Resolution at hand for Newmont in Indonesia

A month after Freeport-McMoRan Copper & Gold (NYSE: FCX) signed a deal with the Indonesian government resolving a standoff over the country’s recently imposed export tax on mineral concentrates, Newmont Mining (NYSE: NEM) appears headed towards a similar resolution.

Based on encouraging progress it has made in talks with the government, Newmont says it’s dropping its legal challenge against the export tax, which was imposed in January. The tax prompted the company to halt exports immediately and suspend production at the Batu Hijau copper-gold joint venture in June. Now that it’s agreed to drop an arbitration claim it filed with the International Centre for Settlement of Investment Disputes in July, discussions can begin on the terms of a new agreement.

Once a memorandum of agreement (MoU) is in place framing the discussions, Batu Hijau will be allowed to restart concentrate shipments.

Batu Hijau is operated by PTNNT, a joint venture between Newmont, a Japanese firm, and three Indonesian corporations. Newmont holds a 48.5% effective economic interest in the JV.

Newmont has always maintained that the export tax violates the mine’s contract of work — the investment agreement that was negotiated before the mine was built.

Along with a ban on the export of unprocessed ore (which temporarily excludes copper, lead, zinc, iron and manganese), the escalating tax was introduced as part of Indonesia’s drive to build more mineral processing capacity — and the associated economic benefits — in the country. Starting at 25%, it increases eventually to 60% in 2017, after which the export of all unprocessed ore will be banned.

In a statement, PTNNT said it would be entering negotiations on a new agreement with the government, but did not say what the discussions would entail.

“The decision to discontinue and withdraw arbitration comes after commitments from senior government officials to open formal negotiatons to conclude a memorandum of understanding (MoU) with PTNNT upon cessation of the arbitration claim,” said the company.

“Signing of a MoU with the government would be followed by the safe ramp-up of copper concentrate production and exports from Batu Hijau.”

Adam Graf, a mining analyst with Cowen & Co. said in a note to clients that the progress could be the result of a change in government after elections last month in Indonesia.

“The new President, Joko Widodo, was officially elected to the position in late July,” Graf wrote. “Widodo has indicated that he aims to seek a more engaging and less adversarial relationship with Newmont than had been sought under the former President Subianto.”

While Newmont did not provide any details about what would be under discussion in the new MoU, Freeport’s recent agreement may provide some insights.

Freeport succeeded in negotiating a lower export tax on its concentrates in exchange for providing a US$115-million bond that will go towards the development of a new smelter. The miner also agreed to pay higher copper and gold royalties.

In return, Freeport was allowed to resume exports earlier this month, and will pay a reduced 7.5% export tax on copper. The rate will decline as the development of a smelter progresses, reaching 0% once smelter development exceeds 30%.

The government also agreed to negotiate a new contract of work for Freeport’s concessions that expire in 2021. Negotiations will take place over the next six months and could amend the size of the company’s concessions, royalties and taxes, divestment, domestic processing, and other aspects of its operations. The government had previously wanted to delay negotiations on a contract of work extension to 2019.

In a release, Freeport said that equitable sharing of the costs of new copper smelter and refining capacity in Indonesia between Freeport, other potential partners, and government would be addressed in talks for its amended contract of work.

There is currently only one copper smelter in Indonesia, Gresik, which is partially owned by Freeport.

While Newmont says studies have shown it would not be economic to build a smelter at Batu Hijau, it has an MoU with Freeport to participate in a process that is “designed to lead towards the development of a smelter.”

Although no details have been released, Cowen & Co.’s Graf doesn’t believe that Newmont will have to go so far to resolve its dispute with the government.

“We think an agreement could be reached that would forgo construction of a smelter, in exchange for payment of a more reasonable export tax,” he wrote.

Graf has assumed a 50% reduction in concentrate sales from Batu Hijau this year; last year, the mine produced 161 million lbs. of copper concentrate.

Newmont shares traded at US$26.50 this afternoon in a 52-week range of US$20.79-34.27. Graf has a 12-month target of US$33.96 on the stock.