November 30, 2017 / 4:20 AM / in 17 days

Breakingviews - Rio Tinto holds valuable card in Jakarta deal

SINGAPORE (Reuters Breakingviews) - Rio Tinto holds a valuable card in a high-stakes game. As Freeport-McMoRan hammers out terms for handing over a majority stake in the Grasberg copper mine to Jakarta, a production arrangement dating back to 1995 gives its Anglo-Australian partner an effective veto. The best way to play this sleeved ace would be to negotiate a graceful exit.

U.S.-based Freeport agreed in August to give 51 percent of the mine in remote Papua, which has been plagued by separatist violence and royalty disputes, to Indonesia. Since the announcement, there has been little evidence of progress.

Lurking in the background is Rio. The $90 billion company could object to any transaction that affects its claim on production, and potentially stall the proceedings. Indonesia probably wants to avoid that scenario.

If presented with a buyout offer, Rio would have a tough decision to make. Grasberg is the world’s second-largest copper mine and a fresh pact with Indonesia brings some stability. There are probably better ways to allocate capital, however.

The company led by Jean-Sébastien Jacques has managed to avoid financial disaster despite strikes and shootings that have prevented Rio from receiving any copper since 2014. A $1.3 billion investment more than two decades ago gave Rio shares in Freeport. It sold those at a profit, but retained a share of Grasberg output: 40 percent of production over a level that varies. It gets to claim more in a few years.

A review of two decades of annual reports, however, reveals the opportunity cost. Rio’s capital expenditures on Grasberg tally nearly $2 billion, while net profit adds up to just $1.7 billion. A recent stretch has been particularly painful. More than $850 million invested between 2012 and 2016 was accompanied by losses of about $150 million. And capital commitments will rise with planned expansion.

That suggests it’s time to focus elsewhere. Rio has approved the next phase of Oyu Tolgoi in Mongolia, a project it controls, with a projected internal rate of return of over 20 percent. Jacques has a chance to distinguish valuable geology from shareholder value, if he plays his Indonesian card right.

Breakingviews

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