By Sara Schonhardt 

JAKARTA -- Freeport-McMoRan Inc.'s standoff with Indonesia over the giant Grasberg copper and gold mine is entering a new phase, as the company scales back operations while trying to force a resolution to the dispute.

Last month, the U.S. miner threatened to take Indonesia to arbitration, saying new rules the country imposed on miners in January violated the terms of an operating agreement struck in 1991 that runs through 2021.

The rules are part of a broad effort to gather more revenue from the mining sector. Under the rules, Freeport is banned from exporting a form of unrefined copper until it agrees to new operating rights that would eventually force it to cede control of Grasberg, the second-largest copper mine in the world, to Indonesian entities.

With the two sides at loggerheads, the miner lowered its output target for Grasberg, shelved investment plans and began laying off workers.

The showdown has reached a critical juncture. A prolonged standoff would be a financial blow to Freeport, which derives roughly a third of its copper output from Indonesia. The mine is readjusting its operations to 40% of its normal capacity.

Indonesia stands to lose hundreds of millions of dollars in annual payments, and its demands for greater control could further imperil already dwindling investment in its resources sector, experts say. The dispute also could undercut Indonesian President Joko Widodo's campaign to attract foreign investment for infrastructure in a nation stretched across 18,000 islands. The wrangling over Grasberg already has contributed to a rise in global copper prices, which could experience even more upward pressure if the conflict drags on.

"In this current controversy...we're either going to all win, or we're all going to lose," said Freeport Chief Executive Richard Adkerson. "And unfortunately we're on a path right now of where we're all potentially going to lose."

As part of its push to earn more from the mining sector, Indonesia banned ore exports and placed restrictions on exports of mineral concentrates in 2014 to push companies to invest in domestic smelting.

Now, Indonesian officials say the operating agreement for Grasberg needs to be updated to reflect changes in the country's legal landscape. Indonesia has asserted more control over foreign investment with the aim of redistributing economic benefits in a more equitable manner, an effort that began after the fall of dictator Suharto.

Freeport has set a deadline of mid-June to start arbitration proceedings and seek damages if it can't come to an agreement with Jakarta. Indonesian officials are standing firm.

"Nobody wants to play hardball," said Luhut Pandjaitan, coordinating minister for maritime affairs, which oversees the ministry of energy and mineral resources. "But of course we also feel that after 50 years we also have to consider the people of Indonesia." Freeport has operated in Indonesia since the 1960s.

In a statement issued March 7, the ministry said it supports foreign and domestic investment and respects the content of existing agreements. It said the divestment obligation was meant to "facilitate" mining companies to join with the government and "bring justice" for the people of Indonesia as the "absolute" owners of the country's resource wealth.

Sitting atop a mountain in western New Guinea island, Grasberg has been a windfall for both Indonesia and Freeport. The company's success at Grasberg allowed Freeport to grow to become the world's largest publicly listed copper miner -- and Indonesia's largest taxpayer.

Indonesia is requiring that Freeport agree to divest enough shares so that the company has only a minority stake in its Indonesian unit as part of new rules that will allow Freeport to resume the export of copper concentrates. Freeport currently has a 90.64% stake and has agreed to divest up to 30%.

The new rules also would require Freeport to build a new smelter by 2022 and pay higher taxes.

Indonesian officials have signaled some willingness to be flexible about the terms and timing of the divestment. It can be done in stages over several years, Mr. Pandjaitan said.

Freeport says the rules violate its operating contract and it won't give up its rights to a mine in which it has invested $12 billion.

Freeport is holding on while other miners have left Indonesia. Last year, Newmont Mining Corp. and BHP Billiton Ltd. sold off interests in their Indonesian units to local companies and exited the country, citing heavier regulation as a factor.

Mining revenue as a share of economic growth in Indonesia has dropped since exports were restricted. Exploration expenditures have declined globally in recent years, as well. Companies now are more wary of investing in countries where the risks are perceived to be high amid economic uncertainty and volatile commodity prices. That has raised concerns about the prospects for Indonesia's mining industry.

"The more these sort of stories come about and the more political risk is created from arguments with Freeport, the less new investment will come in," said David Manley, a senior analyst at the National Resource Governance Institute, a not-for-profit that monitors the global oil, natural-gas and mining sectors.

The effects of the standoff between Jakarta and Freeport already have spilled over into global markets. The export halt in Indonesia and a strike at the Escondida mine in Chile have tightened world supplies. Copper prices are up more than 7% so far this year.

Freeport lowered its mining target for Grasberg to 95,000 tons of ore a day for 2017 from its previous forecast of 140,000 tons and shelved plans to invest $1 billion a year to move more mining underground as the open pit at Grasberg reaches the end of its production life. The company has started laying off some of the contract workers who make up about two-thirds of its 32,000 workers in Indonesia.

"Over the years -- and we've literally been negotiating this situation on the contract for over five years now -- we've tried to make concessions, and various times we'll get close to a resolution but it has not happened," Mr. Adkerson said.

Write to Sara Schonhardt at Sara.Schonhardt@wsj.com

 

(END) Dow Jones Newswires

March 18, 2017 07:14 ET (11:14 GMT)

Copyright (c) 2017 Dow Jones & Company, Inc.
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