Indonesia’s Ore Export Ban and its Impact on Freeport-McMoRan’s Grasberg Mine
How will Indonesia’s ore export ban impact the world’s largest gold mine and second largest copper mine, Freeport-McMoRan’s copper concentrate supply chain, and the global base metals market?
Indonesian Mining Industry (2009-2017):
In an attempt to build up Indonesia’s smelting industry and encourage domestic processing of mineral ores, and thereby increase tax revenue and jobs otherwise loss due to the exporting of ores to other countries for refining, the Indonesian government announced in 2009 a raw ore export ban to take effect on January 12th, 2014[1]. The estimated cost to build the required smelters was $20 billion, and mining companies were given 5 years to execute, 66 of which said they would[2]. Among those levered to the ore export ban is Freeport-McMoRan, a US based mining company whose Grasberg mine, situated in Indonesia, is the world’s largest gold mine and second largest copper mine[3]. The export ban thus posed considerable questions about Freeport’s future in Indonesia, the company’s copper concentrate supply chain, as well as the impact on the global supply of base metals.
Indonesia produces 15% of global nickel supply, and 3% of the copper market[4], with mineral shipments in 2012 representing 5% of Indonesia’s GDP or $10.4B[5]. In 2014, high-grade nickel ore and bauxite exports representing $2 billion per year were banned; however, certain semi-processed copper, manganese, lead, zinc and iron ore concentrates were permitted to continue being shipped until 2017, albeit subjected to new export taxes[6]. Concentrates are an intermediate, semi-processed material between extracted ore and fully refined metal[7]. Tin and coal shipments were not affected.
Mixed Signals – Indonesian Government misses 2016 Budget, Export Ban Eased (2017-Present):
Announced as of January 2017, low-grade nickel ores (< 1.7% Ni) and certain amounts of bauxite were allowed to be shipped for companies already in the process of building smelters[8]. Scaling back the export ban sent mixed signals throughout the capitals markets as Indonesia tried to stimulate its government coiffeurs, missing its 2016 budget revenue by $17.6B[9]. Would the export ban and concentrate tariffs be removed altogether?
Impact on Freeport-McMoRan:
Freeport-McMoRan’s Grasberg mine has been operating since 1972, represents 73% of Indonesia’s copper production, is one of the country’s largest taxpayers, and produced 1/5th of Freeport’s $14.8B in revenue in 2016[10]. The political uncertainty and threat of an export ban posed considerable risk if applied to copper concentrates, potentially resulting in Grasberg having to cut production by 60% and lay off half of its 15,000 local employees[11]. Over 100 mining companies have been forced to shut down due to the export ban[12].
Grasberg Expansion Uncertainty:
Freeport is entering the final years of the open pit which will convert to solely underground block-caving mining. The company has already spent billions of dollars in capitalized development in order to access the underground portion of the deposit, and anticipates total capex of over $15B in order to construct the largest underground mine in the world[13]. Analysts believe Freeport will invest $17-$20 billion in Indonesia by 2031[14]. The company believes the export tax and ban violates their current contract and, until recently, has refused to build a new copper smelter. However, Grasberg’s mining permit is set to expire in 2021, and the Indonesian government has refused to start negotiations until 2019.
Grasberg Divestment 2017 – Further Tensions Down the Tunnel?
In August 2017, Freeport announced it would sell to the Indonesian government at “fair market value” an additional 41.64% stake in Grasberg, increasing the government’s ownership from 9% to 51%. Freeport also agreed to build a second copper smelter, invest $20 billion in the mine, and pay higher taxes and royalties. In return Freeport will have the option to apply for a 10-year extension to its mining license currently set to expire in 2021, with the potential to extend to 2041[15]. Grasberg’s reserves are currently set to last until 2039[16].
However, tension remains on the horizon between Freeport and the Indonesian government over price and timing. In 2016 Freeport offered a 10.64% stake in Grasberg that valued the deposit at $16.2 billion, while the Indonesian government countered at $630 million[17]. With no timeline for divestiture and no agreed upon price, it would appear that further battles lie ahead.
Going Forward:
The gap in valuation with the Indonesian government, permitting constraints, and substantial project risk means that Freeport could consider divesting Grasberg entirely to another mining company. Grasberg would likely have to be sold at a considerable discount; however, doing so may be preferred over expropriation. A second option is Freeport could put Grasberg on care-and-maintenance in order to hit the government’s coiffeurs and apply pressure to finalize an equitable deal. The challenge is Grasberg provides Freeport with considerable cash flow. Lastly, albeit unlikely, Freeport and the Indonesian government could agree to seek international arbitrage over the divestiture sale price.
What should Freeport do? Given the recent easing of the nickel ore export ban, should Freeport delay divestiture until the Indonesian 2019 general election?
