Freeport-McMoRan Inc
NYSE:FCX
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Freeport-McMoRan Inc
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Ladies and gentlemen, thank you for standing by. Welcome to the Freeport-McMoRan Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session.
I would now like to turn the conference over to Ms. Kathleen Quirk, Executive Vice President and Chief Financial Officer. Please go ahead, ma'am.
Thank you and good morning. Welcome to the Freeport-McMoRan third quarter 2018 earnings conference call. Our results were released earlier this morning and a copy of the press release and slides for today's call are available on our website at fcx.com. Our call today is being broadcast live on the Internet and anyone may listen to the call by accessing our website homepage and clicking on the webcast link for the conference call. In addition to analysts and investors, the financial press has been invited to listen to today's call and a replay of the webcast will be available on our website later today.
Before we begin our comments, we want to remind everyone that today's press release and certain of our comments on the call include forward-looking statements and actual results may differ materially. We want to refer everyone to the cautionary language included in our press release and presentation materials and to the risk factors described in our 2017 Form 10-K and subsequent SEC filings.
Richard Adkerson is on the call today, as well as Red Conger, Mark Johnson, and Mike Kendrick. I'll start by briefly summarizing our financial results, and then turn the call over to Richard, who'll be referring to our prepared slides for today's call. As usual, after our remarks, we'll open up the call for questions.
Today, FCX reported net income attributable to common stock of $556 million, or $0.38 per share, for the third quarter of 2018. The results included net gains of $42 million, or $0.03 per share, which primarily reflected adjustments to assets held for sale and the fair value of potential contingent consideration, partly offset by non-recurring charges associated with a new three-year collective labor agreement at Cerro Verde. After adjusting for these net gains, our adjusted net income totaled $514 million, or $0.35 per share.
Our adjusted earnings before interest, taxes, depreciation and amortization, or EBITDA, for the third quarter totaled $1.8 billion, and there's a reconciliation of the EBITDA calculation on page 27 of our slide deck. We reported strong sales during the quarter. Our copper sales exceeded 1 billion pounds of copper, gold sales totaled 837,000 ounces, and molybdenum sales were 22 million pounds in the third quarter. These sales – the copper sales were 8% higher than our previous guidance and gold sales were 20% higher, and this principally reflects higher ore grades and operating rates in Indonesia as we mine the final phases of the Grasberg open pit. In addition, we are confirming in all material respects our operational outlook guidance in the coming years.
Our third quarter average copper price realized was $2.80 per pound. That was below last year's third quarter average of $2.94 per pound. And our gold average realization was $1,191 per quarter, and that was also below last year's third quarter of $1,290 per ounce. For the third quarter, our average unit net cash costs for our mines averaged $0.93 per pound. That reflects a strong performance from our global operations and the continued focus on productivity and cost management. The $0.93 also includes $0.07 per pound of copper associated with nonrecurring charges for the Cerro Verde three-year labor agreement that I mentioned previously.
We generated strong operating cash flows in the third quarter, which totaled $1.25 billion, and those exceeded capital expenditures of $500 million during the quarter. We ended the quarter with consolidated cash of $4.6 billion and consolidated debt of $11.1 billion. Our net debt at the end of September was $6.6 billion, and that continues with our deleveraging that we've had over the last several quarters. We ended the period with a strong liquidity position. In addition to our cash position, we also have a $3.5 billion revolving credit facility and have no borrowings under that facility.
Our board also declared a quarterly dividend of $0.05 per share under the new policy that was established earlier this year, and that dividend will be paid – that quarterly dividend will be paid on November 1.
I'll now turn the call over to Richard, who will be providing additional details and referring to our slide presentation materials.
Good morning, everyone. As we'll be talking about, as I do review these highlights, it's been a very active quarter for us here at FCX. Results from our global mining operations have been solid, our teams continue to execute our plans in a very effective way. In Indonesia, we had an important milestone in progressing our efforts to reach stabilization of our business there in terms of our negotiations with the government with the signing of definitive divestment agreements on September 27.
Operations, current operations in Papua have been strong, and we've made important progress in transitioning the Grasberg ore body mining from open pit to underground, so we'll talk about that.
We are continuing our sharp focus on the important things about our business to build shareholder value. Our unit net costs are at $0.93 a pound, significantly below last year and in line with our plans, it does reflect for the nine months $0.02 as a result of the successful settlement of our labor situation in Cerro Verde and Peru, so that was very good.
Operating cash flows exceeded CapEx in the third quarter by $740 million [ph], $2.5 billion to-date. Net debt, as Kathleen mentioned, is down $2 billion from the start of the year. And this agreement with Inalum is really important. It establishes the path to reaching long-term stability and de-risk our operations over the long-term in Indonesia.
We're going to talk about Lone Star. I mean, we're very excited about it in terms of the future of our company, and this is a ore body that's been identified for decades, but we're doing a lot of core drilling and the more we drill, the more optimistic we get about this ore body becoming a world-class mining operation in the future. It's growing now, has the potential to grow in the future.
Slide 4 [ph], copper market, it's a paradox. To be frank with you, it's a paradox right now. Physical markets are tight. Fundamental drivers remain very positive and yet sentiment about the commodity and about companies like ours in the investor marketplace is what it is and you know their concerns about global growth in China and so forth. But when you look at the fundamentals and look at this drop in global copper exchange stocks, and to see the copper price in that slide parallel to each other is very unusual in our industry typically when inventory stocks drop and they're also dropping at our customers, that indicates higher copper prices, but that's not what we experienced since June.
But when you look at the fundamentals, U.S. constructions and manufacturing remained positive, Europe is steady and positive, large Chinese fabricators are running at higher rates. Our customers have strong order books for us in the United States and business in China is good. Cathode availability is tight globally. There's issues with smelters disruptions in Chile and elsewhere in India. China is constraining scrap. Global stocks are down 40%, since the copper price was well over $3, almost $3.30 in early June, and this is a multi-year low stocks. But speculators are bearish on sentiment and macro drivers, and this is having a significant impact on price.
