by Simon Montlake

Forbes Magazine
Issue cover-dated
Feb. 13, 2012

Cave In: Freeport-McMoRan Digs A Heap Of Trouble In Indonesia

Mining giant Freeport-McMoRan dug up a heap of trouble in Indonesia’s
most tenuous territory, and it won’t get better soon. Investors
beware.
Sitting on a concrete floor just before the holiday at a modest home
in Timika, Indonesia surrounded by dense, mountainous jungle, a
warehouseman named Yonatan Iyai invites me to partake in a lunch and
hear about life in the Grasberg copper mine. “This is a risky job,”
says the 33-year-old, in outlining why he and 8,000 colleagues had
completed a three-month strike that will result in a phased-in 40%
wage hike (Iyai’s current pay: $460 a month), “and we deserve a better
salary.”

Fate underscores his point. As we share fish curry and steamed cassava
in the valley, violence erupts in the clouds, where Grasberg, at
14,000 feet elevation, rests in perpetual fog. A helicopter ferrying
workers and their families to Christmas vacation runs into a hail of
bullets, wounding two women. The company promptly suspends flight
services for a week, forcing employers to travel on a 72-mile access
road that snakes up the mountainside. Last year at least six workers,
including two security personnel, were shot dead along this route,
which is off-limits to outsiders. Two more contract workers were
killed in another roadside attack on Jan. 9.

Remote locations, labor unrest, violence—this is the fracturing
foundation on which the mine’s owner, Freeport-­McMoRan Copper & Gold,
is building its future. “These issues have posed risks for the company
throughout its over 40 years of operations in Papua,” Freeport’s CEO,
Richard Adkerson, says via e-mail when I ask him about this. “Freeport
has successfully managed these risks and developed the Grasberg mine
as a highly profitable operation. We have confidence in our ability to
manage the current issues.” And even though the stock cratered 37% in
2011, as once booming copper prices slumped on fears of a slowdown in
China, many analysts predict a share price turnaround for Freeport,
which mines copper, gold and molybdenum on four continents. It earned
$4.6 billion last year, up from $4.3 billion in 2010. “In my view the
stock is significantly undervalued,” says David Gag­li­ano of Barclays
Capital.

That’s easy to say from New York or Phoenix, where Freeport is
officially based. But make no mistake: Freeport is an Indonesian
company—it derives 45% of its income from there. And as I crisscrossed
the region I came away with an impression very different from
Adkerson’s or Gagliano’s, one that has nothing do with higher wages
for workers like Iyai and that will remain even if the price of copper
rebounds.

Boiled down, Freeport has a Papua problem. Indonesia tries mightily to
pry eyes away from this heavily militarized home of the Grasberg mine.
It’s difficult for foreign journalists to report freely from Timika or
for tourists to get a permit to visit; restrictions for Jakarta-based
diplomats were recently tightened. Locals who speak their mind run a
risk: Human Rights Watch says that 90 are currently in jail for
peaceful political activities.

But the company’s story is interwoven with that of this tenuous
territory, a former Dutch colony in the western half of New Guinea,
the world’s second-largest island. (The eastern half is now Papua New
Guinea.) The native population is racially and culturally distinct
from the rest of Indonesia, more akin to Pacific Islanders than East
Asians.

Until the 1930s tribes in Papua’s rugged interior lived a Stone Age
existence, unknown to the Europeans who stuck to the mangrove-ringed
coastline. Yet their remote highlands held a glittering prize, which a
Dutch geologist discovered in 1936: a mountain of ore at 14,000 feet,
just shy of the highest peak (16,000 feet) east of the Himalayas. It
was like finding “a mountain of gold on the moon,” he wrote. And there
the ore stayed for 30 years.

It took the technical know-how, political savvy and risk appetite of
Freeport to crack open the safe. By then Papua had been handed over to
Indonesian rule with the support of President Kennedy and the promise
of a popular referendum. Australian Prime Minister Robert Menzies
warned Kennedy that it would be “the substitute of brown colonialism
for white colonialism.” But a self-ruled Papua, a dream that persists
today, wasn’t in the cards. In 1966 General Suharto ousted
left-leaning president Sukarno and began courting foreign investors.
Freeport was the first to sign a contract, the start of a long and
deep relationship with the regime. Papuans living around the mine had
no say in the matter. A farcical UN-observed 1969 referendum to
confirm Indonesia’s sovereignty unfolded “like a Greek tragedy, the
conclusion preordained,” cabled a U.S. diplomat.

Freeport brought rapid development to Papua, building roads, schools
and hospitals in the poverty-stricken area. But tax revenues largely
stayed in Jakarta, where Suharto and his clan hosted Freeport
executives and cooked up a back-scratching deal. Now democracy has
unleashed Papuan ­resentment at the exploitation of their resources
and their ­paltry return. “This is their worst crisis in over 40
years,” says Kevin O’Rourke, a political analyst in Jakarta. “And
that’s saying something.”

