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

What the government gave with the one hand it's trying to take with the other.

Rich Duprey
Rich Duprey
Jan 24, 2014 at 5:00PM
Energy, Materials, and Utilities

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.