The long-term fundamentals are becoming increasingly strong. Deficits are inevitable absent a significant downturn in China and the global economy, and a lot of positives are happening in terms of alternative energy generations, electric vehicles, and so forth for our project. Now, what's this doing to us? This uncertainty is causing us certainly to slow down our long-term plans to develop our resources. I mean, we're going to defer those investment decisions until there is clarity in the marketplace. We're continuing to work on them, do preparation for them. We're optimistic about them, but this situation is causing us to defer and I believe it will cause other companies to defer, and that will add to this impending supply gap situation for the industry.
So, as I said, it's a paradox. I was in London for LME Week and most industry executives I talked to there and on the business roundtable believe that this trade situation will get resolved in a way that doesn't disrupt the global economy. But investors are skeptical and that's what we have to deal with in terms of the current situation.
A slide that we commonly show or have shown for many years is on page 5, and it makes an important information here. It's very difficult to replicate a world-class resource. The industry is supply constrained; discoveries are rare. There is 7- to 10-year lead times to develop new projects. And when you go down this list of the day's major copper mines in terms of reserves and production, you see Escondida and Grasberg in the 1980s, Las Bambas in 2000s, and then other mines are 100 years old or more. And with all the activity that's gone on since the super cycle started in 2003, there haven't been new additions to these charts. We think Lone Star is going to be on this chart at some point, but it's important for our industry to note this issue of supply challenges. And that points to the strength of our company with our strong current production levels and our future resources.
So operations update on page 6. As I talk about, we're focused on productivity and cost management. We've had some success with that. There's some cost inflation, but we've largely been able to offset that through efficiency moves and you can see that in our numbers. Our production and cost outlook is stabilizing as we see going forward. In 2016, 2017, because of the low copper prices and some degree because of the situation of our company, we cut back costs. We constrained maintenance capital. We were focused on costs principally. Now we're looking to – and you see this in our numbers in 2018 in Americas, we're looking to maintain our production volumes going forward. We cut mining rates and now we're increasing mining rates, and that involves some costs inherently. But now as we look far with our plans, we think our costs are stabilized. And we do think we're going to be able to manage cost inflation in an effective way, so that's an important part of what we're doing in operation.
We'll talk more about Lone Star, but beyond that we're evaluating our project pipeline to consider alternatives, rank them, make decisions about what we might do in the future. We're going to remain disciplined and we have the chance, the opportunities to do low risk capital expansions when the market is right for doing that.
So, in Indonesia, you can see we had really strong performance in the third quarter and year-to-date in 2018. After an extended period of time of issues associated with our workforce, some of our operating systems, and with security issues, we are now operating in a very effective way safe operation, strong production, making progress on the things that we need to address.
We're mining the final phase of the Grasberg open pit in the fourth quarter of this year. I was there when we were drilling the core holes in 1988 and it's amazing to think about here we are finishing the pit. We're going to extend operations in the pit into 2019 by mining. Our guys came out with a great idea. We had some haul truck ramps that have some high grade ore in it, and so we were originally just going to abandon those and mine that ore from the underground. Now we're going to go back in in the first half of the year and access some of those high grade sections of the haul roads and mine that. By mid-2019 we'll be complete in the pit, and it'll be significantly winding down now and going forward.
At the Deep MLZ mine, which is an important mine for our future, it's separate from the Grasberg Block Cave mine, which really has the bulk of our reserves over the remaining terms of our operating rights to 2041. This Deep MLZ is a great mine. It's a separate mineralization area that started with the Ertsberg pit years ago and we began block caving that mineralization area in the early 1980s actually. And as we commenced this in 2016/2017, we started experiencing, for the first time in our operation, these mining-induced seismic events. To address that, we are using a procedure of using hydraulic fracturing of the rock to manage seismicity and pre-condition the cave. This is done in South America and Chile. It's not complicated technology. It's established and we've begun that process, and today it's been effective in doing what we wanted to do. So it's giving us increased confidence, de-risk our plans for the mid-2019 startup of caving in the Deep MLZ.
With the Grasberg Block Cave, after years of investment plans, our infrastructure is now in place. We're successfully testing a new underground rail system and ore flow system. We're conducting initial blast for undercutting during the third quarter. Rock testing confirms that this rock is suitable. It's the same ore that we've been mining since 1990 in the Grasberg open pit, and it's suitable for a really effective block cave mining. And our company is the world's leader in underground mining because of all the experience we have. In terms of scale, this is going to be the largest underground operation ever done. But in terms of the technical challenges is things we've worked with for years and we're very comfortable in doing it.
So Lone Star, those of you who follow us know that this Lone Star resource is located in Eastern Arizona adjacent to our Safford mine, which began operations – was beginning operations 11 years ago when we acquired Phelps Dodge, and now the Safford oxide ore is declining production. And so we have excess processing facilities that we are going to use in mining oxide ore from Lone Star. We're stripping this. You can see the pictures of the progress we've made by stripping it. Year end 2017 reserves were 4.4 billion pounds of copper; only oxides. It's $850 million project. We're well into it and it's got 200 million pounds annually of production for 20 years.
Now, as we drill this ore body, the oxide resources are expanding, and this has given us some opportunities. And then we had previously drilled an underlying, what appears to be, very large sulfide resource. And our current drilling is confirming this and extending the sulfide resource. So what we're doing now with the oxide project is in essence stripping this material to expose what could be a world-class sulfide resource. Morenci is just over the mountains, very nearby. This has the potential of being a Morenci-type ore body in the future. And it's going to be a key part of FCX's future going forward.
