Freeport Indonesia Promises to Build Copper Smelter in mid-2020 - Photo by PT Freeport Indonesia

JAKARTA (TheInsiderStories) – The long-drawn-out negotiations between the Indonesian government and U.S. miner Freeport McMoRan Inc. (NYSE: FCX) has resulted in absolutely no progress, although the deadline for conclusion of the negotiations has been extended several times. The principles agreed so far are in my opinion a bad deal, as they increase strategic risks for both the country and the company.

The current framework of the deal has Freeport divesting its stake in Grasberg mine, based on fair market value; however, the two sides are so far apart that no agreement has yet been achieved on the parameters of market valuation for Freeport shares. In fact, Freeport and the Indonesian government have diametrically opposing views on the valuation of Grasberg mine assets.

Indonesia bases its calculations by assuming operations of the Grasberg mine until 2021, while Freeport bases its calculations on the assumption that operations will run until 2041, assuming two 10-year extensions to the current contract of work. Freeport also wants to launch an IPO for a part of its stake as soon as possible.

In addition, Indonesia wants Freeport to end the joint venture deal with Rio Tinto, Freeport’s partner in the operation of Grasberg mine. Based on an early agreement between Freeport and United Kingdom’s Rio Tinto, Rio Tinto would be entitled to 40 per cent of Grasberg production after 2021.

On Thursday (25/01), Minister of Energy and Mineral Resources (MEMR) Ignatius Jonan stated the Government estimates the current market capitalization of Freeport McMoRan at about US$20 billion. Roughly, the market value of Freeport Indonesia is thus about $3 billion.

Currently, Freeport Mcmoran holds 90.64 per cent of the shares in Freeport Indonesia, whose assets include one of the world’s largest copper and gold deposits at the Grasberg minerals mine site in Papua Province. Freeport Indonesia operates a proportionately consolidated joint venture, producing copper concentrate that contains significant quantities of gold and silver.

Minister Jonan said negotiations with the U.S. miner are still ongoing and the Government expects a final agreement will be achieved by June of this year. What is clear, he said, is that Indonesia expects a competitive price for Freeport Indonesia shares.

Under the internal deal proposed with Freeport, Rio Tinto shares could be converted into 40 per cent of Freeport shares, should Freeport extend its mining operatorship, right on the Grasberg mining site. Jonan proposed one option for the government to take over Rio Tinto’s participating interest in Freeport and converted the interest into 40 per cent of Freeport shares. This could be done in stages.

Before achieving the deal, the government would undertake due diligence, in order to objectively determine a fair value for the shares. The due diligence is being undertaken by the Finance Ministry and state-owned PT Indonesia Asahan Aluminium (Inalum), which has been given a mandate by the government to take over Freeport shares.

The government will also appoint an independent party to conduct a technical evaluation to determine the value of the 40 per cent of the shares Freeport holds.

Indonesia has an option if no final agreement is reached with Freeport: appointing a new operator or contractor to develop Freeport, or a domestic miner, for instance, PT Aneka Tambang Tbk (IDX: ANTM). The problem is that Aneka Tambang may have limited expertise in terms of developing underground mining on the scale of Grasberg with tunnels up to 700 kilometers in length.

If the negotiations are deadlocked, the Indonesian government could pursue an alternative option, namely, not to extend the Freeport’s contract beyond 2021. This would have to be decided by the President, Jonan said.

August 2017 Deal

Following a framework understanding reached in August 2017, the parties – Indonesia and Freeport – have been engaged in negotiation and documentation of a special license and accompanying documentation for assurances on legal and fiscal terms to provide PT Freeport Indonesia (PTFI) with long-term rights through 2041.

In addition, the permit would stipulate that PTFI construct a smelter within five years of reaching a definitive agreement, and include agreement for the divestment of 51 per cent of the project area interests to Indonesian participants at fair market value.

In late 2017, the Indonesian government (including the regional government of Papua Province and Mimika Regency) and Inalum, a state-owned enterprise, which will lead a consortium of investors, agreed to form a special-purpose company to acquire Grasberg project area interests.

Inalum is 100 per cent-owned by the Indonesian government, and currently holds 9.36 per cent of Freeport Indonesia’s outstanding common stock.

In December 2017, the Indonesian government extended PTFI’s temporary permit up to June 30, 2018, and the company is seeking an extension of its export license (which currently expires on Feb. 16, 2018), to enable normal operations to continue during the negotiation period.

Freeport Indonesia is currently mining the final phase of the Grasberg open pit, which contains high copper and gold ore grades. PTFI expects to mine high-grade ore over the next several quarters prior to transitioning to the Grasberg Block Cave underground mine in the first half of 2019.

Substantial progress has been made to prepare for the transition to underground Block Cave mining: work is sufficiently advanced to allow caving in early 2019. The ore flow system and underground rail line are expected to be installed during 2018.

Subject to reaching a definitive agreement with the Indonesian government to support FI’s long-term investment plans, estimated annual capital spending on these projects would average $0.9 billion per year ($0.7 billion per year net to FI) over the next five years.

Considering the long-term nature and size of these projects, actual costs could vary from these estimates. In response to market conditions and Indonesian regulatory uncertainty, timing of these expenditures continues to be reviewed.

If FI is unable to reach a definitive agreement with the Indonesian government on its long-term mining rights, Freeport McMoRan intends to significantly reduce or defer investments in its underground development projects, and will pursue dispute resolution procedures under its contract of work, the company said.

2017 Results

Freeport Mcmoran reported on Thursday (25/1), Indonesia’s consolidated copper sales of 351 million pounds in fourth-quarter (4Q) 2017 approximated 4Q 2016 sales of 352 million pounds. Gold sales of 584 thousand ounces in fourth-quarter 2017 were higher than 4Q 2016 sales of 401 thousand ounces, reflecting higher gold ore grades.

Assuming achievement of planned operating rates for 2018, consolidated sales volumes from Indonesia mining are expected to approximate 1.2 billion pounds of copper and 2.4 million ounces of gold for 2018, compared with 1.0 billion pounds of copper and 1.5 million ounces of gold for 2017.

Freeport Indonesia’s projected sales volumes for the year 2018 are dependent on a number of factors, including operational performance, workforce productivity, timing of shipments, the extension of PTFI’s export license (which currently expires on Feb, 16, 2018), the extension of PTFI’s export permit after June 30, 2018, and satisfactory progress on the resolution of FI’s long-term mining rights.