The stakes are so high that a deal is almost a certainty. Freeport McMoRan Copper and Gold (FCX) needs the copper production from the giant Grasberg mine, the second largest in the world. The government of Indonesia needs the revenue it gains from Grasberg. It’s just about impossible to imagine that talks over a new contract to operate the mine won’t reach a successful conclusion. But when the politics are as tricky as they are in this case, it’s by no means certain that economic rationality will triumph. After all, I wouldn’t have expected these talks to turn so toxic as to produce a four-month ban on all exports from the mine.
At the core of the dispute is an effort by the Indonesia government to gain greater control over the country’s natural resources. Under a new mining law announced in January, miners must agree to build new ore smelters in the country (instead of shipping raw ore overseas for processing) and to sell 51% stakes in their operations to local investors. The first requirement isn’t a problem in the talks: Freeport McMoRan and its partner Rio Tinto (RIO) have agreed to build a second smelter in Indonesia. But facing the need to invest billions to develop underground copper deposits that will sustain production at Grasberg, Freeport McMoRan has balked at giving up control of the operation to local investors. The new investment would sustain production at Grasberg until 2041. Last year the mine produced one billion pounds of copper, or about 3% of total global supply.
For Freeport McMoRan recent asset sales that have raised $6 billion to pay down debt have left Grasberg as the company’s crown jewel. The company has unwound a very ill-timed acquisition of oil and natural gas assets from Plains Exploration and McMoRan Exploration that resulted in write downs and balance sheet impairments of nearly $20 billion. Freeport McMoRan also sold its Tenke copper mine in the Democratic Republic of the Congo last year to reduce debt.
The uncertainty over Grasberg is one more uncertainty than Freeport McMoRan needs. In the first quarter of 2017 the company’s realized price of copper climbed 20% year over year to $2.67 a pound. Hi-grade copper closed at $2.50 today, May 11, but many commodity analysts doubt that copper will stay that strong with demand from China expected to falter as that economy’s growth slows due to efforts by the Chinese government to rein in leverage in the financial system. Slowing growth in China could take copper back to near $2 a pound.
Freeport McMoRan is a member of my long-term 50 Stocks portfolio.The shares are up 23.77% since I added them to that portfolio on December 30, 2008. Because of Grasberg, Freeport is a core holding in the commodity sector. I think the deal will get done, in the fall or so, and that will remove one uncertainty from the share price. That will still leave the possibility of slowing demand from China. That uncertainty leads me to call this stock “neutral” for the next few months or so. I’d re-examine that opinion in the July through September period.