So returning back to PT-FI and Indonesia, here's where we stand. As Kathleen said, there are no significant changes today to our previous outlook. Activities during this quarter have, in our view, de-risked to a significant degree our ability to achieve this. But we will have – as we complete any mining activities from the pit in mid-2019, we'll have two transition years in terms of achieving production rates for the Deep MLZ and ramping up the Grasberg Block Cave. And when I say ramping up, you see the rust red part of the slide showing the Block Cave ramping up. The purple slots above that showing the Deep MLZ mine ramping up, and that's supplemented by the existing DOZ mine, which is above the Deep MLZ mine, which is in its decline phase.
So, we will have a very significant copper and gold this year. We'll have a couple of years. And you can see all the numbers here shown for you below this chart. And then, we'll be reaching the levels that we will have for our long-term mine operations when all this is fully developed and operating as planned. And that extends through 2041 and this will be one of the world's largest copper mines, big gold mine, very attractive economics because of mixture of both, long-term, low cost operations.
So, the agreement with Inalum, the agreement with Inalum that we signed on September 27, in my view, is very important and it's very positive outcome for all parties. And when I say all parties that includes the government, its state-owned company Inalum, achieving objectives that they had clearly communicated to us over the years. Our joint venture partner Rio Tinto is achieving – will be achieving its objective of exiting this asset. They were facing divestment in any event. They have negotiated a valuation that's acceptable both to them and to the government. And then to our shareholders, I will tell you this, I'm much more pleased about where we are today than what I expected to be last year when we signed the framework agreement. And the reason for that was – the key to this being so positive for all the partners actually was Rio Tinto's decision to sell. The government is acquiring Rio Tinto's interest, which will ultimately be a 40% interest. We're only having to divest an effective just over 5% interest in the property. A year ago, we thought we might have to invest 27%. So that avoided a very difficult valuation negotiation and so forth.
At the end of the day, PT-FI, the Indonesian subsidiary, will get bigger. Previously, it was a joint venture partner with Rio Tinto, and now Rio Tinto's interest will come into PT-FI. PT-FI will then have the total operations. The shareholder own – and it will continue as an entity. The shareholder ownership interest will be 51% Inalum, 49% FCX. We have agreed on a shareholder arrangement that protects the economics that FCX had under the Rio Tinto joint venture agreement. So we will be getting substantially all of the production through 2022.
We've agreed on a corporate governance operating structure, where we will be partners with Inalum in terms of the corporate structure, but there will be a shareholders' agreement that will grant FCX control over an operating committee to ensure that operations are run in a consistent way with what we've done now and consistent with the long-term mine plan that we've agreed to. We will have extension of rights through 2041, with assured fiscal and legal terms and legal enforceability. And there are no significant changes in those terms from our contract work. So, all of this comes together that gives us a very positive deal.
Now, one thing that I believe is very important is by having Inalum as a 51% partner and they seem to be on the verge of commencing the activities of raising the bond financing to finance this acquisition from Rio Tinto is that we'll now have an alignment of interest between the government and the Indonesian Freeport. They will want to see the operations run with stability, because they'll need cash flows to fund this significant debt they're taking on. And the markets being very positive – appears to be very positive in terms of being receptive to this bond offering, and so they'll want to see the operation run smoothly, to generate cash flows, to service their debt, and generate dividends. So, I believe firmly that this will create a better overall environment for operations than what we've experienced in recent years because of the divergence of opinions and views about what we should be doing now. I think we're all going to be together aligned, and that will be helpful.
So we have a very diversified global set of assets. We're in a leadership position. The core feature of our company is we operate all the assets that we own interest in. That gives us significant operational synergy, shared resources. We can allocate capital in a way that's prudent and effective. Large long-term production capacity with long-term expansion. Three-quarters of our reserves and resources are located in North America and South America. In today's world, that's a positive. We've got a great team, experienced in operations, project development, execution, innovation, leadership in the industry.
And in the United States, we benefit from the improved regulatory environment, but also across the tax situation. One consequence of the oil and gas deal was a very large tax loss carryforward, which means we're not going to pay taxes in the United States for many years. And the recent Tax Reform Act actually drops the effective tax rate for our company absent the NOL to around 10%. That's a big difference from what you face internationally. So, that's going to be very positive for us in terms of looking at Indonesia.
Now, market valuations – market valuation – I've been around long enough to know that's just what it is. But the one thing the way we've looked at this recently to think about, talks about the valuation of our asset is recognizing going back to that chart of the major mines where we have three of today's major mines that the portfolio that FCX have is very difficult to replicate. Our copper equivalent capacity to our equity share is about 4.5 billion pounds of copper a year. When we look through projects around the world that we're looking at and others are looking at, we see it's $8 to $10 a pound to develop capacity. And that means on that simple high-level metric that the implied replacement cost for our current capacity is on the order of plus or minus $40 billion. Just a thought for you guys to look at, but that's where we are.
Okay, so 2018 outlook is unchanged from previous guidance: copper at 3.8 billion pounds; gold's a bit higher at 2.45 million (sic) ounces; molybdenum, 95 million pounds; site production costs reflecting this $0.02 special item at Cerro Verde for the labor settlements in line with where we're before; after by-product credits just over $1; operating cash flows at $2.85 for copper for the fourth quarter, it would be (sic) $4.2 billion. We are going to have some...
Dollars.
...dollars. $4.2 billion. We are going to have some tax – essentially tax-related working capital usage totaling about $500 million in the fourth quarter. And we of course very highly leverage copper prices for the fourth quarter of $0.10 means just over $100 million to us. No real changes in our capital expenditures from previous guidance. And so we're basically confirming the guidance we've given you previously.
Sales profiles are presented on the slide 12. We've essentially brought forward some copper from the fourth quarter into the third quarter this year. We always try to do that. We'll try to do it in the fourth quarter. But for the year, our – we were up in the third quarter keeping our year guidance consistent with where we are. And you can see how the outlook goes for copper, gold and molybdenum.
When we look at the cash flow generating capacity of our company on slide 13, we are showing this to show the transition years, 2019 and 2020, and then the average for the years after transition (sic) 2021 and 2022...
