9-504-061 REV: JUNE 21, 2004
V. KASTURI RANGAN ARTHUR MCCAFFREY
The Freeport Mine, Irian Jaya, Indonesia: “Tailings & Failings”—Stakeholder Analysis Whereas: PT-FI [PT Freeport Indonesia Company] currently dumps over 110,000 tons of mining waste per day into local Irian Jaya rivers and is considering the expansion of milling operations to exceed 190,000 cubic tons per day. According to the Overseas Private Investment Corporation (1995), a U.S. government agency which provided political risk insurance to this operation, the mine “created and continues to pose unreasonable or major environmental, health, or safety hazards with respect to the rivers that are being impacted by the tailings, the surrounding terrestrial ecosystem and the local inhabitants” . . . Resolved: That shareholders request the Board of Directors of PT-FI . . . to take steps to: 1.Postpone the expansion of milling operations until a just, accepted, peaceful and permanent resolution of local indigenous concerns can be reached in consensusbased process with all stakeholders. — Freeport McMoRan Copper and Gold, Inc., Shareholder Resolution filed and submitted by Seattle Mennonite Church, 3120 N.E. 125th St., Seattle, Washington, November 15, 1996 Poor regions of the world are often the targets of large-scale economic relief or commercial development projects. When these are planned and implemented in a “top-down” fashion, as was the case with Freeport’s massive mining project in the province of Irian Jaya in Indonesia, it often creates conflict with local stakeholders whose lives and livelihoods are most directly impacted by such megaprojects. This, in turn, creates short- and long-term problems of both efficiency and equity for commercial projects that frequently undermine their ultimate legitimacy, viability, and endurance. Some kind of management process is needed here to guide private or public investment programs in a way that will protect the vested interests of all the legitimate stakeholders involved, powerful investors and vulnerable indigenous populations alike (Exhibit 1 identifies several groups of investors with vested [and legally contracted] interests in the mining operation. These include the parent American company, Freeport-McMoran in Louisiana, its public investors and shareholders, the Indonesian government, plus its investment and commercial partners in Spain, Japan, and the United Kingdom). The following brief history1 describes the chronology of events surrounding the operation of the Freeport Copper Mine on the island of Irian Jaya in Indonesia between 1966 and 2001. An analysis of these events is intended to raise questions concerning ways to resolve conflicts over how best to represent the interests of all legitimate stakeholders.
________________________________________________________________________________________________________________ Professor V. Kasturi Rangan and Senior Research Associate Arthur McCaffrey prepared this case. This case was developed from published sources. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright © 2004 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.
504-061
The Freeport Mine, Irian Jaya, Indonesia: “Tailings & Failings”—Stakeholder Analysis
Brief History: 1945–2003 Much of the early history has been summarized from Richard Vietor, “Freeport Indonesia,” HBS Case No. 796-124 (Boston: Harvard Business School Publishing, 1996). 1945–1996 !
Phase 1. A development partnership is established
On August 17, 1945, the Indonesian nationalist forces unilaterally declared Indonesian independence after almost 350 years of Dutch rule. Five years of revolution and military hostilities with the Dutch occupation followed. As a result of the intervention of the British and the United Nations Security Council, agreement between the Dutch and Indonesians was reached on November 2, 1949. The Republic of the United States of Indonesia was granted complete and unconditional sovereignty on December 27, 1949.
1963 !
The territory of Irian Jaya, New Guinea (2,200 miles northeast of Jakarta), was turned over to Indonesia by the United Nations.
1966 !
The new government of General (President) Suharto in Indonesia passed a new foreign investment law and signed a draft contract of work with Freeport. P.T. Freeport Indonesia (PT-FI) was created and received an exclusive 30-year contract to develop and mine the area around the Ertsberg ore mountain in West Papua (Irian Jaya), which contained 30 million tons of iron, copper, gold, and silver.
1966–1971 !
Freeport built access roads through the jungle, from sea level to over 6,000 feet. In addition to roads, the five years’ worth of construction produced new towns, tunnels, tramways, a mill, a seaport, an airport, and a luxury hotel.
1973 !
President Suharto dedicated the mining project in March 1973, and the project became operational in July.
