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JAKARTA – When Indonesia’s government took majority control of the legendary Grasberg mine from American mining giant Freeport McMoRan Copper & Gold (FCX) two years ago, visions of an onrushing gravy train obscured the cost realities of operating one of the world’s richest copper and gold complexes in Papua’s mist-shrouded central highlands.
Central to the negotiated takeover from PT Freeport Indonesia (PTFI) was a nationalistic demand that the Phoenix-based company build a US$3 billion smelter, which in theory would allow Indonesia to reap the benefits of more value-added production rather than exporting mere raw materials.
With the Covid-19 pandemic straining the country’s public finances and Freeport now an important part of the state mining stable, signs had emerged in recent months that the government was rethinking its insistence on the expensive facility slated to be based in East Java.
Like Freeport, industry experts have been adamant from the start that the final 5% stage of refining the Grasberg’s concentrate into copper cathode hardly justifies the huge cost of a smelter, even as part of President Joko Widodo’s strongly cherished venture into more industrial development.
But Coordinating Minister for Maritime Affairs and Investment Luhut Panjaitan, whose over-arching portfolio includes mining and oil and gas, is having none of it. “It is going ahead, absolutely,” he told Asia Times. “We have to have the smelter in Indonesia.”
Indeed, national pride seems to demand there is no backing down. Panjaitan says he is well aware of the economics, but as he points out: “We have been exporting our mineral wealth for decades. We need to get more value. We’re not stupid anymore.”
Perhaps the closest of Widodo’s advisors, he says it is even possible that a second smelter will be built in Papua, tying increased copper processing into plans for a domestic electric-car industry, which may become more viable if Europe sticks to its pledge to ban fossil-fuelled vehicles by 2045.
South Korean car-maker Hyundai has announced plans to build a $1.5 billion electric car plant in West Java, with the material for fast-charging lithium-ion batteries coming from a Chinese-funded Morawali nickel complex in Central Sulawesi and several other plants in operation under development in Sulawesi and neighboring Maluku.
Rumors of a policy rethink emerged with the newly-amended Mining Law, the first piece of legislation passed since the onset of the coronavirus, which leaves it up to the government to determine how far miners must go in downstream processing.
Instead of making value-added production a hard and fast requirement, the new law stipulates that future regulations dealing with minimum levels of refining and smelting should take into account economic gains and market needs, factors which have been largely ignored so far.
It’s an argument FCX has made ever since the passage of the 2009 Mining Law, which imposed a value-added requirement on all minerals with only scant regard for what would make a profit in a notoriously roller-coaster industry.
The quest to add value to Indonesia’s minerals is understandable, but Freeport’s copper concentrate, shipped down a 112-kilometer-long pipe from the high-altitude Grasberg, is already 95% of the value of the final product when the slurry reaches the drying sheds on the coast.
“The language in the law does open the door, but the issue of political vested interests still presents a challenge,” says one mining executive, familiar with the Freeport case. “The problem is also the bureaucrats, who have convinced themselves there will be a public outcry (if the smelter is scrapped).”
While that would be less likely with the control of PTFI in the hands of state holding company Mining Industry Indonesia (MIND ID), Widodo has shown on several occasions that he is particularly sensitive to any suggestion he is bowing to foreign interests on issue of the country’s natural resources.
Although some of the president’s senior ministers are believed to be having second thoughts about the smelter, at least in private, Panjaitan is not one of them. “Freeport still has the commitment.” he says firmly. “It’s the law.”
Grasberg’s copper reserves currently stand at 36 billion pounds, making it the fourth biggest copper deposit after Chile’s Escondida and Collahuasi and the FCX-owned Cerro Verde mine in southern Peru, which it acquired with the takeover of Phelps Dodge in 2007.
After leading the world for decades, Grasberg’s current 29.1 million ounces of gold reserves now puts it in second place behind South Africa’s South Deep, with an estimated 32.8 million ounces buried under the Witwatersrand Basin, southwest of Johannesburg.
But Freeport is strictly speaking a copper play and in the mining’s world of valuation offsets the three-million-year-old volcano’s high gold grades allow the company to produce a pound of copper for about 20 cents, reputedly lower than any of the 20 largest copper mines worldwide.
