Commodities

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

What's a mine worth?

In theory, valuation could be based on the amount of salable metal it can produce. On that basis, Freeport-McMoRan Inc.'s Grasberg on the island of New Guinea is one of the best mines in the world, with the third-largest reserves of copper and one of the biggest gold deposits, worth more than $100 billion at current prices.

Of course, extracting metal from rock can't be done for free. Still, at copper prices of around $2.59 a pound and Grasberg's latest unit costs of 83 cents a pound, the company could in principle generate $47 billion of earnings from digging up the Indonesian mine's 27 billion pounds of copper -- and Freeport as a whole is worth only $19 billion.

It's a bit more complicated than that, though. Mining analysts tend to base their calculations on discounted cash flow -- an estimate of the free cash that can be generated over the life of the mine, adjusted for the fact that a million dollars in 10 years is worth less than a million now.

Such calculations are always fraught with uncertainties, but there's a particularly big challenge with Grasberg: Indonesia's government, which is engaged in a sticky negotiation with Freeport to lift its 9.36 percent stake in the venture. Jakarta wants as much as 51 percent of the project owned by Indonesian investors.

Arguing about valuation should be bread and butter to executives like Freeport's president Richard Adkerson, but there are signs that patience is starting to flag.

Back in January, Adkerson was clear that 30 percent was more or less Freeport's upper limit for the local minority stake. "Had we had a requirement to divest 51 percent from the start of this contract, we would not have invested in the way that we did," he told investors.

That position seems to be crumbling. Asked Tuesday in the U.S. whether his opposition to 51 percent was still implacable, he demurred in language that could have been cribbed from the management classic Getting to Yes. Everything, including the level of shareholdings, was now "on the table," he said.

The one point on which Freeport would insist was that any divestment be made "on the basis of the fair value of the assets," Adkerson said following first-quarter results.

Jakarta has played its hand with brutal efficiency. Grasberg's operations have been at the mercy of the government since 2014, when it banned exports of unprocessed ores. That left the 60 percent of output that can't be processed at Freeport's part-owned Gresik smelter stranded at worst, or at best left to the whims of short-term permits. A dispute over the contract under which the mine operates tightened the thumb-screws further.

That doesn't bode well for how Freeport will be able to manage the next stage of the process. The company is engaging in a costly shift from mining Grasberg's open pit to working underground, with an estimated $1 billion of capital expenditure in each of the next five years. There'll be no point in doing that if it can't export.

Money Pit
Grasberg accounts for almost half of Freeport's operating cash, but a disproportionate share of capital spending too
Source: Company presentation
Note: Figures are for March quarter of 2017.

Already, Freeport has cut about a tenth of its 32,000-strong workforce at the site and slashed spending on the underground mine to $40 million a month, Adkerson said Tuesday. Suspending underground work altogether would remove a further 5,000 jobs, he said -- but that could make quite a difference to the bottom line, given the quarterly saving would be $120 million and net income in the most recent period was only $228 million.

Mined Out
Grasberg has been doing better, but operating income fell 70 percent from the December to March quarters
Source: Bloomberg, company reports

In arguing over valuation, Freeport must deal with the fact that the fair market value of Grasberg is more dependent on Indonesia's mining policies than anything the company can control.

That doesn't mean Jakarta is a clear winner. Inbound foreign direct investment in Indonesia's mining sector fell to a record negative $855 million in the fourth quarter as companies divested projects such as the Batu Hijau copper mine, which Newmont sold out of last November.

Ebb Tide
Overseas investment in Indonesian mining projects has turned sharply negative
Source: Bank Indonesia

Grasberg's entanglements will only further deter foreign mining companies, which already take a pretty dim view of Indonesia as an investment destination. The country is at risk of becoming, like South Africa, a region whose mineral riches are corroded by political uncertainty.

The other end of New Guinea's archipelago shows where such resource nationalism can lead. The Panguna copper project on the island of Bougainville hasn't been mined since the 1980s after it sparked a civil war in the province, part of Papua New Guinea. Last year, former operator Rio Tinto Group divested its stake in a pit containing $51 billion of copper -- for nothing.

However much metal is buried in the ground, it's worth nothing if it can't be turned into cash.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net