Much of Freeport’s workforce, and the majority of senior staff, are
Indonesians from other islands. Laborers like Iyai complain that
they’re stuck on the bottom rung. Former employees say racism is
common among Javanese managers, who see Papuans as primitive. Company
spokesman Eric Kinneberg says over 500 staff-level managers are
Papuans.

For every job at the mine, another 37 are added locally. But Papuans
say this mostly benefits carpetbaggers, not the native-born who make
up roughly half of the 3 million people in the California-size
territory. The rest are newcomers, including migrants resettled by the
government from other islands. “Migrants dominate the economy, and
locals are marginalized on their own land,” says Socratez Sofyan
Yoman, the chairman of Papua’s Alliance of Baptist Churches.

While officials blame separatist rebels for attacks like the
helicopter shooting, many Papuans point the finger at Indonesian
paramilitary police and military units who are paid by the company to
guard the mine. The apparent motive: squeeze more money from Freeport
by justifying their deployment in the area. “If there’s no conflict,
there’s no money,” says Reverend Yoman. “It’s like an ATM.”

Indonesian forces have been implicated in a sabotage of Freeport’s
pipelines last October. The pipelines, which transport copper and gold
slurry, were cut at multiple points parallel to the access road to
Timika. Sources close to Freeport say that aerial photos show
Indonesian troops supervising the cutting by gangs of illegal miners,
who then extract the concentrated gold. When engineers later went out
to repair the pipelines they came under fire. In some cases, these
sources say, acts of sabotage occurred within earshot of police
checkpoints, yet no arrests were made.

A military spokesman in Jakarta denied any military  involvement in
the violence. He noted that armed civilian groups often wear army
fatigues. He said swift action would be taken against any soldiers if
there were firm evidence against them, and he invited human rights
groups to report their findings to the military. “If we find our men
were guilty, we’ll take action. We will enforce the law. We will send
them to military court,” says Rear Admiral Iskandar Sitompul.

Whoever is doing the shooting and looting, Freeport’s security budget
is rising. As well as paying Indonesian troops for protection, a
controversial yet common practice in the mining industry, Freeport
spent $28 million in 2010 on its own security force, up from $22
million in 2009. It has also brought in Triple Canopy, a private
security firm staffed by former U.S. Special Forces that replaced
Blackwater in guarding U.S. missions in Iraq. While such costs are
relatively small compared with the lode emerging from those mountains,
it’s hard to have security certainty if security expenditures just
lead to more chaos.

Freeport must also deal with the freelancers. In the last decade
thousands of small-scale miners have flocked to the area, tracking the
upward march of gold. Timika, a dusty town of 120,000 people, has over
40 gold shops where specks are weighed and sold. While some miners pan
for grams in lowland rivers, others travel closer to the mine, where
higher concentrations are found in the waste rock. Far from deterring
the trade, Indonesian security forces allegedly organize the transport
of miners and supplies to camps inside restricted zones, taking their
cut from the rich pickings.

For Freeport the surge in illegal miners adds the risk that they will
start using mercury for extraction, posing a severe health risk to
themselves and to the river system. Some gold shops already use
mercury. Freeport is working with local authorities to discourage the
practice and educate miners and merchants about the dangers, according
to Kinneberg. It has installed monitoring devices in Timika and along
the river.

Arguably the biggest risk of all emanates from Jakarta, 2,000 miles
and two time zones away. As Indonesia’s economy revs up, politicians
are playing hardball with foreign companies in the resources sector.
Under a 2009 mining law foreign entities must divest to local partners
20% of equity in new mines within five years of production. Government
officials now propose raising this level to 51%, effectively handing
over control to the locals. They argue that the law also allows for
the renegotiation of existing contracts to bring them into line, which
is anathema to mining executives.

As Indonesia’s largest taxpayer, Freeport should enjoy some goodwill
in Jakarta. Since 1991 it has paid over $12 billion into Indonesian
coffers. But as with its security headaches, money can’t buy you love.
To its critics Freeport remains a tainted symbol of foreign privilege
under the 32-year dictatorship of President Suharto, which ended in
1998. Environmentalists accuse it of despoiling a pristine landscape.
Rights activists in Papua see it as a partner of an occupying
military. And politicians are jumping on the bandwagon, calling on
Freeport to stop complaining and start renegotiating.

“We’re not Bolivia or Venezuela. We’re quite nice. We just ask them to
be nicer than before,” says Satya Yudha, a lawmaker on a mines and
energy commission. One provision in the mining law that could apply to
Freeport requires miners to process more metals at the source. “Let
them keep it and be the operator. No nationalization. But in return
for that, build a smelter here,” says Hashim Djojohadikusumo, a
blue-blooded tycoon whose brother leads an opposition party.

