The Freeport saga

Freeport mine location
Irawan Ronodipuro

IO – The Jokowi administration often boasts about its progress in deregulating the economy.  True, the process for obtaining business permits and licenses has been streamlined and many approvals previously required by the government, which were little more than exercises in rent-seeking, have been removed.   And earlier this year, the government issued a regulation providing tax holidays for investors in pioneer industries such as high value-added manufacturing.

Although we have been critical about this government’s macroeconomic policies,  kudos are in order for these regulatory changes.  Compared to a decade ago, it is easier and less costly to set up shop and start a business.  In the World Bank’s latest Ease of Doing Business Index, Indonesia jumped 19 places to 72 from its previous rank of 92.

But waving a deregulatory wand does not necessarily mean investors will risk their capital.  Yes, the partial unraveling of Indonesia’s bureaucratic byzantine maze has facilitated business operations.  On the other hand, there are other, equally if not more important issues, such as legal certainty and sanctity of contract, that play a larger role in shaping the investment climate.  On this score Jokowi’s cabinet has failed miserably.

A prime example of this failure is the government’s handling of U.S.-based Freeport McMoRan Inc., one of Indonesia’s longest-standing foreign investors in the mining sector and majority shareholder in the Grasberg copper and gold mine situated in Papua.

Under an agreement forged last year, Freeport is obliged to divest a 51 percent share of the Grasberg mine to the Indonesian government.   Negotiations over the terms of the divestment, which have been dragging on for over a year, have been caught in a mire of vested interests spanning the ministries of mines and energy, state-owned enterprises, environment, finance and even the president’s inner circle.

The government has been optimistic, at least in public, about the chances for closing a deal before the end of 2018.  Behind closed doors, however, Freeport executives are becoming increasingly pessimistic and skeptical about the Jokowi cabinet’s intentions.

One major hurdle for reaching a divestiture deal is the government’s valuation of Freeport shares.  According to insiders, the government’s valuation of Freeport McMoRan Indonesia is US$2.6 billion, roughly one-sixth of Freeport’s estimates of the Indonesian company’s fair market value.  One mining expert noted, “Freeport’s valuation is, from a mining industry perspective, a fair one. The fact the Indonesian government is trying to pressure Freeport to accept such a low price shows a complete lack of good will, and there is no way Freeport executives and their shareholders could justify accepting the proposed deal.”

But share valuations are not the only problem.   Freeport has found itself under continuous attack by various ministries to comply with new regulations that make little commercial sense and could result in forcing Freeport to close down the Grasberg mine.

A major threat to Freeport is a new environmental decree issued by the Ministry of Environment and Forestry that requires 90 percent if its tailings to be stored on land.   Historically half of Freeport’s tailings have been stored on land, and according to Freeport McMoran CEO Richard Adkerson, then new targets are unachievable.  “It cannot be done with 6 months, 24 months, 5 years.  This is so far out of bounds it cannot be done.”   Although the new environmental standards do not pose an immediate threat because there is still no timeline attached to meeting the standards, it is clear to Adkerson and others watching the entire saga that they were implemented with the intent to gain leverage in the divestiture negotiations.

Freeport has also found itself under extreme duress over government requirements for the company to refine its copper concentrate, hence forcing it to invest in a multi-billion dollar smelter.  Copper and gold mining executives in Indonesia have long argued that smelters are not commercially feasible and actually provide very little value-added, which has always been the government’s main rationale for its policy.  Freeport has understandably tried to delay investing in a smelter, and the government has responded with a new regulation stipulating that unless 90 percent of the smelter is completed by the end of June this year, an impossibility, then it will slapped with an additional 20 percent royalty on its exports.     If that does happen, industry watchers are saying Freeport will find it unprofitable to continue operations.

In the final analysis, Freeport and the Indonesian government are headed on a collision course.   The Jokowi administration’s hardball tactics might result in Freeport offering some concessions, but the government must first show some flexibility and good faith in its dealings with Freeport.  If not, Freeport will not be the only loser.  The Indonesian government’s reputation with the international business community will suffer wide and far, as well. (Irawan Ronodipuro)