2021, 2022.
2021, 2022. And EBITDA would be $4.3 billion at $3 copper, $7.1 billion for 2021, 2022 at (31:52) $3 copper, operating cash flows just over $3 billion to $4.7 billion, and the $3.50, that grows significantly to EBITDA of $5.9 billion for the transition years, over $9 billion for the subsequent years with cash flows $4.3 billion to $6.4 billion. So, our company is characterized by the ability to generate very strong cash flows from our existing productive facilities. Capital expenditures, really no changes from what we've talked about. We had a plan, we're sticking with it.
Financial policy, Kathleen talked about net debt being at $6.6 billion at the end of September. In early 2016, we had set a plan to reduce our $20 billion of debt at that time by $5 billion to $10 billion over two years. We've already done $13.6 billion. And so we've really come a long way in addressing Freeport's balance sheet issue and we have a strong financial situation now after the strong deleveraging over the past two years. And so, we are – as I said, looking forward continue to strengthen our balance sheet. We reinstated the dividend. We're looking forward to the time of paying higher dividends. We've got growth opportunities. We're going to be very disciplined about when we undertake those. We're going to need to see clarity in the marketplace, some of these uncertainties resolved, and we'll continue to review this financial policy as we go forward.
But I'm really pleased with the way our company is really set up for future success. With our global portfolio of copper assets, copper is very attractive. When you look at its long-term fundamental market outlook, that's something you hear from a lot of others in the industry. With our company, we have strong margins and cash flows, long-lived reserves, good development opportunities, geographically diversed with 75% of our future P&D (34:23) come from the Americas. And we've got a great organization that's experienced and had success.
Now, we've addressed our balance sheet, I believe the Indonesian overhang issue has been addressed, I will say we're no longer debating issues in Indonesia. We do have to complete some documentations of our agreements prior to closing. We expect closing to occur, if not at the end of 2018, in very early 2019. And today, I would suggest that our attraction – our value attraction is – valuation is attractive in light of all these other factors. And we are looking forward to outperforming and committed to that.
So, I will open the line for questions. I look forward to responding to any questions you may have.
Our first question will come from the line of Chris Terry with Deutsche Bank. Please go ahead.
Hi, Richard and Kathleen, thanks for taking my questions. First one I had is just on the capital allocation decision going forward. I think you'd mentioned previously that you wanted to get net debt below $5 billion as your target. So, can you just talk through where you want the balance sheet to be at?
And then leading on from that, if you believe in copper, you've talked about the fundamentals and how you see it playing going forward, will you invest in new projects and potentially look at M&A et cetera if the sentiment remains bearish, i.e., will you continue down the path that you see is the right way to add value even if investment sentiment isn't in the market for the next year or so? Thanks. That's the first question.
Chris, I'll take the first part of that, and let Richard address the second part. Our net debt target has been reached. We had set out to get that net debt to $10 billion. And we reached that last year. And so, now we're just continuing to strengthen the balance sheet. We've initiated the dividend to shareholders, we'll continue to look at capital allocation and return to shareholders, but we feel good about the net debt that we currently have, and that is below our target.
So, Chris, with respect to your second question, we're going to prepare ourselves for future investments. We've got a number of alternatives and we're going through a ranking process to decide sort of which one to focus in on first, and we'll do that. I would say, in thinking about what you said; to me, this is not a question of investor sentiment, but it's really a question is, where is this world heading. On one hand, if – and this is the consensus view of business people I talk to that all of this issues between the U.S. and China today is a posture in creating a lever to try to address some fundamental industrial policy issues in China, and many people believe that there will be a resolution of that similar to what we just went through with NAFTA and so forth that it's a question of style and strategy to reach a settlement. And that's one thing, because if that's reached, then – the underlying economies are still really strong in China and globally, and particularly in the United States.
On the other hand, if this goes in a different direction and results in a significant impact in China, there are those who say that China has the ability to address a weakening of its export manufacturing economy by investing in infrastructure, in this Belt and Road Initiative and so forth. But all of that, it's a question of what really is result of all of this. If that has an impact on copper demand in China so important, then we're going to wait to see how that sorts out. So, we're not going to be bullheaded about this, we're not going to be overly confident about our ability to predict it. We're going to prepare. We're not going to start investments until we have clarity about the ultimate outcome of all these current uncertainties that are weighing so heavily on investors' minds today.
We're going to focus on internal opportunities and increasing shareholder returns. If we get a favorable outcome of all of this and copper price recovers, we'll be making a lot of money. We have the chance to invest internally and increase our dividends. We're going to be out there observing everything that goes on in the marketplace. I can assure you we get contacted by companies and bankers about opportunities all the time. And we're going to be open to those. But it's a high hurdle for an outside opportunity to compete with our internal opportunities because we have no value for those right now. We also have no taxes to pay on future operations in Indonesia and wherever else, I mean, in the U.S. Indonesia, we'll pay strong taxes. But here in the U.S. – and that's a huge advantage when you're looking at comparing after-tax rates of returns because resources are taxed heavily wherever they are in the world. You have investment certainty in the U.S. that is stronger than anywhere else. So, anyway, that's where we are, Chris. And it's not – I see it more as a fundamental question as opposed to an investor sentiment question.
Okay. Thanks. Thanks for the color there. And my second question is just around Grasberg specifically. I assume you'll give guidance or you'll zoom in on the full year results in February. But can you talk just a little bit more about 1Q and 2Q? I guess you've given guidance that the open pit will be complete by the end of – or the middle of 2019. Which is, I guess, the highest risk period in 1Q or 2Q, how do you see those two quarters playing out specifically? Thanks.