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[1] Yoga Rusmana, Eko Listiyorini, “Indonesia’s Export Ban Flip-Flop Sows Confusion: QuickTake Q&A,” Bloomberg Markets, [https://www.bloomberg.com/news/articles/2017-02-14/indonesia-s-export-ban-flip-flop-sows-confusion-quicktake-q-a], accessed November 2017.
[2] Ibid.
[3] Reuters, “After Pushback, Indonesia Is Likely to Ease Ban on Mineral Exports,” New York Times, January 11, 2014, [https://www.nytimes.com/2014/01/12/business/international/after-pushback-indonesia-is-likely-to-ease-ban-on-mineral-exports.html], accessed November 2017.
[4] Joe Cochrane, “Indonesia Announces Export Ban on Raw Ore,” New York Times, January 12, 2014, [https://www.nytimes.com/2014/01/13/business/international/indonesia-announces-export-ban-on-raw-ore.html], accessed November 2017.
[5] Reuters, “After Pushback, Indonesia Is Likely to Ease Ban on Mineral Exports,” New York Times, January 11, 2014, [https://www.nytimes.com/2014/01/12/business/international/after-pushback-indonesia-is-likely-to-ease-ban-on-mineral-exports.html], accessed November 2017.
[6] Ibid.
[7] Wikipedia, “Copper extraction,” https://en.wikipedia.org/wiki/Copper_extraction#Concentrate_and_copper_marketing, accessed November 2017.
[8] Wilda Asmarini, Bernadette Christina Munthe, “Indonesia eases export ban on nickel ore, bauxite,” Reuters, [https://www.reuters.com/article/us-indonesia-mining-exports/indonesia-eases-export-ban-on-nickel-ore-bauxite-idUSKBN14W1TZ], accessed November 2017.
[9] Ibid.
[10] Freeport-McMoRan, Inc., December 31, 2016 Form 10-K, [https://www.sec.gov/Archives/edgar/data/831259/000083125917000012/a2016form10-k.htm], accessed November 2017.
[11] Reuters, “After Pushback, Indonesia Is Likely to Ease Ban on Mineral Exports,” New York Times, January 11, 2014, [https://www.nytimes.com/2014/01/12/business/international/after-pushback-indonesia-is-likely-to-ease-ban-on-mineral-exports.html], accessed November 2017.
[12] Ibid.
[13] Reuters, “How Freeport Reached a Mining Deal in Indonesia,” New York Times, August 25, 2014, [https://www.nytimes.rcom/2014/08/26/business/international/how-freeport-reached-a-mining-deal-in-indonesia.html], accessed November 2017.
[14] David Fickling, “Freeport 1; Indonesia 0,” Bloomberg Gadfly, [https://www.bloomberg.com/gadfly/articles/2017-08-30/freeport-1-indonesia-0], accessed November 2017.
[15] Fergus Jensen, “CORRECTED-Indonesia cheers Freeport “win” as Grasberg valuation fight looms,” Reuters, [https://www.reuters.com/article/indonesia-freeport/corrected-indonesia-cheers-freeport-win-as-grasberg-valuation-fight-looms-idUSL4N1LG2QO], accessed November 2017.
[16] Freeport-McMoRan, “Development & Construction Update of the Grasberg Block Cave Mine” (PDF file), downloaded from MassMin 2016 website, [http://www.massmin2016.com/Media/MASSMIN2016/presentations/1140_Brannon.pdf], accessed November 2017.
[17] Fergus Jensen, “CORRECTED-Indonesia cheers Freeport “win” as Grasberg valuation fight looms,” Reuters, [https://www.reuters.com/article/indonesia-freeport/corrected-indonesia-cheers-freeport-win-as-grasberg-valuation-fight-looms-idUSL4N1LG2QO], accessed November 2017.
Great choice of topic, Sean! Not surprising, coming from you who’s a mining buff though. It’s always great to have someone take a deeper interest in Indonesia and you’ve definitely hit a very hot topic here. While I didn’t get the opportunity to personally visit Freeport’s mines, I’ve visited the “Freeport Village” that it had essentially built from scratch to house its employees and workers. As it is a very complex issues, I have lots of thoughts but will keep it relatively succinct here.
First, to your ending question, my personal opinion from a business perspective is that they’re better off waiting and delaying the negotation until 2019 given how political the mining business is Indonesia. As context Freeport’s mine is located in Mimika, Papua where it is one of Indonesia’s most remote and underdeveloped region. Having seen it personally, one can see that Freeport plays a very integral part in both the high-level economics of the city as well as the day-to-day life of the community given that it provides the largest employment in the region. In fact, Mimika’s airport was created by Freeport and rented to the government to be used as a public airport. This leads to my second point, which is addressing the political and social issues surrounding mining and especially Freeport given its size.
