A guide to understanding the Freeport divestment deal

July 16, 2018

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Analum BUMN Copper Divestment FCX Freeport Freeport-Indonesia Freeport-McMoran Informasi Pajak IUPK Mining Pajak Papua Smelter tax

On Thursday, four Indonesian ministers gathered to witness the signing of an agreement between state-owned mining holding group PT Indonesia Asahan Aluminium (Inalum) and Freeport-McMoran (FCX), the owner of PT Freeport Indonesia (PTFI).

Under the agreement, Indonesia will take control of 51 percent of Freeport Indonesia’s equity, and hence hold a majority stake in the company that operates the world’s largest gold mine, the Grasberg mine, in Papua. The signing was the culmination of years of negotiations, preceding the current administration of President Joko “Jokowi” Widodo, and a tug-of -war between Indonesia and the American company

The presence of four ministers at the signing was an indication of the economic and political importance of the deal to the Jokowi administration. But it is not yet a done deal, as officials have liked to claim. The agreement requires the two parties to conduct further negotiations to finalize the details of the divestment. The government expects to finish ironing out the details sometime in August.

Here is your guide to understanding the seemingly never-ending negotiations, and why it matters for Indonesia to cement the deal as soon as possible:

Freeport’s footprint in Indonesia

Freeport-McMoran has operated in Indonesia since it signed its first contract in 1967 in a deal that was good for 30 years. In 1997, it received an extension for its operation until 2021. The two contracts in essence covered mining for copper, with gold and silver treated as associated resources found alongside copper ores.

Both contracts were signed during the regime of president Soeharto. The first contract in 1967 was widely hailed as a landmark moment, symbolizing the ushering in of Indonesia’s open-door policy to foreign investment under the pro-Western Gen. Soeharto, who had just taken over power from the socialist-leaning Sukarno a year earlier.

Developing the mines deep in the mountainous jungles of Papua required huge initial investment to build core infrastructure, including roads, housing and power plants, as well as preparing the pool of workers. In return for this investment, Freeport received generous tax breaks.

Freeport’s first phase of operations exploited the Ertsberg Mountain in Mimika regency. Once the mountain was flattened, Freeport turned to mining the adjacent Mt. Grasberg, which turned out to contain even larger reserves. Freeport is looking to mine the large gold reserves underground, assuming the latest agreement holds.

Bloomberg Intelligence estimates that the reserves at the world’s biggest gold deposit and second-largest copper mine are worth about $14 billion. Freeport-MacMoran’s operations in Indonesia accounted for 47 percent of its operating income in 2017, according to Bloomberg.

Freeport’s huge profits have been a source of contention with long-standing criticism that the tax and royalty revenues paid to the Indonesian government represent only a pittance of its true income. Indonesia’s 9.36 percent stake in PTFI, as stipulated in the 1991 contract of work (CoW), also does not amount to much, particularly as Freeport has at times withheld paying dividends. For example, PTFI paid Rp 1.4 trillion in dividends in 2017 after three years of failing to make any payments, according to the Finance Ministry.

Freeport has also attracted controversy for the environmental and social impacts of its operations in the heart of Papua. Last year, the Supreme Audit Agency (BPK) came out with a damning report claiming that Freeport had caused $13 billion in environmental damages.

Wind of change for Freeport

In 2009, Indonesia passed the Coal and Mineral Mining Law, or Law No. 4/2009. The law requires all foreign mining companies to divest 51 percent of their shares to the Indonesian government, state-owned or regional-owned enterprises or private Indonesian companies within 10 years of the start of operation.

Freeport has managed to work its way around the regulation by indicating that it is operating under a CoW, which is good until 2021.

In January 2017, the government issued a new regulation requiring all mining contracting companies to switch to special mining permits (IUPK) in order to export products in the form of concentrates, which is one step above ore but still not refined.

Freeport refused to fully comply, arguing that the IUPK was not a nailed-down scheme because the stipulations, including the taxation scheme, could change according to changes in government regulations.

In February 2017, the Energy and Mineral Resources Ministry issued PTFI an IUPK saying the company had finally agreed to the terms, paving the way for the divestment deal signed on Thursday.

Series of agreements

In August 2017, following pressure from the government to divest its shares in PTFI, Freeport-McMoran’s top management agreed to increase Indonesia’s share in PTFI to 51 percent, as well as to develop a smelter and increase Indonesia’s revenue from PTFI’s tax and royalty payments.

The Indonesian government chose state mining holding company Inalum to become the majority shareholder in PTFI.

However, questions remain regarding the price tag and how Inalum will pay for its stake in Freeport. Inalum president director Budi Gunadi Sadikin said on Thursday that the company would have to pay $3.85 billion in August and that it had already secured loans from 11 banks.

What are the benefits of majority ownership in Freeport?

Bisman Bakhtiar, the executive director of the Center for Energy and Mining Law (Pushep), said it was time for Indonesia to take control over the huge gold reserves in Papua, as 50 years had passed since PTFI began operations.

“Too much of our resources have been exploited. Surely after 50 years, we have the capability to operate it ourselves,” Bisman told The Jakarta Post on Friday.

Indonesia will reap the largest share of the profits and dividends, which in the past had almost entirely gone to PTFI. The government will also continue to enjoy taxes, royalties as well as a cut of the revenue.

“There are many ways to maximize the benefits from PTFI for the people, and divestment is one of them,” he said.

However, Bisman urged the government to ensure that Indonesia benefited from the next phase of negotiations to finalize the divestment deal.

“Even though we will finally become the majority owner in August, we need to look at the tax, royalty and revenue sharing arrangements. Are they better or not?”

Source: Jakarta Post.

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