Well, the open pit will continue through the first half, and we're not expecting at this point for Deep MLZ to start caving. So most of the production that we're expecting in the first half is coming from established production either the open pit or DOZ in the first half. We have in our estimates for Deep MLZ incorporated some contingency plans and at this point in time, we still believe that the mid-2019 startup is appropriate. We do have the chance to potentially accelerate that. And as we always do, we always look for ways to accelerate metal. But we will begin – as Richard said, we've got the Grasberg Block Cave infrastructure prepared, and we will begin activities in the Grasberg Block Cave in the first half in parallel with completing the open pit. So, the Deep MLZ, as Richard said, is a very small portion of our 2019 production, it's less than 10% of our ore through the mill.
And, Chris, just refer back page 8, and you can see that Deep MLZ and the Grasberg Block Cave are both small parts of the annual production in 2019 growing in 2020, and the pit is completed in first half of 2019, DOZ is there. So you can see from that really where we're doing and that starts emerging in the second half of the year when we're out of the pit altogether.
Okay. Thanks. I'll leave it there. Thank you.
Thanks, Chris.
Our next question comes from the line of Matthew Korn with Goldman Sachs. Please go ahead.
Hey, good morning, everyone.
Good morning.
Congratulations on a good solid operational quarter there. Question on Indonesia, in the context of the agreement, if you could help us understand a little bit more where we are regarding the environmental issues. I think it's an element I find investors are still somewhat unclear. So, first, have there been any changes so far as to what's actually been requested of Freeport? Second, what part of the government are you interacting with and what's your read on what they want? And then again at the end, at the end of the day, do you expect that this is going to result in any kind of real material change to the operations there? Thanks.
Okay. Thanks, Matthew. Good to hear from you. So, the government is working in a coordinated fashion across the ministries. Energy and Mines Ministry, which administers our basic operations; the Finance Ministry; the state-owned enterprise industry which manages our new partner, Inalum, and the Ministry of Environmental and Forestry, which deals with the environmental issues. We have been given assurances that environmental issues will be resolved in a way that will not disrupt our operations or add significant additional cost to our operations. And, in fact, there is today and recently articles in the Indonesian press to that effect. We are working with the Environmental Ministry to document how to deal with these new decrees that came out and announced in our first quarter earnings call.
And so, the objective is to come up with ways to amend those decrees to achieve that objective of not disrupting our operations or adding additional costs. All of us are working together that – as you can imagine, this is a significant matter for Inalum and its financing activities. And we've been working with their banks and lawyers in terms of understanding that and working with the Environmental Ministry to achieve that goal. So, everybody is working with the same goal. We have to get documentation for it. It's necessary to have that done before we close the deal. We also have some wording in the new license agreement to complete. We're working on some agreements to give us international arbitration rights to enforce our rights going forward. All of those things, as I said earlier – issues are not being debated. Work is coming together to get documentation of what we've agreed to.
Got it. I appreciate all that color. Very helpful. Second one is simpler, yeah, we saw the one-time charge for Cerro Verde that had been the big pending labor agreement for you all. Cost-wise, what should we think – how should the effect be in terms of P&D costs going forward for that region as a result? Thanks.
Matthew, this is Kathleen. We're not expecting any significant changes in our net cash costs in South America or North America as we look forward. As Richard talked about earlier, we have been taking steps during 2018 to reinitiate mining rates and reestablish the production capacity following the curtailments in 2015 and 2016. But from here, we're not expecting the unit cost to change significantly as we look forward...
Yeah, great...
...for 2018.
And I'll compliment Red here that milling facility I believe is the largest in the world in the mining industry and with our recent expansion and the sizeable mill that we had there before that, man, it's going great. I mean, it is above nameplate. And so all of that – it's a big low-grade deposit, mining is relatively easy, just a lot of work, lot of material to move, but that's a great operation with years of – of a lot of cash flows ahead of it. And we were very pleased with the labor settlement. We had this one-time charge, but it allowed us to meet the aspirations of the workforce and do it in a way that controlled our costs.
Great. I appreciate it. Best of luck to you, folks.
Okay. Good luck to you too, Matthew.
Your next question comes from the line of Lucas Pipes with B. Riley FBR. Please go ahead.
Hey, good morning, everybody. Richard, Kathleen, I wanted to follow up a little bit on the shareholder agreement that has been put in place to maintain the split of economics through 2022 and then beyond. In the hypothetical case where maybe things take a little bit longer to ramp in Indonesia, would you still preserve the same split? So, in other words, if maybe production goes from 2022 to 2023, would that have any impact on your economics? Thank you.
Yeah.
The answer is, yes. We preserve the economics.
That's...
(49:33)
We'll be in the same position we would have been in with Rio Tinto.
There is a specified amount of metal that...
It's not a timing deal, it's a specified amount of metal.
Great. Excellent.
And one thing I should have mentioned when I was talking about this overall deal, when we were on the NPV of this operation under our COW and our joint venture arrangements with Rio Tinto, it's rough – it's very much equivalent to what we'll have under this new structure. And if you think about how far we've come to end up with an answer of where we've achieved our goal for extension stability and preserved the FCX's economic interest in this great asset, that's a great accomplishment. And we're not popping the champagne bottles until closing, but we're very optimistic about getting this done in the timeframe that I talked about.
Excellent. No, great job on it. And, yeah, I look forward to the agreement coming over the finish line here in short order. I wanted to follow-up on the operations in Indonesia. So, Richard, I think you mentioned in your prepared remarks that you've de-risked it. Now when I look at your guidance, it hasn't changed materially. So should we be thinking about you having narrowed the confidence interval around the mean? So if you could elaborate on that, that would be helpful. And specifically to the DMLZ and Grasberg Block Cave, what are some of the milestones that we should be looking forward to over the next six months or so?
So this is what we've done. With respect to our current operations – and it's the open pit mine, the DOZ essentially, but also running the mill with the ore flow delivery systems, with the concentrate delivery systems, using the slurry pipelines to get to the port, our relationship with our workforce and local community and security, all of those things are much, much improved and they are important.
