Indonesia's new policy of discouraging exports of unprocessed ores and encouraging smelting could hurt the stock value of Freeport- McMoRan (FCX). Freeport's largest operation is the Grasberg Mine in Papua, New Guinea.
Last week, Indonesia's Finance Ministry expanded the list of ores that will be subjected to a 20% export tax. The tax already affected 14 metals, including copper and gold. The tax is designed to force miners to comply with a 2014 deadline to start refining metals in Indonesia. The idea is to create jobs on Indonesia's most populated islands, such as Java, which have not seen much benefit from the nation's mining boom.
Currently, most of the ore from Grasberg is shipped directly to refineries in China. The Indonesians want it to be processed there, and then shipped to China. This obviously leaves Freeport in a lurch. It will either have to pay the tax, which would destroy profits, or spend a lot of money building or buying refineries in Indonesia.
Either course of action would significantly cut Freeport's earnings per share and perhaps its dividend. The company would have to take on a lot of debt or use profits to cover the added expenses. Naturally, that would send Freeport's stock values falling.
Freeport-McMoRan on Indonesian Smelting Operations
There was some evidence that Freeport owned a refinery in Indonesia through its PT Freeport Indonesia subsidiary, but that has disappeared from its website. So, Freeport could be more vulnerable to politics in Indonesia than previously thought. Oddly enough, the English language version of PTt Freeport Indonesia's website, which used to be easy to access, has also vanished from the web.
Such secrecy is not going to endure Freeport with investors, and it could cause its stock value to fall. If investors think Freeport is hiding something in Indonesia, they could start dumping its stock. This could be very likely after media reports about violence that could affect operations at Grasberg.
That could benefit companies with large copper operations outside of Indonesia, including Rio Tinto (RIO), BHP Billiton (BHP), Southern Copper (SCC), and Anglo American. Billiton, which has large mining operations in Australia, would benefit the most because it is in the best position to ship to China.
Indonesia Encouraging Smelting
The Indonesian government does want to help mining companies comply with the new law. Reuters reported that it is planning to offer unspecified financial incentives to companies that want to build refineries there. Unfortunately, details of the incentives are not available, so it is not known whether Freeport would benefit from them or not.
The nation's trade ministry has also granted exemptions to the new law to two mining companies, PT Aneka Tambang (or Antam) and PT Sebuku Lateric Iron Ores. These appear to be Indonesian- owned companies, so this tax could be a way to force foreign mining companies to sell more assets to Indonesians.
Freeport's commitment to Indonesia could hurt its stock value
Freeport does seem to be committed to staying in Indonesia. Its's subsidiary, the Freeport-McMoRan Exploration Corporation and Kalimantan Gold (KMGLF.PK), are drilling test holes for gold and copper in Central Borneo. Kalimantan is the Indonesian name for the part of Borneo that it controls. The Indonesian government has given the companies the necessary forestry permits to drill there, s. So it is obvious that Freeport thinks it has a future in Indonesia and that the Indonesian government would like Freeport to stay.
The question will be whether investors view this as a risky move. Indonesia is politically unstable and the mining industry is unpopular in the nation. This instability will grow because the country faces a presidential election in 2014, and like his counterpart in the U.S., President Susilo Bambang Yudhoyono can only serve two terms. His second term is up in 2014, so Indonesia faces a contested presidential election then.
Foreign -owned mining companies are sure to be a popular scapegoat on the Indonesian campaign trail in 2014. That means we're likely to see calls for even greater restrictions on foreign mining in Indonesia in the years ahead. If that happens, expect to see a serious drop in Freeport stock. Also expect to some other companies to divest themselves of Indonesian assets.
If it could locate and develop another large copper and gold mine in Indonesia, Freeport could greatly increase its stock value. Borneo is closer to China and Indonesia's more populated islands than New Guinea is, so it would have lower shipping costs from Kalimantan. The company also has experience in Indonesia, so it might have an easier time developing the mine.
The Kalimantan work indicates that Freeport is committed to preserving and expanding its stock value in the future. The interesting question is whether the political climate in Indonesia will cooperate with this strategy.
Rio Tinto's Commitment to Expansion could also hurt stock value
Freeport isn't the only big mining company whose stock price could be sunk by a seemingly mindless commitment to questionable expansion. Reuters reported that Rio's iron ore boss, Sam Walsh, told reporters that his company is committed to doubling iron ore production by 2016.
The problem is that there could be no market for all that extra iron ore Rio wants to mine. China is the biggest customer for steel and iron, and its manufacturing seems to be contracting because of falling exports. Things are even worse in Europe, where auto sales have declined by 18% because of the debt crisis.
That would seem to indicate that the demand for steel does not justify Rio's expansion plans. If Rio doesn't trim back its expansion plans and soon, it will see its stock values crumble.
The big winner here could be Billiton, which has shown a willingness to adapt to a changing economic reality. Unlike Rio and Freeport, Billiton has shown a willingness to review expansion plans and shelve them until the numbers justify them. That could help its stock values, as other miners waste money on unwarranted expansion.
Australian state Government could force Billiton to go Ahead with Questionable Expansion
The state government in South Australia is trying to force Billiton to start work on a new open pit mine at Olympic Dam whether it wants to or not. Tom Koustantonis, the mining minister for the state, said he would not grant Billiton an extension on permits it needs for the open pit work. That means Billiton must start the work by the end of 2012.
Billiton already has an underground copper and uranium mine at Olympic Dam. It has plans for a $20 billion open pit operation at the same site. The company wants to put those plans on hold because it wants to reduce spending on expansion. Billiton wants to reduce expansion because its management team believes the current commodities market doesn't justify the expansion.
South Australia's head of government, Premier Jay Weatherill, has claimed that Billiton's reasons for not going ahead with the project are artificial. Weatherill has asked Australia's federal government to get involved and take action to help Billiton start work at Olympic Dam.
This could hurt Billiton's stock value, because it could be forced to go ahead with a project that it admits may not be economically justified. The falling price of copper and the falling demand for uranium caused by the Fukishima disaster in Japan mean that there may not be a market for increased production from Olympic Dam.
Billiton may have to shift its plans and cancel another big ticket expansion. It might also be able to comply with the requirements by conducting small scale operations at Olympic Dam.
This incident calls into question the belief that Australia is a safe political environment for miners. Australian politicians seem to be just as prone to attacking mining companies as their counterparts in Indonesia. Like some other political leaders, they seem to be intent on forcing mining companies to provide good paying jobs to voters at the expense of the bottom line.
That could seriously undermine the stock value of companies such as Vale, Billiton, and Rio Tinto, which have bet heavily on Australia. They could be forced to make politically motivated decisions that will undercut profits, earnings per share, dividends, and ultimately stock values.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.