Freeport-McMoRan: Things Remain Tough In Indonesia

| About: Freeport-McMoRan Inc. (FCX)
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Summary

Freeport-McMoRan restarts Grasberg.

Negotiations with Indonesian government continue.

The situation seems to be headed to arbitration.

In my previous article on Freeport-McMoran (NYSE:FCX), I evaluated 4 possible scenarios for Grasberg. Now that we have fresh news from Indonesia, it's time to look at the stock once again.

Freeport-McMoRan resumed producing copper concentrate at Grasberg after a stoppage that took place on February 11. The restart of production is positive news for Freeport-McMoRan, but the big issue with the contract of work remains unresolved.

As a reminder, the 4 scenarios I previously presented were 1) sale to an outside firm 2) sale to Indonesia 3) arbitration 4) amicable agreement with Indonesia. The fourth scenario is clearly the best for Freeport-McMoRan, but hardly the most likely one. Any news from Indonesia should be evaluated with the scenarios in mind - where the situation is headed?

I decided that reading Indonesian press could bring additional color to the story. Jakarta Post is available in English, which is very handy indeed. I read everything regarding Freeport-McMoRan that was published in March, and here are the key highlights.

The first story that I would like to mention is the story of "violation of rights of indigenous people during the 50-year operation in Papua". In short, locals claim they have not been properly compensated for the use of their land and want a 10% - 20% share in Freeport Indonesia.

Such things almost always arise when there is a dispute between a local government and a foreign investor and serve as a mean to put additional pressure on the foreign company. One has to be extremely naïve to believe that local groups have been silent for half a century about the violation of their rights and then suddenly had their moment of revelation and decided to protect their interests. This is a negative development which shows that Indonesian government is serious about making a deal with Freeport-McMoRan on its own terms.

Another story covers the problems of the Papua economy due to Grasberg stoppage. It mentions the suggestion by Bank of Indonesia that Papua administration should boost other industries like fisheries or tourism (!), another sign that we should expect a prolonged fight.

Meanwhile, the Indonesian government and Freeport-McMoRan officially started their negotiations on March 8. The Indonesian government sticks to its terms - Freeport-McMoRan should divest 51% of shares in Freeport Indonesia and convert the contract of work to a special mining license. So far, Freeport-McMoRan's response to the crisis (besides stopping the work at Grasberg) was to drop the sponsorship of the local soccer club.

Judging by recent developments and commentary from Indonesian officials, it is premature to expect a positive resolution of the deal despite the restart of production at Grasberg. The terms of the Indonesian government are unacceptable for Freeport-McMoRan. Rio Tinto (NYSE:RIO) has reportedly gave up on the project, so Freeport-McMoRan is alone in this fight.

While you can debate the pros and cons of divesting the stake if the price is at least "normal", the conversion of the existing contract of work to a special mining license would be a huge defeat for the company. More, such a conversion will lead to eternal uncertainty over the company's future in Indonesia.

In my view, the situation is heading to arbitration unless Freeport-McMoRan can find a buyer for Grasberg (perhaps, divesting a stake to Indonesia and selling the rest to an outside firm). This means that uncertainty over Grasberg will continue to weigh on the company's shares, which were under additional pressure recently due to downside in the copper market.

All publicly available information points to the fact that this time negotiations with the Indonesian government will be extremely tough. I am convinced that a successful sale of Grasberg (at a fair price, of course) will lead to upside in Freeport-McMoRan shares, but this is easier said than done. If the company has to agree to operate under a special mining license, downside should be expected.

As of now, I expect that Freeport-McMoRan shares will try to consolidate between $12 and $13. Additional news from Indonesia or a big move in the copper market will be the next catalyst. Given the risk of deterioration in Indonesian negotiations, Freeport-McMoRan is a hold at current levels.

Additional read: if you want to feel the local sentiment on Freeport vs. Indonesia, read this article by an analyst at the Indonesian Tax Justice Forum. I suspect that this view (anti-Freeport, of course) is shared by many locals and the Indonesian government has full public support and incentive to negotiate hard with Freeport-McMoRan.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.