Locked in protracted negotiations with the Indonesian government over the future of its hugely profitable Grasberg mine, Freeport McMoRan Copper & Gold now faces an unsteady share price and deteriorating security around its Papua-based operations to add to its troubles.
Despite the release of better-than-expected third quarter revenues of US$3.41 billion, Freeport’s shares slipped by as much as 4.9% in heavy trading on October 25 as investors sent a sharp reminder that the outcome of the talks with Jakarta are what matter most.
The Phoenix-based company is worth US$20.4 billion on the New York Stock Exchange, with the Grasberg responsible for more than a quarter of its overall copper production in 2017, estimated at 3.7 billion pounds, and almost all this year’s expected haul of 1.6 million ounces of gold.
Since Freeport reached a framework agreement with the government last August to divest 51% of subsidiary PT Freeport Indonesia (PTFI), the talks between parent chairman Richard Adkerson, Mines and Energy Minister Ignasius Jonan and Finance Minister Sri Mulyani Indrawati have run into hard going over valuation issues.
It may not be all gloom, however. With President Joko Widodo reportedly taking a direct hand in steering the process – and Adkerson expressing a measure of optimism in recent days —the two sides do appear to have made progress on some fronts.
Although the share price has largely recovered from its October 25 dip, what appeared to catch the market unawares was Adkerson’s remark that Freeport’s stake in PTFI would eventually drop from its current 90.64% to 29% under any new deal with the government.
He was referring to a complication created by Freeport’s 1995 joint venture with Rio Tinto, under which the Anglo-Australian company gets 40% of production above specific levels until 2022 and 40% of all production after that.
That means the current negotiation centers on the ownership of 60% of Grasberg’s future production which, with the planned closure of the open pit late next year, will come solely from the underground operation where Rio Tinto has been investing its capital.
As Adkerson spelled out clearly, accepting Indonesia’s demands for 51% of Freeport Indonesia would effectively see the parent company’s stake in the world’s largest gold reserve and second biggest copper deposit reduced by two-thirds.
“While our interest in the participation in Grasberg would be reduced, we would be receiving cash from that interest,” Adkerson reassured analysts in his conference call from Jakarta, where every question focused on the Grasberg. “There’s positives and negatives to that.”
Rio Tinto’s deal applies no matter who owns the mine, but its chief executive Jean Sebastian Jacques has already indicated the company wants out of the Grasberg, saying “it might be a world class deposit, but not a world class investment.”
His remark in a recent Bloomberg interview that “an investment in Indonesia would have to prove more valuable than competing opportunities,” reflects how the Grasberg issue has colored investor sentiment across Indonesia’s natural resources sector.
Last week, multinational energy giant Royal Dutch Shell pulled its country manager out of Indonesia in a signal that Shell will not be going ahead with the development of eastern Indonesia’s Marsela gas block so long as the government insists on it being an onshore rather than offshore project.
Rio Tinto executives have already been in Jakarta talking to prospective Indonesian buyers, including state-owned aluminum producer PT Asahan Aluminum (INALUM), which has also been selected to acquire Freeport’s shares under the divestment plan.
Freeport values PTFI at roughly US$16 billion, twice what minister Jonan believes the parent’s stake is worth — without considering its enterprise value, calculated on market capitalization plus debt, minority interest and preferred shares minus total cash.
The two sides have been far apart on that score and with Indonesia making it clear that the Grasberg’s reserves constitutionally belong to the people of Indonesia, they still must agree on a pricing formula to bring them closer together.
The government accepts the principle of fair market value, but has so far rejected Freeport’s suggestion of a 10% float of PTFI on the Jakarta Stock Exchange as a way of letting the market determine how much that figure should be.
In the meantime, Freeport has cut 25% from the US$1 billion it has been spending each year to extend the mine’s underground operations and says it will suspend further investment altogether if a solution is not found by year’s end.
That will have a serious impact on output over the short to medium term, given the fact that it will already take five to six years to ramp up block-caving production to what has been the norm from the vast open pit over the past two decades.
For all the boastful statements by Indonesian public figures with vested interests and a passing appreciation of the challenges involved, how Indonesia would fund and operate the Grasberg on its own is a question that gets little public airing.
The capital required to buy the 51% stake is only part of what will be needed to continue the underground expansion, which analysts say is beyond the country’s technical expertise.
“Without Freeport, who is going to lend or buy the bonds?” asks one banker who requested anonymity. “The way Indonesia has been going about this does not impress the international money people.”
Security is another growing concern. Gunmen have killed a policeman and wounded 13 other people, including an ambulance driver and his patient, in a renewed outbreak of violence south of the high-altitude mining town of Tembagapura in the past week.
In the latest incident on October 29, shooters targeted a police station and a security post despite paramilitary police conducting a sweep operation in response to the previous incidents, which began on September 24.
Four Freeport employees, including an Australian, died in a series of mystery shootings in 2009 and again in 2011 on the final precipitous stretch of road linking Tembagapura with the lowland town of Timika, Freeport’s logistics center.
Since then, helicopters and armored buses have taken workers to the mountain jobsite. But the latest incidents – and a threatening letter a purported Papuan rebel group recently sent to security forces – have again set the community on edge.
It is a distraction Freeport can do without as it seeks to resolve the stand-off with the government or, as Adkerson reminded Indonesian officials once again last week, the firm is reluctantly forced to fall back on international arbitration as a last resort.
Adkerson said Jonan and Indrawati had brought a “new urgency” to the talks, perhaps mindful that any serious disruption to operations would not just hurt revenues, but risk social unrest across an already-rebellious Papua.
President Widodo has said he wants a “win-win” solution, but for Freeport McMoRan’s shareholders, at least, the only winner at this point appears to be Indonesia as it seeks to wrest control of a world-class deposit that has been under foreign control since the late 1960s.