While mining is, as mentioned, a big economic driver for the country and especially for Papua it is also rife with ill treatment of its workers and high safety hazards – very similar to our Cynthia Carroll’s LEAD case essentially. Moreover, many Indonesians (and Papuans especially) don’t necessarily have a great impression of Freeport because it’s been seen as extracting much of the nation’s valuable resources while giving very little back. Many of the residents (including Freeport miners) still live in dire poverty with very little access to education, healthcare and basic infrastructure. Personally, it was mind-blowing how beautiful the “Freeport Village” was where it had its own roads built by the company, hospital and school within the compound but once you leave it you’re in an entirely different world. At the same time, given how big of an economic driver they are it’s also hard to say that they should just pack up and leave.
This is further complicated with how complicit the government often is in denying basic human rights and needs to their own citizens. There’s been numerous scandals of government officials receiving bribes or insinuating the need for bribery to Freeport management. The most recent one actually involved the Speaker of Parliament and caused quite an uproar – certainly an embarassing debacle for the nation. While we have no idea who will be elected in 2019 and what kind of administration it will be – at least, based on the past, change is the only constant Freeport can expect and if they can afford to wait and negotiate with the right people who can carry the deal forward it will be a wiser move for the company.
All this being said, I am a big proponent of seeing big companies like Freeport who have the resources to help develop the communities to partner with local government and help provide a decent living standard for the communities it works in – starting from its workers and families.
Sean, this really is a pertinent issue. Especially so with recent trends in areas such as gold mining, where despite an abundance of investment funds, companies are reluctant to enter emerging or frontier markets. (https://www.reuters.com/article/mining-gold-randgold-rsrcs/gold-miners-must-invest-in-emerging-markets-for-future-randgold-idUSL2N1GL16A). Therefore, the final direction taken by the Indonesian government may turn out to be a precedent that changes the global mining supply chain permanently. Freeport’s troubles seem to be two-fold – near term decision on Indonesian government’s stand, and longer term modification of the industry’s supply chain. In the near term, I would argue there is merit in waiting out the 2019 general election. Realistically, the likelihood of a newly elected government to get organised behind a proposal to uphold the export ban within a 12-24 month timeline (i.e., prior to the initial 2021 license expiry for Freeport) is low, especially if Freeport is also making a local $20bn smeltering investment. The employment generated by the local investment should yield valuable political capital for Freeport. The longer term view on supply chain is more complex. There is mixed evidence currently out there. For instance, the Mongolian government’s recent ruling to further open up the country to potential copper and gold mining (https://www.cnbc.com/2017/05/23/miners-ready-for-new-mongolia-boom-with-one-fifth-of-the-country-to-be-opened-for-digging.html), vs. Indonesian government’s varying stance on the export ban. Both impact a mining companies ability to transport raw ore to cost-efficient destinations for processing. Dig a little deeper and it seems that moves by both the countries’ governments were driven by broader macro-economic cycles – the Mongolian government pursuing a $5.5bn IMF-led bailout, and the Indonesian government trying to correct a budget deficit. So, it seems that similar to demand for mining output, the fate of the global mining supply chains is also acutely tied to the economic performance of countries.
To me it seems like the best bet for Freeport is to hold off until 2019 to put pressure on the government as suggested. However that runs the big humane risk of devastating the Freeport community that seems so dependent on the economic activity of the mine, and I worry that Freeport won’t consider the lives of its employees when making such a decision. In an ideal world, I’d love to see Freeport stop activity to put pressure on the government to reverse the tariffs, while still finding a means of employing its people productively. Perhaps their jobs could temporarily be redirected towards improving the quality of living standards in the region?
Very good topic mainly because this can be taken to many other countries, both developed and emerging. I would definitely vote for Freeport to hold its investment until 2019 and putting its current mines in “care-and-maintenance” mode in order to pressure the government. The idea of isolationism is detrimental to any industry or country because it goes against improving supply chains, resulting in a more efficient world. At the end of the day, wolrdwide market trends and country specific decisions and capabilities are the ones that should dictate where commodities are processed, not the governments. Some countries will be more efficient in one area, product, or industry, and the rest in other areas, products or industries.
This example highlights how isolationist policy can lead to adverse consequences regardless of intention. The government’s policy may eventually yield an improvement in the economic status of Indonesia, but it is difficult to asses the progress of such legislation in the short term. Layoffs and reduced taxes may force Indonesia to reconsider their position on ore exports. In contrast, Freeport’s revenue is heavily dependent on the Grasberg mine. Freeport is likely to invest in the domestic smelting; the concentration of their profitability in a single asset necessitates either discontinuing operations or continued investment without superior alternatives.