Then in terms of the Grasberg Block Cave development, which over the years with all the disruptions that we had from export bans and security issues and so forth, that's just gone really good. I mean, Mark Johnson and his team have done an exceptional job, and now, Mark, pipe up. But I say, we have completed and met all the risk of infrastructure development for the Block Cave mine, so that's important. That's not risk facing us. We are addressing the seismicity issue at the Deep MLZ. Early indications are that this fracking approach, which we've never used, but is common technology in the industry, is going to be very effective in dealing with that issue for us going forward. So, that's a major positive.
So, milestones to watch. Beginning in the second half of 2019, we began block caving mining in the Grasberg Block Cave. That's very similar to – it's big, but it's very similar to what we've been doing now since early 1980s. We know the rock fully drilled, same rock that we mine from the pit. So, you'll be able to see the results of that in the second half of the year, the beginning results of it. And then, as we continue with this fracking operation in the Deep MLZ, we'll see the consequence of that, but we're really encouraged about it right now. So, how do I answer your question? There's always risk in mining. There's always risk in underground mining. But, Mark, why don't you...?
Yeah, just to elaborate a little bit on the GBC. We announced last quarter that we commissioned the ore flow system, which was the big crushing/conveying system. We continue to ramp up the rail system, which – what delivers ore from the mine to the mill or to the ore flow system, and that's ramping up as expected. We took our first undercut blast in September, a little ahead of schedule. And in January, we do our first drawbell in the Grasberg Block Cave, and that continues to ramp up. The GBC, Grasberg Block Cave, is a little different than some of our other block caves, in that we have multiple working areas. And so, we're paging the – ramp the same process throughout three different areas over 2019.
The Deep MLZ, as Richard mentioned, the hydrofracking is working very well. We're seeing the seismic response that we would like. We're getting the seismic stresses away from our working areas and above the cave, and we're seeing good signs that the cave is propagating vertically, which is what we hope for and it's a very optimistic start. Big Gossan, we don't talk about that a lot, but we're ramping it up to full production of 7,000 tonnes a day by the fourth quarter of 2019, and that's about a year ahead of schedule that we had a year ago.
And then the DOZ, we don't look past it. It's still a significant producer. We're continuing to advance the remote mining associated with the wet material that we're dealing with. And we're very encouraged by that. We've had – this last week we're well over 40,000 tonnes a day, and that's where we need to be next year. So those are the milestones that I see. The mill next year won't be a constraint. Power systems, we're going to be doing a lot of maintenance, as needed, and being prepared for the ramp-up 2020 and 2021.
Okay. Thanks, Mark.
This has been very helpful. I appreciate all the detail on this and best of luck.
Thanks. Appreciate it.
Our next question...
I was just going to say, in the interest of time, if we could limit people's questions to one, so we can move through this. We've got a list of people in the queue, so...
And our next question will come from the line of Alex Hacking with Citi. Please go ahead.
Yeah, thanks, Richard and Kathleen. Richard, in your prepared remarks, you talked about that you were slowing down some investments. I guess, could you be more specific there, if possible, in terms of investments or projects that you're slowing down and also kind of the cadence of (00:56:56).
So it's not...
Thanks.
Alex, maybe I wasn't clear, but it's not really slowing down things. It's when do we initiate investments. I mean, we're continuing with our Grasberg underground development, the Lone Star project, and so forth. So, we haven't really slowed those things down. We're, obviously, looking at costs and constraining them in this uncertain market environment. But the issue is, when do we start major new projects on our resources and we've deferred the decision to start those until we get market clarity. And that would include our potential large scale project at El Abra in Chile, where with our partner Codelco we've completed pre-feasibility. It's an attractive project, lots of capital. We've got projects in the United States at various of our mines, including a mill expansion at our Bagdad mine in Northwest Arizona. So, what we slowed down is pulling the trigger to start, but that's where we are.
Okay. That makes sense. Thanks for the clarification.
Okay, good
Our next question will come from the line of Orest Wowkodaw with Scotiabank. Please go ahead.
Hi. Good morning. Richard, just wanted to ask to get a bit of color just from some of the recent media articles, where you've been interviewed. It seems to suggest that the company is open to a sale. And I'm just curious how to think about that, given your earlier comments about just all the resources you have on the ground and all the future projects and sort of how undervalued you are. Can you maybe offer a bit of context on those comments?
I'm glad to. Thank you for your question. So, as most of you probably have noted, as we've been in negotiation over this extended period in Indonesia, other than our earnings call and investor conferences, I have really not been giving interviews to the media like I used to. Trying to encourage our partners in Indonesia also to not do this.
So, around LME, with the signing of this agreement, I've given a number of interviews, including one interview where at the very end of a large interview I was asked the question – I didn't bring it up – that there had been some comments in the marketplace that Freeport could potentially be acquired. I have a stock answer to that. I'm saying, we have no plans to sell the company, we're focused on our internal business.
Two, as a public company, we're going to be open to opportunities for our shareholders as they evolve in the future and that would be a wide range of opportunities that we might have. And so it was a stock answer, one I've given for years, one I'll continue to give. And in my view it was mischaracterized in headlines in the way this thing was talked about. I personally do not believe that in today's world with these uncertainties, there are opportunities for big M&A transactions in the industry. I certainly don't consider it to be something that we would look at in the near term, given our share price.
Okay, perfect. So it's not something you're actively pursuing?
No. And like I said, I don't think in today's world with all these uncertainties, I think it's unlikely that anybody's going to be pursuing big scale deals.
Okay. Thank you. And just one clarification. In slide 23, the Grasberg mine plan, can you maybe explain how come the gold at 1.9 million ounces in 2022 is the same when you show it on 100% basis versus including Rio's share and then PT-FI share, whereas obviously the copper is different, I assume, because of the metal sharing agreement. But does that not apply to the gold in that year?
It also applies to gold. It's just that when you look at the years 2019 through 2021, the production is less than the metal strip. And when you get to 2022, there is some sharing in copper. But the way the metal strip works for gold, all the gold in 2022 is – substantially all the gold in 2022 is for PT-FI's interest.
