Freeport stands strong in eye of Indonesia’s nationalisation storm

VANCOUVER — The world’s largest, publicly-traded copper producer, Phoenix-based Freeport-McMoRan Copper & Gold (FCX-N), is standing tough in the face of simmering labour turmoil and nationalisation overtures aimed at its Grasberg copper-gold mine in Indonesia’s Papua province.

A three-month labour strike at the mine last October — which resulted in a 13% and 26% drop in respective copper and gold outputs last year — was thought to be resolved when Freeport’s Indonesian subsidiary PT Freeport Indonesia (PTFI) agreed to a two-year labour agreement with its workers union in mid-December. Hostilities again broke-out in February, however; as employees who supported the strike clashed with those willing to cross picket lines during the labour unrest,

“During the first quarter we continued to face work interruptions in connection with our re-integration of the labour union workers back into our operations,” explained Richard C. Adkerson, Freeport’s president and chief executive officer. “We had roughly a three-week suspension of activities as we met with our workforce to resolve certain issues, and to undertake a socialization of the new labour agreement.”

Freeport’s year-on-year first quarter net earnings dropped sharply as a result of the labour turbulence, clocking in at just US$764 million or 80¢ per share, compared to US$1.5 billion or $1.57 per share during first-quarter 2011.

According to vice president and chief financial officer Kathleen Quirk, estimated losses attributed to the first-quarter work stoppages at Grasberg totalled roughly 80 million lbs. of copper and 125,000 oz. of gold. Operations and productivity at PTFI have reportedly improved recently, with quarter-to-date milling rates averaging 200,000 tonnes of ore per day, compared with just under 115,000 tonnes of ore per day in the first quarter.

Freeport has yet to lift a “force majeure” imposed on certain copper concentrate contracts due out of Grasberg over the past six months, but according to Adkerson the company will do so as soon as “operations return to normalcy”, which the company speculates will happen during the second quarter.

In tandem with resolving the PTFI-labour disputes, Freeport is also in negotiations with the Indonesian government to extend its contract of work through 2041. The negotiations come at a time when Indonesia is undergoing aggressive nationalisation debates due to a recently-ratified mining law that requires 51% domestic ownership in international companies,

“Our contract technically has a status, which means it was adopted by law and has a status of law in Indonesia,” Adkerson commented. “The situation in Indonesia, in terms of resource nationalism, is something the mining industry is facing globally right now.”

Freeport signed a 30-year contract of work with the Indonesian government in 1991 that also provides for two 10-year extensions. The company is currently in talks with Indonesia’s Ministry of Finance, Ministry of Mines and Energy, and Ministry of Industry in order to solidify Grasberg’s operations for the next 29 years,

“On the terms of the original contract, applying for those extensions, which we have started that process now, requires government approval,” Adkerson said. “But the contract provides that the approval cannot be withheld unreasonably.”

Under Freeport’s existing contract of work the company pays a 35% income tax rate — statutory rates in Indonesia are 25% — as well as 3.5% royalty on copper, 1% royalty on gold, and a 10% withholding tax on payment of dividends from PTFI to Freeport. Indonesia’s new mining legislation requires royalty payments of 4% on copper and 3.75% on gold, but Adkerson maintains when including a 9% stake the Indonesian government maintains in PTFI operations, that Freeport is contributing over 50% of Grasberg’s cash flow to domestic interests.

“Our contract-of-work payments to the government are higher than prevailing law,” Adkerson stated, “In fact they are higher than if the laws of any other country were applied to our mining operations.”

Freeport is one of the largest taxpayers in Indonesia, and has contributed over US$60 billion to the country’s national gross domestic product since 1992. The company is the largest employer in Indonesia’s Papua province, and has contributed US$500 million through its “Freeport Partnership for Community Development” initiative since its establishment in 1996.

“The partnership is the biggest revenue for the region,” said company chairman James R. Moffet, “Roads, schools, hospitals, government buildings, community housing. There is nobody that has contributed as much to the local community.”

Despite the fact Freeport maintains it has immunity from any divestiture requirements, the Indonesian government has been releasing rhetoric to the contrary.

 Director General of minerals and coal Thamrin Sihite told reporters on April 18 in Jakarta that the country was readying a ban on unprocessed metal ore shipments. According to reports, companies with existing contracts of work like Freeport and Newmont Mining (NMC-T, NEM-N) will be permitted to ship through 2014,

“We will allow exports for some companies, but they will have to sign a letter of commitment that they will stop all shipments by 2014,” Sihite said.

When asked about the Indonesian government’s overtures during a conference call, Adkerson brushed off the comments as “political talk” in light of an upcoming election scheduled for 2014,

“Just like comments we hear in our political process, there are things often said that are changed as the reality facing the situation comes to bear,” he said.

The negotiations come at an integral time for Freeport, which is moving forward with a US$6.4 billion expansion plan at Grasberg designed to provide access to underground ore bodies at the Grasberg BC and Deep MLZ zones. The two projects are scheduled to hit ramp-up stages through 2016, with steady-state expected by 2021. The company has completed 55-km worth of development at Grasberg BC, and 20-km worth of development at Deep MLZ at a cost of US$1 billion.

According to Moffet, if negotiations do hit the arbitration route there is precedent supporting Freeport’s case.  In 1998 MidAmerican Energy Holdings successfully filed for arbitration against Indonesian state-owned utility company Perusahaan Listrik Negara. The government entity reneged on conditions in a contract involving the development and operation of a series of geothermal-electric power plants. MidAmerican successfully recouped US$290 million when it exercised arbitration proceedings against the Indonesian government pursuant to its existing work contract.

“The idea is that there exists a precedent that you cannot change the contract without mutual agreement between the parties is well known,” Moffet said. “To say there is a ‘middle ground’, what does that mean? There is no middle ground. The international arbitration clause has no middle ground. We can’t give it up; the government knows we can’t give it up.”

Freeport’s shares have struggled over the past 52-weeks under strains relating to its Indonesian operations, as well as weaknesses in copper and gold markets. Company shares are down 31% or $17.05 when compared to this time last year, closing at $38.02 on April 19 on a 26-million-unit trade volume.

Despite relatively depressed share valuations, the company remains optimistic regarding socio-economic conditions at the global level,

“Markets continue to be very positive this year for copper. We saw a stronger than expected start for our business in the U.S. Europe is weak, but it is not as weak as some feared going into the second half of 2011,” Adkerson commented. “China has taken steps to control growth, but continues to spend money on infrastructure projects, and its fundamental economy appears to be strong, and overall the copper market is very positive given the uncertainties of the world we’ve been living in.”