Thursday, May 7, 2009

Freeport Trucks Billions From Congo Mine

While the eyes of the world are drawn to the brutal war over an estimated $200 million in annual illegal mineral revenues in the eastern provinces of the Democratic Republic of Congo, negotiators for American and Chinese corporations are angling to control ten times that amount in mining contracts in Katanga Province.

Two multi-billion-dollar copper and cobalt contracts are currently being negotiated by the DRC Ministry of Mines. One is for Tenke Fungurume, which is managed by American mining goliath Freeport MacMorAn. It’s one of six existing contracts the DRC wants to renegotiate. The other is with two Chinese firms, Sinohydro Corp and China Railway Engineering Corp, and deals with two under-developed mines being transferred from Katanga Mining Corp. Neither one is finalized as of this writing, but both are problematic from the standpoint of what they actually mean for the economic health of the DRC. I’ll cover the Chinese deal in a subsequent post.

Freeport began shipping copper from Tenke Fungurume this year. The company expects the mine to produce 250 million lbs. of copper and 18 million lbs. of cobalt annually during the initial phase, with more than 400,000 tons of copper per year within five to seven years. At recently posted prices for copper ($4500 per ton) and cobalt ($30,000 per ton), this will generate some $2.7 billion in annual gross revenue at full production. When prices for the commodities rise—-as they surely will from today’s depressed levels—-this operation could easily gross $5 billion per year.

That’s not all profit, of course, but the margin is very high since production costs in the DRC are extremely low. Freeport projects that the net revenue generated by cobalt—-even at prices substantially below those achieved in the current market—-will more than cover the cost of recovering and shipping copper from Tenke. In fact, at $10 per pound (two-thirds the current price level) for cobalt, a 2007 feasibility study published in the African Review of Business and Technology says Tenke operating costs are actually negative $380 per ton for copper. At current price levels, in other words, Tenke can generate a minimum annual profit of $2.2 billion once the project reaches full production.

It should be noted that not all of that will flow to Freeport’s bottom line. The company owns a 57.75% stake in Tenke it acquired in 2008 when it bought Phelps Dodge. Another 24.75% of the project is owned by Lundin Mining, which had the original concession. The remaining 17.5% is owned by Gecamines, the DRC’s state-owned mining company. Freeport and Lundin are responsible for the total $1.75 billion cost of developing the mine. Subtracting Gecamine’s share of the profits (a not-inconsiderable $400 million), however, still gives Freeport and Lundin a nifty 100% annual return on that investment.

It’s no wonder that the DRC Ministry of Mines is asking for the contract to be renegotiated. The DRC wants to increase its share of the project to 45%, the level at which the deal was struck with Lundin in 1996. It also seeks to increase the signing bonus from $100 million to $250 million. The original agreement with the DRC was amended in 2005 to the current terms. The official line is that the new terms were necessary to provide the company a return commensurate with the risk it was assuming at the time, even though the agreement ending the Second Congo War had been signed in 2003 and the country’s first national elections were scheduled for 2006. The transitional period still saw substantial unrest, however, which supposedly justified the greater return.

The Carter Center says, though, that there were other factors at work:

“There are several reports that the political officer and temporary ChargĂ© d’Affairs of the embassy was personally engaged in urging the President’s office to sign....The same official that is said to have actively lobbied for Phelps Dodge retired from the State Department in 2006. In September of that same year, she became Vice-President for Government Relations, Africa for Phelps Dodge, whose only major African interest is Tenke Fungurume. This official’s important role at the US embassy and the timing of the move have fueled suspicion on the part of DRC government officials and others regarding the interests of Western governments. At the very least it indicates obliviousness to the appearance of impropriety.”
As I mentioned earlier, Freeport acquired its stake in the project when it absorbed Phelps Dodge.

When the DRC requested a reversion to the old contract terms last year, Freeport responded with a simple “no.” In a 2008 SEC filing, it said
“The Restated Agreements were negotiated transparently and approved by the Government of the DRC following extended negotiations, and we believe they comply with Congolese law and are enforceable without modifications. We are currently working cooperatively with the Ministry of Mines to resolve these matters while continuing with our project development activities.”
The hypocrisy is glaringly obvious: a “contract is a contract” and can never be changed—-unless it is in the company’s interests to do so as it was in 2005. Subsequent statements have stuck to that position, although negotiations supposedly continue while Freeport ships copper and completes construction of the cobalt processing operation.

Also used to justify the one-sided contract are the expenditures made (mostly under terms of the 2002 Mining Code) for community support and infrastructure development in the region. There is no question that considerable economic benefit accrues to the DRC from Tenke, although nowhere near what the company claims. About 1,000 employees will be hired, with another 4,000 jobs indirectly created. Freeport is also spending on social programs for the local community as well as investing in the region's infrastructure by upgrading roads, railways and a hydropower facility—-all items needed to make the operation successful. The DRC collects royalties, taxes, and other fees, too. It should be kept in mind, though, that all these expenditures—as helpful as they may be—are required by law. They’re also considered part of the project expenses, so are already included in the calculations for net profit.

If past is prologue, the Tenke Fugurame contract will eventually be revised. The DRC will get a higher stake (although nowhere near the 45% it’s requesting, much less the 51% that is fairly standard for similar contracts in South Africa and Zambia) in the project. Don’t expect Freeport to give without receiving, however. Watch for the Ministry of Mines to grant rights to another deposit in the region, agree to reimburse the company for its capital investment, or make some other major concession to get the deal done.

Dave Donelson, author of Heart of Diamonds a about in the

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