Okay. Thank you.
So there is different metal strip for copper and gold.
These metal strips were decided (01:01:59) in 1996, 1997, and they were just fixed. And so that's just the way it works. It was based on the old mine plan with old government capacity. And it was just a complicated part of that original agreement with Rio Tinto.
Okay. And just finally, will you be continuing to consolidate Grasberg when this definitive agreement is completed or are you going to change sort of the way you start reporting this?
So that's an issue we're currently studying as we complete this deal. Normally, in consolidation, 51% is the criteria for share ownership. This is different, because we have base control over operations through the structure in the shareholders' agreement. So, it is something that we're considering now. I'll tell you this, in terms of meeting our objectives, Freeport's objectives, of having authority to control the operations of the business, we're very satisfied with the way this thing ended up. And when we have time with investor meetings and so forth, we can go through that in some detail, but we have an operating committee that FCX controls and its authority is broad and effective in terms of running the business.
Great. Thank you very much.
Thanks. And I'll just ask again to limit to one question, if possible.
And get back in the line if you have time, so...
Our next question will come from the line of Oscar Cabrera with CIBC. Please go ahead.
Thank you, operator. Good morning, everyone. Well, my three questions became two and now one, but that's fair enough. So, getting back to capital allocation, disciplined approach is great. Balance sheet appears to be where you want it to be, but you're still generating strong cash flows from operations. So can you talk a little bit more about returning cash to shareholders with share buybacks that some of your mining peers are doing be considered in that?
So, well, Oscar, while we met our targets in the uncertainties with today's world, excess cash flows will continue to be used to reduce debt. Our cash flows will fall off in these transition years, so we face that circumstance. And then with these uncertainties in the overall marketplace that I talk about with Chris' question initially, that's going to make us conservative and cautious about financial policy. So, we're going to be solid with what we're doing and it's driven by both, the circumstances in the marketplace and our company's situation of having these transition years. But when we look beyond that, then we'll have lots of opportunities to do different things.
Okay. Thank you, Richard. So, I'll get back in the queue.
Our next question comes from the line of John Tumazos with John Tumazos Very Independent Research. Please go ahead.
Congratulations on all the good progress and people even asking about buybacks. In terms of El Abra and Bagdad potential projects that might move ahead in better times, roughly, how many metric tons per day might the mills be at El Abra or Bagdad, roughly?
At El Abra, we're looking at roughly the size of Cerro Verde 2, 240,000 tonnes a day, and at Baghdad...
120,000 tonnes.
As you hear Red, 120,000 tonnes.
120,000 tonnes, John. Now, these aren't equivalent projects. First of all, El Abra in Chile has a 49% partner. We have 51%. It will involve a major desalinization plant and the infrastructure to pump that water to elevation with attendant energy costs associated with it. It's a great resource, but it's a bigger project.
At Bagdad, benefits from no taxes as we go forward. We've for years made plans for developing water resources for it, tailings areas. And so, it's a smaller project in the aggregate. We own 100% of it. We own the land and sea there. It's a remote area, great relationships with local community, straightforward type project. So, those are the tradeoffs.
And then in the U.S., we have the benefit of attractive energy cost today, good regulatory environment, a workforce that is supported by the community in terms of housing, education, and healthcare, and so forth. People drive their trucks to work, bring their lunch. So there's a lot of tradeoffs, John, that go into those decisions. And over the years – and you remember like I too well when the Southwest copper district was considered totally dead. With all those changes today, it is very attractive.
Thank you.
Thanks, John.
Your next question comes from the line of Brian MacArthur with Raymond James. Please go ahead.
Good morning. You brought up the tax advantage a few times. So just very quickly, can you remind me where we are on tax pools in each of the regions? So if I'm looking for after tax cash flow or cash cost per unit of copper, I mean, you're sort of saying it's 10% or less in the U.S., it's 35% in Peru and Chile, and 50% in Indonesia. I'm just trying to see the next couple of years if you have lower Indonesia earnings or whatever, how that's all going to blend in and you're going to generate after tax cash flow?
So, we're unlike many other global companies, in that we pay higher taxes outside the U.S., whereas many companies before tax reform paid higher taxes in the U.S. We're taxed individually in those countries and those tax rates, in Indonesia there's a 35% corporate income tax. There's a 10% withholding tax that's additional to that for funds that come out of Indonesia, and then you have the royalties that you have there. So all of that's there.
In the U.S., we have a very large tax loss carryforward, so that our tax rate for a long time will be zero. And when that expires many years in the future, under the current tax laws, the effective tax rate on our operations in the U.S. would be about 11%. And that's because percentage depletion was retained under tax. And so that's where we are. In South America ...
It's around 35%, yeah.
You're right.
And those are cash taxes, right, as opposed to effective accounting taxes?
Correct.
Yeah, we write checks internationally like everybody else.
Perfect, great. It's just you brought it up and said it's – your, obviously, cash flow is going down, but your after tax is being somewhat more efficient across the U.S. versus Indonesia as we go forward, right? So it's not going down at first if you look...
Well, the U.S. production is not going down – our U.S. production and South America production is not going down. It's only...
Right, right.
...Indonesia and that will be shielded, to a degree, by taxes there. That's an important thing in looking at the smelter obligation too. The smelter costs will have a tax effect associated with it.
Great, thanks. And that's all embedded, which I assume is why when you look at that chart on page 13, you see the EBITDA over the transition years compressing down and the average operating cash flow, it doesn't go down as much as you think, because you're getting all those tax benefits.
Well, yeah, tax consequence...
For tax consequence. So it's not a benefit, I get it. Okay. Great. That's very helpful. Thank you very much.
Thank you, Brian.
Your next question comes from the line of Michael Dudas with Vertical Research. Please go ahead.
