Will Freeport Suffer From Indonesia's Mineral Export Ban In 2014?

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Freeport McMoRan Copper ( FCX ) may have to bear the brunt of a mineral exports ban that Indonesia is planning to put in place beginning January 2014. From January, mining companies are required to first process the mined ore within Indonesia before exporting it. Freeport currently gets most of its processing done at international smelters outside Indonesia.

Freeport is the biggest miner in Indonesia and operates the massive Grasberg copper and gold mines. Grasberg is the world's second largest copper mine. The company may have to cut its exports to about 40% of current levels and lay off a large portion of its workforce if the ban comes into effect. The Indonesian government's move isn't a bolt out of the blue though. It had been legislated quite a while back but mining companies have been hoping to somehow evade it. Hectic parleys and discussions are still going on according to Freeport, but as late as last week there had been no change in the government's stance. It is to be noted that a reduction in exports will impact the government's own revenues as it will no longer receive royalties on the ore not exported.

We have a Trefis price estimate for Freeport McMoran Copper of $29 which represents a 15% downside to the current market price.

See our full analysis for Freeport McMoran here

What Is The Export Ban All About?

A mining law enacted in 2009 prohibits export of unprocessed minerals from Indonesia after January 12, 2014. The purpose is to increase the value of commodity exports and encourage development of the local processing industry. As late as last week, the parliament reaffirmed its support for the law.

The problem for mining companies like Freeport is that there is a shortage of smelters in Indonesia even if they were ready to process all of their ore before exporting them. In addition, Freeport says that it ships its minerals under long-term contracts to international smelters and wishes to honor these contracts. It says that it entered into these contracts in the first place because its initial agreement with the Indonesian government allowed it to export concentrates without placing any restrictions. However, the company has displayed its willingness to study the viability of constructing additional smelting capacity in the country. The problem is that any such additional capacity can't come up in such a short time. (( Indonesia trying to skirt its own ban on mineral exports , Reuters))

Newmont Mining, another major copper producer, currently smelts less than a quarter of its ore in Indonesia and has warned that it may have to halt operations at its Batu Hijau mine.

What Is The Expected Impact Of Enforcing The Ban?

Apart from being a large producer of copper, Indonesia is also the biggest producer of nickel, the top shipper of tin and the leading supplier of bauxite to China. The export ban will thus have a tremendously negative impact on the country's finances.

Currently, Indonesia is struggling to cut a large current account deficit. As a result of the high deficit, confidence in its currency is being undermined which has been Asia's weakest performing this year after falling around 20% relative to the U.S. dollar. Any cut in exports will results in bigger deficits and a further weakening of the currency. A weak currency makes imports costlier which in turn fuels inflation and angers the population. So far, the authorities have been deliberately slowing growth in an attempt to cut imports and the current account deficit but a reduction in exports may cause the deficit to widen to unmanageable proportions.

If the ban stands in its present form, Freeport is expected to face a loss in revenue of around $5 billion next year. This amounts to 65% of its total revenue in Indonesia. Right now, it processes about 40% of its output at a smelter in Java while the rest is exported. Therefore, the company's output at the Grasberg mine will fall by 60% after the ban, with the production of copper reducing by 900 million pounds and that of gold by 1.7 million ounces. It would also have to layoff half of its 15,000 employees in Indonesia, which may cause worker unrest and pose further problems for the government. Financially, the country will lose $1.6 billion in taxes, royalties and dividends, which translates to a reduction of 0.6% in its GDP growth rate. According to the country's central bank, the GDP growth rate is expected to be 6% next year if the ban is not enforced.

According to Nomura, Indonesia could lose as much as $400 million a month in export revenue. This would have a substantial impact on its trade deficit of $700 million a month.

What Is The Government's Stand?

Given the adverse ramifications of enforcing a ban, the government is understandably keen to resolve this tricky situation without being accused of breaking the law. Last week, lawmakers rejected the government's effort to water down the ban by allowing mining companies to export unprocessed ore if they were able to show they were building smelters or were prepared to pay higher export taxes.

The government can now try to find a way around the law by adjusting the regulation that determines minimum purity thresholds for processing. According to the Indonesian Mining Association, the law only states that companies must process and refine their products domestically. Right now, there is a huge discrepancy between the minimum processing threshold for copper (99.9%) and nickel pig iron (6%) set out in a government regulation, which is outside the purview of the parliament. This can be changed through a ministerial decree without requiring the parliament's approval or breaking the law.

We will have to see how events play out over the next few weeks because it's not clear how far the government would be willing to go in the matter. Any attempts to tweak regulations to make it business as usual for mining companies may be seen as violating the spirit of the law. At the same time, the government will find it difficult to ignore pressure from the mining industry which has warned that barring a few players, the sector will not survive in the country after the ban.

In case the ban does go through in its present format, Freeport's revenues will suffer phenomenally. In 2012, the company reported total revenues of $18 billion. Despite expectations of higher revenues this year on account of the oil and gas business, a loss of $5 billion would be a huge setback.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: ABX , FCX , NEM , RIO , VALE

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