Whether the smelter actually goes ahead may still depend on financing from international banks and how willing they are to support the project in a post-pandemic environment, particularly when it has faced constant delays already for both political and economic reasons.
Before the change of ownership, Freeport was the company everyone loved to hate in Indonesia, largely because of the free ride it was perceived to have been given by president Suharto’s New Order regime as the fledgling republic’s largest foreign investor.
Handing over of PTFI’s majority rights to the mine and agreeing to build the two million-ton smelter were the two key concessions FCX had to make to continue working the Grasberg until 2041, a period during which it will remain in charge of operations.
During an April 24 conference call, FCX chief executive Richard Adkerson noted Indonesia’s “struggle” with state revenues, subsequently underlined by the unveiling of a new $43 billion pandemic-related recovery package, including $3 billion earmarked for state enterprises.
He said while FCX was still committed to the project, it had been “engaging with the government whether this new circumstance (Covid-19) might provide a way where it might be mutually advantageous to reconsider what we are doing with the smelter.”
He made it clear, however, that the exchange should not be characterized as a negotiation, leaving observers to speculate on the purpose of his unannounced visit to Jakarta last February to meet Economic Coordinating Minister Airlangga Hartarto.
With the pandemic as a possible distraction, the amended mining law won the support of all the political parties, apart from former president Bambang Susilo Yudhoyono’s centrist Democrat Party, which argued that further discussions were needed.
Jakarta resources lawyer Bill Sullivan agrees the language in the amended law hints at a possible softening of the policy. “It’s something the mining companies have been pushing for some time,” he says. “When it comes to smelting, one size does not fit all.”
If there is a perceptible change in the language on processing, it was largely overlooked by commentators focusing on the central government winning back the authority to issue mining licenses from regional administrations after years of local-level corruption and chaos.
But the biggest coup was engineered by the six big coal companies, representing some of Jakarta’s most powerful political and business interests, who were effectively guaranteed 20-year extensions to their mining permits when they expire between 2020 and 2025.
It ends a concerted move by previous state enterprise minister Rini Soemarno to take over many of the largest concessions in Kalimantan, in what had become a struggle between the public and private sectors for control of the $32 billion coal industry.
For private business, it was a welcome victory over state firms, which despite a reputation for inefficiency, have played an increasingly dominant role in Widodo’s signature infrastructure program and other sectors of the Indonesian economy.
Freeport McMoRan didn’t have the same political muscle, finally being forced to relinquish a 51.2% interest in PTFI to state-owned bauxite refiner PT Indonesia Asahan Aluminium (Inalum) in December 2018 after two years of tough negotiations.
Last August, Inalum, PTFI and three other state mining companies, PT Tambang Timah (tin), PT Aneka Tambang (gold and minerals) and PT Bukit Asam (coal), were all placed under the umbrella of MIND ID, which controls more than $6.6 billion in assets.
Widodo called it an “historic moment,” but the effective nationalization of the Grasberg was always going to bring a heavy financial burden coming in the middle of the mine’s transformation from an open pit to a complex underground operation.
In fact, the costs are so high that some senior officials began wondering out loud whether the government would be guilty of scoring an own goal by pressing ahead with a smelter that technical experts agree is unnecessary, unjustified and uneconomic.
“It’s an old argument we made for years,” says one former negotiator. “Do they really want to spend taxpayer capital on a losing proposition for purely nationalist reasons? Surely they can find a better use for the money at a time like this.”
PT Smelting, Mitsubishi Heavy Industries’ existing smelter in Gresik, East Java, which was built in partnership with Freeport, already turns out 300,000 tonnes of refined copper a year, enough to meet all of Indonesia’s needs, but on perilously thin profit margins.
Analyst assessments show a new smelter would lose between $200-$300 million a year, compared to the tariff revenue generated by exporting 60% of Freeport’s concentrate to mainly China and South Korea, as it continues to do for now.
This year’s global benchmark processing charges are $62 a tonne for smelting and 6.2 cents a pound for refining, far below the $90 and 9.5 cents the Chilean mining industry calculates is necessary for a smelter’s long-term viability.
In the current market, Chinese smelters need charges in the $72-75 range to break even, still below last year’s $80.80, which were already the lowest since 2011 when over-supply saw refined copper trading at $10,000 a tonne, compared to $5,240 today.