Hi. Good morning, everybody. Looking at your capital spending plan over the next few years in the chart, I noticed the increase in the maintenance or non-growth spending. Is that all catch-up? Is there some equipment squeeze or any unusual opportunities that you're going to see there for the next few years or are you anticipating higher vendor prices for what you're going to be investing? Thank you.
Well, some of it is we had deferred maintenance during 2015, 2016, into 2017, so some of it is catch-up. But this is – I mean, these are very reasonable levels of maintenance capital for operation our size. There's nothing unusual there and we've done some great things like – Red, when's the last time we bought a truck?
2008, a new one.
A new truck in 2008. We rebuild all of our trucks. We've got great deals with our tire – we're constantly working with our suppliers to mitigate cost increases. And when you step back from this, this is a very reasonable level of maintenance cost for an operation of this size and this nature.
Yeah. And to answer the latter part of your question, we're not seeing, of course, only edges (01:12:16). We've always got cost inflation to manage and work with our vendors, but that's not the reason why we've got capital where it is. It's more this effort to sustain our operations, rebuild the equipment, add equipment to increase mining rates, and which we believe will drive long term value.
Thank you, all.
Thanks.
Our next question comes from the line of Chris Mancini with Gabelli & Company. Please go ahead.
Hi, everybody. Thanks. Just a quick question. In the North America operations, you're saying that the costs there were a little bit higher in the quarter because of higher mining rates. And, Richard, you kind of referenced this in your opening comments that you're mining more now relative to what you were doing when you were trying to cut costs. Is this laybacks at some of the mines and is it – when these are completed, will the unit costs come back down in North America? And then also, is there an opportunity to reopen the Miami mine? Those are my two questions.
So, Chris, this is Red.
Hi.
The mining rates are at levels that we can sustain long-term, gives us the flexibility to be able to blend ores and all those kinds of things are important to us and higher copper prices and longer term outlook for those mines, and the cost will come down a bit as we get all of that dialed in. We are playing catch-up. Right now, we constantly look at the resources that we have. We don't see anything out in the future for Miami, but it's not off the list either.
Yeah. We have an ongoing program of environmental management there and when we discuss with other operators in the area things that might be possibilities. We are very encouraged about our Chino mine in New Mexico, which we thought it would be completed by now, but we're finding resources at depth. So, we started this Cobre project there to help current operations. Our guys are doing a great job managing that currently and it has some potential for the future as well.
Okay. Thanks a lot.
Our next question will come from the line of Matt Murphy with Barclays. Please go ahead.
Hi, Richard. Just another question on the pipeline in the Americas. I'm interested in what you think your response time could be. If at some point you feel more comfortable on the copper price outlook, how quickly you could put some of these options into production?
So I think the most shovel-ready-type project we have is at Bagdad and it's five, six, seven, eight years from pulling the trigger to go to getting production out of it.
Now, you've seen the Lone Star...
Yeah.
...production that we're expecting to come online at the end of 2020. And as Richard was talking about earlier, as we strip, we're really going to expose additional oxides, and there could be a project at Lone Star to increase from 200 million to higher rates. We'd have to put in some additional tank house capacity, but that one could be quicker in terms of adding volumes, because we think the resources there adding some capacities, that will be quicker than putting in a new mill, for instance. So Lone Star keep on the radar for potential increases to the 200 million that we've got at the end of the 2020 period.
Okay. Appreciate it. Thanks.
Our final question will come from the line of Timna Tanners with Bank of America Merrill Lynch. Please go ahead.
Oh, hey, good morning. Thanks for letting me in. Just one question. I wanted to ask if you could please give us an update on any details regarding the Grasberg smelter. I noticed a small change in language between the two releases. And also as you were talking about cash flow expectations for the next several years, I didn't hear a mention of the smelter. So, if you could just provide us your latest thinking on timing, cost, and split with Inalum, that would be great.
So, it is the commitment of our companies that with the completion of the extension, the documentation, the resolution of the environmental issues, all of this comes together as a package at one time; the share transfers, the shareholders' agreement, all of that, it's a one-time closing of a number of these different things. And with that completed, we will undertake to fulfill our commitment of PT-FI to build the smelter. It would be on a standalone basis to enhance the $3 billion project. We've said we would do this and we are committed to do this within five years of signing this document.
It would be a commitment of PT-FI, so Inalum would be 50% owner of that commitment and they've agreed to participate in any equity capital calls that might be required for that. We have plans to develop a project-type financing with that, as we did with the existing smelter back in the 1990s. And so we would proceed to maximize project-type debt financing probably or financing through PT-FI to minimize upfront capital for it. Then we have the potential of bringing other partners into this. We're having discussions with PT Amman, which acquired the Batu Hijau mine from Newmont. They face the smelter commitment and we're having ongoing discussions with them about participating with us, and that has the potential of reducing – increase the size of the smelter, but decrease the capital requirements for our company.
Going back to the earlier conversation about tax effects; big picture, currently the government gets about 50% of the economics of the projects through taxes and royalties. They now have 50% of the equity. So, 75% of all this is the government now. I mean, our 25% interest is potentially what we had under the Rio Tinto deal and so forth. So, all these numbers you need to take into account that the effect of the smelter will be reduced by tax consequences and by the government's participation in it. So, we've spent couple of hundred million dollars today in planning. We're working with contractors. And with completion of the deal, we'll move forward with construction, contract plans, and so forth, and we'll be able then to lay out a cash flow profile for what will be required, how it would be financed, and what capital commitments will be for us.
Okay. And completed within five years or begun within five years, my just one clarification.
Completed within five years. We will commence – I mean, we're doing planning now, but we'll commence the project immediately on issuance of the new license and completion of all these other transactions is part of the package.
Okay. Thank you very much.
Thank you.
I will now turn the call back over to management for any closing remarks.
All right. Thanks, everyone. Appreciate your interest. If you have follow-up questions, get back to David Joint, and we'll be moving on and upward.
Ladies and gentlemen, that concludes our call for today. Thank you for joining. You may now disconnect.