RPT-COLUMN-Copper is unexpected victim of Indonesian export …
(Repeats Thursday column without change)
By Andy Home
LONDON, July 3 (Reuters) – When Indonesia banned the exportof unprocessed minerals in January of this year, the consensusview was that the most significant impact would be on the nickeland aluminium raw material markets in that order.
Copper barely warranted a mention.
Analysts at Macquarie Bank, for example, issued a researchnote on January 14, two days after the ban came into effect,examining the implications in a question-and-answer format. Theonly reference to copper came in the 19th bullet point under thetelling heading: “Have copper producers been let entirely offthe hook?”
Six months on, though, and one of the country’s two giantcopper mines is on care and maintenance and the other has cutproduction by half. There have been no concentrate exports sinceJanuary.
Not only is this the single biggest hit to copper minesupply this year but it is acting to accelerate a fracturing ofthe copper concentrates pricing model.
CONTRACT CONFUSION
Both Freeport McMoRan, which owns and operates theGrasberg mine, and Newmont Mining, major stakeholder inand operator of the Batu Hijau mine, appear to have beenblind-sided by the January rule changes.
After all, not only are both major employers and tax-payersin Indonesia, but both also thought themselves protected by whatthey believed to be legally-binding contracts of work (COW)covering their operations in the country.
In theory, such COWs set in stone the level of taxes androyalties payable over the contracts’ life-time.
And anyway, copper concentrates are not unprocessedminerals. As Newmont has repeatedly pointed out, around 95percent of the value chain is captured in this form of copper.Why would anyone build a new smelter in Indonesia just to getthe last five percent?
Indonesian policy-makers, though, beg to differ. There willbe a steep and escalating tax on exports of copper concentratesuntil 2017, when they will also be banned completely.
Those legally-binding COWs, it seems, will simply have to bechanged to accommodate the new regulations.
After weeks of negotiations, Newmont this week announced itwould seek international arbitration.
Freeport is still talking. But then it has an even biggerproblem. Its COW expires in 2021, unlike Newmont’s, which runsto 2030.
That places a major question-mark over the future of theGrasberg mine, not least because Freeport has to spend heavilyon switching to underground mining when the open pit isexhausted in 2017.
SUPPLY HIT
In the interim, neither has been exporting since the startof the year, depriving the global market of a major source ofraw materials.
Freeport has reduced the milling rate at Grasberg by aroundhalf to align mine output with the intake capacity of thecountry’s sole existing copper smelter, which Freeport partlyowns.
Newmont also has an off-take agreement with the Gresiksmelter but not big enough to support continued operations atBatu Hijau. Rather, it will deliver 81,000 tonnes ofconcentrates from stocks over the remainder of this year. Themine itself was shuttered and placed on care and maintenance inJune.
Batu Hijau was scheduled to produce 110,000-125,000 tonnesof contained copper this year, meaning it will lose around10,000 tonnes for each month of closure.
Grasberg was originally expected to produce 1.1 billion lb(just under 500,000 tonnes) of contained copper in 2014,guidance that was trimmed to 900 million pounds (just under410,000 tonnes) at the time of Freeport’s Q1 report.
Even that, though, assumed a resumption of exports in May,the company warning that any delay beyond then would mean “adeferral” of 50 million lb (22,700 tonnes) per month.
Right now, therefore, the absence of a deal on theresumption of exports is costing around 34,000 tonnes per monthof lost, or “deferred” as Freeport would call it, copperproduction.
In times gone by this would have been a major bull driver inthe copper market. But those were the days of chronic mineshortfall. Today, the supply picture looks very different as awave of expansions and new mines comes on line to the point thatjust about every analyst out there thinks 2014 will be a year ofsubstantial market surplus.
Albeit a little less substantial, given the combined hitfrom both Indonesian producers.
FRACTURED MARKET
But the real significance of the loss of export flows fromIndonesia goes beyond just the affected tonnage.
Both Batu Hijau and Grasberg produce “clean” copperconcentrates containing a lot of gold and very little bad stufflike arsenic.
This is an increasingly important differentiator in thecopper raw materials markets because a lot of the new minescoming on stream produce “dirty” concentrates.
The prime example is the Toromocho mine in Peru, owned andoperated by China’s Chinalco, which warned in Junethat not only was it downgrading its production guidance thisyear due to commissioning issues but that the arsenic content ofsome of the concentrates being produced exceeded five percent.
That’s a critical threshold, since Chinese smelters can’ttreat such material on environmental grounds. In fact, theycan’t even legally import it.
This means it must be blended with cleaner concentrates,such as those from Grasberg and Batu Hijau.
The copper concentrates pricing model was already startingto fragment along these lines even before the Indonesian exporthalt.
The treatment charge on Toromocho material, for example, isquoted at close to $200 per tonne, compared with the $95.50negotiated by BHP Billiton with Chinese smelters forsecond-half 2014 deliveries. And that’s not factoring in theexcess penalties smelters can charge for all the bad stuff inthe concentrates.
That evolution of concentrates pricing into a two-tiermodel, one for “clean” and another for “dirty” concentrates, isonly going to accelerate with the loss of a sizeable amount of”clean” Indonesian material.
LOSSES TODAY, LOSSES TOMORROW
Some sort of deal between Freeport and the Indonesiangovernment, allowing for the resumption of exports fromGrasberg, does look on the cards. Newmont may find it tougher,judging by some pretty pointed comments from Indonesia’s newchief economics minister about its decision to go forarbitration.
But the longer-term impact is unchanged, since Indonesianpolicy-makers show no signs of bending on the key provision thatfrom January 2017 what is mined must also be refined in thecountry.
The inference is that Asian copper smelters are going tolose permanently two major sources of concentrates supply, and”clean” supply at that, in a couple of years time.
By then, the current mine supply growth dynamic will havewaned. Indeed, analysts are already pencilling in a return tocopper deficit, a lagging effect of the current shareholder-ledausterity in the natural resources sector.
The copper market appears to have been just as blind-sidedby events in Indonesia as the two producers operating in thecountry.
But this is still a preview. The real impact will come inJanuary 2017, when the total ban on copper concentrate exportskicks in. (Editing by William Hardy)