It’s a deal (sort of)

Irawan Ronodipuro

IO – Last week, after more than a year of wrangling and heated negotiations, Freeport McMoRan Inc. inked a heads of agreement with the Government of Indonesia’s state-owned mining holding company, Inalum, on the structure and a price tag of US$3.85 billion to transfer majority ownership of its Grasberg mine.

Not long after the signing of the agreement, President Jokowi immediately declared victory, acting like the deal was completed.  Unfortunately, the president failed to check the facts.  It was only after the foreign business media reported on the details of the so-called deal that Indonesians came to the realization a final transaction is still not a sure bet.

Announcing a deal before there is a deal seems to be a habit of the Jokowi administration.  Government officials have repeatedly told the public, even before last week’s agreement and on multiple occasions in the past, that a divestment deal was near completion, but in off-the-record discussions with senior people close to Freeport McMoRan Indonesia, it became evident there were major points yet to be worked out.

Those familiar with the negotiations starting last year have told us that even on the issue of pricing, there was initially a huge difference between the two parties. Freeeport McMoRan’s valuation of the entire Grasberg mine was nearly US$12 billion, while the Government of Indonesia came up with a valuation of less than US$3 billion.

Such a low valuation for the world’s second largest copper and gold mine was viewed as ludicrous by Freeport McMoRan’s senior directors and board, and in ensuing months the atmosphere was further soured by incessant demands the company build a smelter that would make neither commercial sense nor provide Indonesia with any economic benefits.  Making matters worse, in April it seemed negotiations would break down when the ministry of environment issued a regulation on tailings which, as Freeport McMoRan Inc. CEO Richard Adkerson pointed out, would be impossible to comply with were it enforced.

What happened in the interim is not clear, but the fact the government has managed to agree on a reasonable pricing, more in line with Freeport McMoRan’s valuation, is a sign perhaps the two sides will finally agree to a deal which market watchers and the international mining community will deem as fair.  If so, the Jokowi administration will manage to resurrect its reputation—after all, the Freeport McMoRan divestment story has been viewed by foreign investors as a litmus test, and until now there has been a substantial dose of skepticism.  Perhaps Jokowi will prove them wrong.

As usual, the devil is in the details.  Freeport McMoRan might be able to live with a requirement to build a smelter, but it certainly won’t agree to having to operate under the current environmental regulatory regime.  Here there is reason for optimism—since the tailings regulation, if it remained in place, would effectively force the mine to shut down, it is in state-owned Inalum’s interest now as well to make sure the regulation is either radically changed or removed.

The real test, however, lies with future negotiations over a joint venture agreement, which will cover critical issues such as managerial control, shareholder voting rights and capital investment responsibilities.

When it comes to managerial control, Freeport McMoRan has already insisted it have managerial control before it makes any capital investments for its new underground mine.  Given the poor track record of the Government of Indonesia in handling other divestments, in particular cases involving the Newmont Mining Corporation and Rio Tinto, executives of Freeport McMoRan would be very wise to make sure they maintain operational control of the mine and its Indonesian partner is not able to use its majority stake to force the joint venture company into decisions that are contrary to Freeport McMoRan’s commercial interests.

Most critical will be the Government of Indonesia’s stance on capital investment requirements.   A standard joint venture agreement would require shareholders to take proportionate responsibilities for capital investments.  So far, the mining company must make a future US$5 billion investment to develop the underground mine.   A further US$3 billion is needed should the government continue to insist the company construct a smelter.  This means Inalum should be prepared to invest an additional US$4 billion to cover its share of capital outlays, an amount the company can ill afford given its plans to borrow nearly US$4 billion for the Grasberg share purchase.

The question is, will the government change its mind about the smelter and therefore save itself US$1.5 billion for an investment that makes little sense?  Or, alternatively, will the government try to negotiate a joint venture agreement that places a disproportionately larger burden on Freeport McMoRan for investments?  Certainly it would be wise to decide on the former, but if the government tries its hand at the latter approach, expect yet more delays and a continuation of a complicated saga that, so far, has served nobody’s interest.