“Outside of China, the building and running of smelters is difficult to justify given the capital and operating costs,” says London-based copper analyst Simon Hunt, noting that the Chinese already account for 46% of global refined production.
Last year, China also accounted for 52% of world refined consumption, driven increasingly by infrastructure, property and electricity-intensive products in the New Economy, including 5G networks, robotics, data centers and electronic vehicles.
But as Hunt points out: “China will continue to expand its smelt and refining capacity to meet its growing demand for cathode. This means it needs more concentrate than cathode imports. We should expect some restructuring of existing operations, but also more expansion using state of the art technology.”
Quite apart from the economics, analysts point to another sobering set of facts about the Mitsubishi smelter that they feel the president should be mindful of in his single-minded quest for more value-added across the board.
While the facility has been refining 40% of Freeport’s concentrate for more than two decades, the only ancillary industry to develop around it has been a state-owned fertilizer plant, which utilizes the sulphuric acid by-product from the smelting process.
Because of the high cost of moving finished copper cathode across Java, PT Smelting’s customers around Jakarta already have a hard time competing against an over-supply of cheap imports from China and South Korea, particularly copper sheet, strip and tube.
Market analysts say Indonesia has always had a surplus capacity of wire rod, the base product for power, telecommunication and building cables, partly because aluminium is a common substitute and partly because of overseas competition.
Previously timed for completion in 2023, Adkerson has already warned that pandemic-related worker restrictions and supply chain disruptions will cause further delays to the new smelter at an industrial estate north of the East Java port city of Surabaya.
In its 2019 annual report, FCX notes it will be paying only 49% of the $500 million budgeted for the facility this year, providing ammunition for those in government who feel a better course of action will be for PTFI to take over and expand the Mitsubishi smelter instead.
During a May 18 webinar, PTFI president-director Tony Wenas and Rachmat Makkasau, chief executive of second-ranked copper miner PT Amman Mineral Nusa Tenggara, both said they hoped the pandemic would convince the government to do a re-think.
About a third of Amman’s annual output of 336,000 tonnes of concentrate is also processed by the Mitsubishi smelter, but the idea of the privately-owned Indonesian company joining forces with Freeport appears to have been moved to a back-burner for now.
Jointly owned by financier Agus Projosasmito’s PT AP Investment and oil and gas pioneer Arifin Panigoro’s PT Medco Energy, Amman lacks the financing to build a $1.9 billion smelter, in addition to closing out its Batu Hijau mine and opening a new concession 40 kilometers away on Lombok island.
Under the provisions of the 2009 law, Indonesia stopped all exports of raw ore, including nickel, bauxite and copper concentrates, in late 2014, then relaxed the ban in 2017 on the condition that miners used part of their revenues to build smelters. That is due to run out in January 2022.
About 40 smelter projects of varying sizes are currently under construction, more than half of them nickel processors and the biggest of those being built by Chinese investors who were on the ground in mineral-rich Indonesia long before anyone else.
Unlike copper, nickel processing also adds as much as 40% value to the end product. So does bauxite, but the up-front cost makes it less attractive to financiers. Other mineral deposits, such as manganese and lead-zinc, are often insufficient to make a processor economic.
Although PTFI’s 29,000-strong Grasberg work force has been hit by the Covid-19 outbreak, work on the $10 billion underground expansion continues apace, with FCX’s first quarter report only noting a deferred $200 million mill project.
As the majority shareholder, MIND ID will be liable for half of those development costs, or an estimated $800 million a year, mostly in the initial five years as PTFI expands the infrastructure needed to fully exploit four of the mine’s five underground deposits.
Apart from future loan repayments and having to meet half the expense of the new smelter, part of MIND ID’s revenue stream will also routinely go towards its share of the company’s operating costs, which last year came in at $2.53 billion.
As it was, last year’s revenue totalled only $2.7 billion, well down on the $5.4 billion recorded in 2018 and $4.44 billion in 2017, both years boosted by the increasingly rich copper and gold grades encountered in the bottom of the open pit.
Employing a 28-kilometer automated underground railway system, Freeport plans to ramp up annual output from 670 million to 1.7 billion pounds of copper and one million to 1.7 million ounces of gold over the next three years, more than it was producing from the pit.