Freeport-McMoRan (FCX) is a huge copper and gold miner and is responsible for about 9% of the world's copper supply. It has been in the news for quite some time that the Indonesian government has put a ban on metal ore export in order to strengthen the economy in the long-term. However, the government faced stiff opposition from smelters and realized that it would be devastating for the economy. As a result, Freeport-McMoRan received an exemption on Copper Ore export. As good as it sounds, the threat is not over yet. The Indonesian government has agreed to do it just as long as Freeport-McMoRan pays the new export tax of 25% which may continue to rise up to 65% till 2016.
Risks and Impact of The Indonesian Decision
There are concerns for Freeport-McMoRan at both supply and demand ends. The demand side risks are the low prices of copper due to over-supply and decreased demand from China, which accounts for 40% of the world's copper consumption. The new tax which is levied on the company by the Indonesian government would result in Freeport paying roughly $5 billion in taxes by 2016. This is obviously a big outlay for the company - however, as I mentioned in my previous article, the losses from the ban would have been far larger than this payment. As a result, this is a far better option for Freeport-McMoRan in my opinion. Indonesian operations account for a substantial portion of the total production of the company and during the year 2013, the Grasberg mine in Indonesia accounted for 27% of total production. The company has currently held its shipments of copper exports and stays firm on not conforming to the new taxes as it violates the previous agreement.
Coping Strategy: Leverage and Diversification
The Indonesian threat has been a long time coming and the company has taken a few steps to take control of the situation. Currently, Grasberg's mine in Indonesia accounts for 915 million pounds of annual production of copper. For any negotiation, you need to have leverage which is exactly what Freeport-McMoRan is working on. The company is investing in its second largest copper mine in North America, Morenci, to cope with the losses that may arise from the Indonesian threat. According to year-end 2013, Morenci accounted for 564 million pounds of copper production annually. The company is already working on its expansion and by 2015, its annual production would exceed a billion pounds of copper annually. Considering the worst case scenario, if the company were to shut down its operations in Indonesia, it can still make up for 38% of it through Morenci by 2015.
Moreover, it is not likely that the company will shut down its operation in Indonesia. Freeport-McMoRan accounts for a big chunk of their exports and this is why the government of Indonesia has given them the exemption on exports. I expect the parties to reach an agreement as the decision by the Indonesian government shows that they acknowledge the importance of the company to their exports - this will give Freeport-McMoRan substantial negotiating power. The company realizes this and continues to expand its operations in Indonesia as well simply because there is too much potential in the Grasberg mine, 94% of which the company owns.
As I said, this threat has been a long time coming, and the company has been preparing for it through diversification. With its acquisition of McMoran Exploration and Plains Exploration & Production for $9 billion, the company has the power to mitigate the risks it is facing in the demand and supply of copper.
Even though these are not the best of days for Freeport-McMoRan, the strategy it is playing to cope with the threats is astute, in my opinion. The Indonesian government should settle for a reasonable tax and the company would continue its operations. This is because Freeport-McMoRan accounts for too much of their copper exports for them to lose. The company has taken huge amounts of debts to fund the acquisitions and expansions in the last year and the debt increased by 82%. This has resulted in increased interest cost. The company plans to bring its debt down to $12 billion from the current $20 billion by the end of 2016 which should further enhance the profit margins of the company.