In fact Freeport already smelts 25% of its copper at a plant in
Indonesia. What really perks up politicians and their backers is the
prospect of a compulsory divestment of the mine. A troubled asset
could be on the market, with a potential windfall for the lucky buyer.
“Everyone is using [the mine] as a battleground,” says Tony Wenas, an
executive of the Indonesian Mining Association and former legal
counsel for Freeport.

Kinneberg says Freeport isn’t required to divest equity in two locally
incorporated units, though it has offered to sell shares in one unit
to Papua’s provincial government (the central government has a 9%
stake in the other). He says Indonesia has “consistently indicated”
that it will honor existing contracts. “We believe our contract is
fair to all parties,” Kinneberg says via e-mail.

Surrender is not an option. Grasberg’s copper and gold reserves are so
immense that Freeport is spending $600 million a year to build a vast
network of tunnels below its open-pit mine. It knows it can keep
digging profitably in Papua for decades. The richness of the ore
explains its low production costs: $0.60 per pound of copper in Papua,
compared with $1.25 in Peru and Chile. “The geology is the easy part.
The regulatory side is multidimensional chess, with electrical shocks
for the wrong move,” says a Jakarta-based consultant to U.S.
­corporations.

The vice minister of mines and energy, Widjajono Partowidagdo, insists
that Freeport must be flexible on buying local content and equity
divestment. He acknowledges, though, that foreign companies don’t want
to give up control. “Fifty-one percent [divestment] is our first
position, and then we can go in the middle. We have to acknowledge the
needs of our nation, and we should also consider the needs of foreign
investors,” he says.

There’s a precedent for this game of chicken. In 1991 Freeport signed
a new 30-year contract, with options for two 10-year extensions,
subject to government approval. (“They have a very good deal,” notes
Widjajono.) The agreement was sealed shortly after the company sold a
10% stake in the mine to the politically connected Bakrie family for
$213 million, of which $173 million was financed by Freeport. A year
later the Bakries sold half of the shares back to Freeport for $212
million, effectively giving them a free 5% stake that they sold in
1996 at a substantial profit.

Could this formula work again? O’Rourke says that the highly leveraged
Bakries may be ready to buy another cheap stake in Freeport, in return
for using its political clout to resolve its regulatory risk. Analysts
say the Bakries would face competition from other tycoons in the
resources sector, if Freeport took this route. Asked if any Indonesian
companies had made approaches, Kinneberg declined to comment.

A discounted equity sale would be bad for Freeport shareholders. It’s
also not clear that it would end the insecurity at the mine, which
remains hostage to political and ethnic tensions. The sins of the
past, some of which Freeport had a hand in, many of which it did not,
now represent a risk premium on the company’s stock. At this point,
there isn’t much Freeport can do but keep digging and hope for the
best.

The man who shut the mine

One evening I slip out of my hotel to visit Sudiro, the mechanic who
led the strike. It’s nearly midnight, and several burly guards wait
just inside the gate. Inside the house I meet a trim, soft-spoken
43-year-old Javanese in shorts and a black Freeport polo shirt. As a
TV plays in the background, he describes his journey from tae kwon do
champion to union firebrand who defied a mighty U.S. corporation.

Born into a military family, Sudiro (one name) joined Freeport in
1992. One of his trainers at the mine was a U.S. pilot from the
Vietnam War, who praised him for his work ethic. He rose to the
highest grade as a mechanic, worth $615 a month in basic pay. In
October 2010 he was elected union leader and began researching wages
at Freeport’s South American mines. He decided that Indonesians were
being underpaid, and last July he made a dramatic demand: an eightfold
wage hike. When Freeport brushed him off, he staged a walkout of 8,000
workers in September.

Three months later Sudiro sat across from Freeport CEO Richard
Adkerson in a Jakarta boardroom to discuss a revised pay deal.
Adkerson, who had called the initial demands “excessive and
unreasonable,” adopted a friendly tone, says Sadiro. “He told us,
‘Please help our company to survive.’” Sudiro replied that he hoped
Adkerson had come “to provide a solution to our problems.” The deal
was signed later that day, and Sudiro flew overnight to Timika, where
thousands of Papuans were waiting at the airport to give him a hero’s
welcome.

Why did the strike succeed? Sudiro says he drew on his strict military
upbringing to lead the workers and press their demands. A Muslim from
Java, he invoked Jesus to rally Papuans, who are mostly Christian. His
ethnicity also made it harder for authorities to label unionists as
separatists and crack down, though shots were fired at his house and
car. “If the strike was started by Papuans it would have been crushed
a long time ago,” says a rights activist in Jakarta. One miner offers
his own explanation. “We had the power of God behind us,” he says.
Freeport should be so lucky. —S.M