The year 2021 was mentioned multiple times on the recent Freeport-McMoRan Copper & Gold earnings call. The reason for this is simple -- 2021 is the year when the company's contract of work in Indonesia ends. The contract has the option to be extended to 2041, but this extension has yet to be secured.
Recently, Freeport-McMoRan faced tough times in Indonesia due to the copper concentrate export tax, which was imposed in early January. Indonesia has just offered miners a concentrate export tax of below 10% following lengthy negotiations, but the question over the year 2021 remains.
The faster the contract of work is renegotiated, the better
The Grasberg mine, which is operated by Freeport-McMoRan, is certainly one of the world's best copper and gold deposits. The key thing to consider is that final activities in the Grasberg open pit will take place in 2016. This will be a big year for Freeport-McMoRan in terms of copper production, and the company expects that copper sales will increase by 39% in comparison with 2014. After this, Grasberg will switch to underground mining.
Sure enough, this transfer will need significant capital spending. The problem is that the Indonesian government previously indicated that it was ready to talk about the prolongation of Freeport-McMoRan's contract of work in 2019. However, the company needs the prolongation of this contract before making big investments. Otherwise, the risks are too big.
The Indonesian government has already surprised miners with the controversial export tax, aimed at providing incentives to build smelters within the country. Both Freeport-McMoRan and Newmont Mining have multiple times indicated that the tax breached their existing contracts of work, but this was useless. The government took the hard line, and in fact, Freeport-McMoRan's dovish response worked better than Newmont Mining's aggressive stance.
At least Freeport-McMoRan will restart exports, although at worse conditions than before. In turn, Newmont Mining, which went for international arbitrage to resolve the issue in Indonesia, risks losing its assets in the country.
There is absolutely no guarantee that the Indonesian government will not play the same game again when the time comes to negotiate the prolongation of Freeport-McMoRan's contract. That's why Freeport-McMoRan has to secure a new contract of work before investing heavily in Grasberg underground development.
Rio Tinto will ultimately get involved in the Indonesian story
Interestingly, Rio Tinto has been silent over the latest developments in Indonesia. The company currently owns a 40% share of production above specific levels. However, Rio Tinto will own 40% of all production from Grasberg after 2021. Yet, there are only a few lines about Grasberg in Rio Tinto's second-quarter operations report stating that a small proportion of copper and gold from the mine has been attributed to Rio Tinto in the first half of 2014.
However, Rio Tinto will ultimately have to participate in the Indonesian story. During the second-quarter earnings call, Freeport-McMoRan was asked whether Rio Tinto would be responsible for funding 40% of the capital expenditures to build a smelter within the country. Freeport-McMoRan stated that Rio Tinto "will certainly be at the table on this."
During the last seven months, the Indonesian government made it clear that building smelters in the country is the only way to stay in business for copper producers. That's why Rio Tinto will have to share some financial pain.
Freeport-McMoRan has demonstrated flexibility in negotiations, which allowed the company to restart exports from Indonesia. The resulting terms could have been better, but the company more or less solved its tactical problems. However, the strategic issue is yet to be solved. The year 2021 is not that far away, and Freeport-McMoRan has a lot of work ahead to secure a decent contract of work that will enable it to work until 2041.
Vladimir Zernov has no position in any stocks mentioned. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.