After months of negotiation, Freeport-McMoRan – the operator of the world’s second largest copper mine – has caved-in and agreed to sell a majority stake in the Grasberg mine to the Indonesian government.
The Grasberg mine shut operations for most of February 2017 as the Indonesian government failed to renew the company’s ore export licence. Although a temporary export licence was awarded, Freeport and the Indonesian government have been embroiled in a bitter battle to control the mine. We argued in Copper – strong fundamentals and improving sentiment that the ongoing negotiations posed a threat to further disruptions at Grasberg.
Eases our concerns about further mine disruption
This deal partially eases our concerns about further mine disruption this year at Grasberg. However, we note that key elements of the deal have yet to be thrashed out. Freeport values Grasberg at US$16.2bn. The government only owns about 9% of the mine at the moment. Purchasing another 42% (to get to 51%), could cost the government US$6.8bn. Based on discussions early this year, it does not appear that the Indonesian government shares the same valuation, insisting unmined copper reserves should not be included. Until details are agreed on, the threat of further disruptions linger.
If the deal goes ahead, it will remove one of the road-blocks to Freeport making further investments in the mine. As a large part of the open-pit mine has been exhausted, the miner will need to deeper into the rock beneath it. Freeport is expected to invest between US$17bn and US$20bn in Grasberg through to 2031 and will be awarded operating rights until 2041. It will also need to build a new smelting facility as part of the deal. Given the dearth of investment by miners over the past 3 years, the new commitment from Freeport will be welcome in securing future supply.
Copper prices have continued to rally despite the news of the agreement, indicating the market shares some of our scepticism of the success of the deal.
Nitesh Shah, Research Analyst at ETF Securities
Niteshis a Commodities Strategist at ETF Securities. Nitesh has 13 years of experience as an economist and strategist, covering a wide range of markets and asset classes. Prior to joining ETF Securities, Nitesh was an economist covering the European structured finance markets at Moody’s Investors Service and was a member of Moody’s global macroeconomics team. Before that he was an economist at the Pension Protection Fund and an equity strategist at Decision Economics. He started his career at HSBC Investment Bank. Nitesh holds a Bachelor of Science in Economics from the London School of Economics and a Master of Arts in International Economics and Finance from Brandeis University (USA).
The correction in the US Dollar following the March FOMC meeting brought some relief to commodity prices last week. Oil and copper were once again favoured by investors, while gold continued to see outflows. Going forward, we expect demand for cyclical commodities to continue to benefit from the stimulus-driven cyclical rebound, while gold is likely to continue to feel the weight of rising interest rates in the US.
Long oil ETPs record the largest inflows in over two months, as current prices are deemed unsustainable. Total inflows into long oil products reached US$146.5mn last week, with WTI accounting for US$127.3mn. The price of WTI fell below US$45/bbl last week, the lowest level in 6 years, as US crude stockpiles soared for a tenth week, while output continued to rise. Meanwhile, the spread between Brent and WTI continue to widen, as US crude oil stocks have increased by over 70 million barrels since the beginning of 2015, putting storage facilities under pressure. We expect WTI and Brent to return to trade at around US$55/bbl and aUS$65/bbl by year end, as the massive decline in drilling activity in the US translates into substantial output cuts.
Copper back in favour as production stops at Grasberg. ETFS Copper (COPA) recorded US$11.7mn of inflows last week, the largest in 15 weeks, after operations at Freeport’s Grasberg mine, the world’s second-largest copper producer, were suspended for 5 days due to a labour dispute. This is not the only production disruption in the copper market since the beginning of the year. Last month, BHP Billiton reported a 60,000 tonnes reduction in copper production from its Olympic Dam mine in Australia due to problems at its mill. With the copper market having been in a deficit for the past 3 years, any unplanned supply outages have the potential to send prices higher.
Gold ETPs suffer the 4th consecutive week of outflows. Despite a partial recovery in price, gold ETPs continued to see outflows last week as investors favored cyclical assets once again. The correction in the US Dollar following the March FOMC meeting last week brought some relief to commodity prices that had been severely hit by the strength in the US Dollar. Although the Federal Reserve is no longer indicating that it will be ‘patient’ in raising interest rates, beyond the bullish jobs data it has relatively little ammunition to pull the trigger on rate hikes. The Fed is likely to raise rates more slowly than the market currently expects, leading to a short-term US Dollar pull-back. Gold is likely to continue to feel the weight of rising interest rates in the US. However, currently the price of gold over-estimates the pace of that tightening, and gold can offer a relatively cheap hedge to some of the tail risks of policy mistakes that may occur as the rise of anti-establishment political parties in Europe threatens to challenge the status quo.
Key events to watch this week. A number of manufacturing PMIs for Japan, China, the US and the Eurozone will be released this week and will help investors assess the strength of those economies. CPI releases for the US and the UK will also be monitored for any indication that higher rates may be warranted.
Video Presentation
Simona Gambarini, Research Analyst at ETF Securities provides an analysis of last week’s performance, flow and trading activity in commodity exchange traded products and a look at the week ahead.
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