrate exports for Freeport-McMoRan (NYSE:FCX) and Newmont Mining (NYSE:NEM), the Indonesian government has decided to force producers to pay cash guarantees for building copper smelters. The country has already enforced a progressive tax on concentrate imports in the amount of 25% in 2014. This tax rises to 60% by mid-2016.

As a result, mining exports from the country were halted, as both companies entered a discussion about the new rules with the government officials. However, the latest news shows that Indonesia is unlikely to facilitate the situation for miners, at least in the short term.

Indonesia doesn't have enough smelting capacity
Indonesia tries to force producers to build copper smelters in the country. Currently, the only smelter that operates in the country is situated in Gresik, and both Freeport and Newmont supply part of their production to the facility.

However, the smelter is unable to serve all the needs of the producers, so the remaining concentrate is exported. PT Indosmelt plans to build a new smelter, but the construction won't be finished until 2017 at best. The new smelter will begin to operate when the export concentrate tax turns into an export ban.

However, it doesn't look like Freeport and Newmont are going to export any concentrate when the tax is active. What's more, both companies were not sure that building a smelter in the country was economically liable, although Freeport is conducting a feasibility study which results have not been released yet.

The impact
Indonesia accounted for 25.6% of Freeport's copper sales in the fourth quarter. The company also had 30 billion pounds of copper proven and probable reserves at the end of 2013. Freeport expects sales from Indonesia to reach 1.1 billion pounds of copper, but now these plans are surely under question.

While Newmont is a gold miner, it is also active on the copper front with production from Boddington in Australia and Batu Hijau in Indonesia. Batu Hijau produced 58% of Newmont's copper in the fourth quarter. Newmont's shares were already under pressure after the company's 2014 outlook revealed that no major improvement on the cost front was expected in the current year. The situation with Indonesian copper puts even more pressure on shares of the miner.

The export tax takes some copper out of the market, but it is unlikely to push copper prices higher as giants like BHP Billiton (NYSE:BHP) and Rio Tinto (NYSE:RIO) continue to increase their copper production. BHP's fourth quarter production rose 9% consecutively, while Rio's copper production was up 6%.

What's more, Turquoise Hill Resources' (NYSE:TRQ) Oyu Tolgoi copper operations in Mongolia are still in the early stages of mine development. Oyu Tolgoi will throw more copper at the market as the project unfolds. Rio Tinto owns 50.8% of Turquoise Hill's shares. Oyu Tolgoi is expected to produce between 150,000 to 175,000 tons of copper and concentrates in 2014, with more production coming in future years.

Bottom line
Indonesian assets represent core operations for both Freeport and Newmont. Both companies state that the new tax violates their existing contracts of work, but at this point the government seems to ignore this fact. The proposed smelter cash guarantee does even more harm to the industry.

As I've stated earlier, I believe that this will be a lengthy battle. Estimated aggregate capital spending on Freeport's Indonesian projects was expected to average $0.9 billion, but, given current conditions, these figures could be revised to the downside. Given the current state of things, both Freeport's and Newmont's copper sales estimates are unlikely to be met.

The situation in Indonesia will continue to put pressure on shares of Freeport and Newmont. 

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