Freeport McMoran’s Giant Grasberg Problem

Daniel is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Freeport McMoran Copper & Gold's  (NYSE: FCX) biggest asset is also its biggest liability. If you know anything about Freeport, you know that its biggest money maker is the Grasberg in Papua (the Indonesian half of New Guinea), the world’s biggest gold mine and second-biggest copper operation.

When it’s operating, the Grasberg produces an impressive 1 million pounds of copper and 1,000 ounces of gold a day. The problem is that the Grasberg isn’t operating that much; in recent years the mine has been closed more than it has been open. The latest closure from May 15 to June 21 cost Freeport 115,000 ounces of gold and 115 million pounds of copper.

The reason for that closure was a tunnel collapse that shut down the open pit operations there and killed 28 workers on May 14. The mine appears to be unstable and unsafe and the object of violence. One of the main reasons for its reopening appears to be that the miners were rioting and attacking the mine to get it to reopen. It seems the miners are so poor that they cannot afford to be out of work for even a few weeks.

This was only the latest act of unrest and violence at the Grasberg; a strike in 2011 shut the mine down for months. The mine and Freeport have also been targets of attacks by rebels in the area, who want to be independent of Indonesia. The rebels are mostly Christians, who don’t like the idea of most of the money produced by mines going to the Islamic-controlled government in Djakarta. 

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The really scary thing is that some of Freeport's fundamentals are actually better than other big players that rely on mega mines. The copper company reported a year-over-year quarterly revenue growth rate of 0.5% on March 31. That sounds pathetic but it's rosy compared to Barrick Gold, which posted a year-to-year revenue growth rate of approximately -5.7% and Newmont Mining's (NYSE: NEM) -18.9% figure.

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Mega-mines are a liability

Yes, Freeport has a huge money maker in the form of the Grasberg, but it also has a massive liability. Mining companies like Freeport have been able to greatly increase their production and cash flows by building such mega-mines. Yet they’ve also greatly increased their liabilities.

The experience of other miners with mega mines is even worse than Freeport's; at least Freeport is able to occasionally get some gold and copper out of the Grasberg. Newmont Mining and Barrick Gold haven’t been able to get a single ounce out of two multi-billion dollar projects.

Newmont Mining has sunk $5 billion into its Conga gold mine in Peru but still hasn’t mined a single ounce of gold there. Protestors, mostly local farmers who think the mine will ruin the water supply, have managed to stop it from opening. Not even support from Peru’s President Ollanta Humala has enabled Newmont to start digging at the Conga.

Barrick Gold has spent $5.5 billion on the Pascua Lima project in Chile, which, like the Conga, has not yet produced a single ounce of gold.

Mega-mines are definitely a bad risk for mining companies and for investors. Instead of cash cows, they look more and more like back holes into which cash disappears never to be seen again.

A mega-mine that might make money

Okay, at least one miner has had some success with a mega-mine lately, but it’s hardly reassuring. Rio Tinto (ADR) (NYSE: RIO) has finally started shipping copper to China from its $6.6 billion Oyu Tolgoi mine in Mongolia. Or at least that’s what Mongolia’s mining minister tweeted to the press. News stories haven’t actually confirmed the shipments; they only printed what a politician says.

Yet even Rio Tinto’s copper shipments were delayed because of tensions between China and Mongolia. The shipments were supposed to start in June, but they didn’t begin until early July. The reason for the delay seems to be that the Mongolian government wanted to make sure it got its cut of profits from the mine.

So at least one mega mine is producing and might become a huge money maker because it’s next door to the world’s largest market for copper: China. Yet even Oyu Tolgoi’s future is questionable because of the restrictions the Mongolian government puts on it.

Rio Tinto is going to have to ship a lot of ore from Oyu Tolgoi to make for its other losses. The ironing mining reported a quarterly year-over-year revenue growth rate of -19.6% in the last quarter of 2012. That means it will take several good years at Oyou Tolgoi just to give Rio Tinto positive revenue growth.

Conclusion

Mega-mines and the miners that own them seem to be less a value investment and more of a huge risk. Value investors would be well advised to avoid mega mines and the miners that love them.

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Daniel Jennings has no position in any stocks mentioned. The Motley Fool owns shares of Freeport-McMoRan Copper & Gold. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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