1988 !
By the end of 1988, the company was producing 25,000 tons of ore per day, yielding 300 million pounds of copper, 139,000 ounces of gold, and 1.9 million ounces of silver while generating an annual revenue of more than $300 million.2 The daily output was to rise to over 200,000 tons eight years later.
1989–1993 !
2
By 1988, as the Ertsberg mountain deposits became depleted, exploration of the neighboring Grasberg mountain revealed 1.9 billion tons of mineral ore. In 1989 feasibility studies were done for producing 52,000 tons of ore per day, rising to 115,000 tons by 1993. To protect Freeport’s capital investment, the government of Indonesia expanded PT-FI’s exploration permit to 6 million acres and renegotiated the work contract for another 30 years (with two 10year extensions).
The Freeport Mine, Irian Jaya, Indonesia: “Tailings & Failings”—Stakeholder Analysis
!
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In 1991, almost 20 years after the start of the mining operation, Freeport employee Bruce Marshall arrived in Irian Jaya to begin development of an environmental management organization for Freeport.
1993–1995 !
After 20 years of operation, Freeport had created huge transformations of the physical environment. The mining operation was now producing vast amounts of debris that needed to be dug and safely stored. The Grasberg operation was producing 2.8 billion tons of “overburden” (non-ore excavated rock), while 115,000 tons of “tailings” (waste ore after extraction) were discharged from the extraction mill every day in the form of finely ground rock. These tailings, plus effluent from the extraction mill, flowed into local rivers.
!
All of this excavation was done to produce about 4,000 tons per day of ore concentrate that were shipped to smelters in other countries, including one in Spain that Freeport had bought. In addition, in order to expand its downstream processing capacity, Freeport entered into a joint venture with Mitsubishi and FluorDaniels to build a new 200,000-ton/year smelter on nearby Java.
!
To finance this continuing growth in support of its plans to increase mining volume to 125,000–180,000 tons per day, Freeport sold 11.4% of its stock to U.K.-based RTZ, the world’s largest minerals mining company. In exchange for Freeport agreeing to expand its mining capacity beyond 120,000 tons/day, RTZ was to invest up to $750 million to support this expansion, to make the Irian Jaya mine one of the largest in the world. Although Freeport’s permits already allowed it to produce 160,000 tons/day, with their new investments it became feasible to expand to 250,000 tons/day, a feat that would generate enough profits to pay back RTZ over a very short period.
1995 !
Between 1992 and 1995 Freeport doubled its revenue to more than $1.7 billion. Economic benefits to Indonesia were demonstrated in the 1995 balance sheet by direct and indirect payments (dividends, royalties, taxes, wages, goods/services purchased) to the government of Indonesia totaling close to $1 billion (see Exhibit 2). However, in 1995, MIGA, the World Bank’s political risk insurance agency, came under pressure to cancel its policy to Freeport for $50 million because of its record on social and environmental issues. To make matters worse for the company, Freeport became “tainted by association” in human rights violations by the Indonesian military. The latter provided security for the company’s operations, but between late 1994 and early 1995 this same military was involved in the killing of 19 members of a separatist guerilla movement (OPM) on the island of Irian Jaya.
1995–1996 !
After five years of hard work and fighting hostility from local (Freeport) mine managers, Freeport environmental manager Bruce Marsh managed to build up his environmental management organization to a staff of 90, with annual operating budgets now ranging from $17 million to $41 million. His activities included health, garbage collection, water recycling, reclaiming dumps, building sewage treatment facilities, developing recycling systems, experimenting with the reclamation of tailings, growing plants, and laboratory analyses of water and plants.
3
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The Freeport Mine, Irian Jaya, Indonesia: “Tailings & Failings”—Stakeholder Analysis
!
This work was complemented by environmental and social audits by outside firms. In 1994, an Indonesian government environmental commission did a study of Freeport’s environmental management program and monitoring system, and the Indonesian Environmental Forum (Wahli) made constructive comments to which Freeport responded. However, around the same time, a Wahli activist, Emmy Hafild, publicly criticized the commission report and accused Freeport of plundering the environment.
!
By 1995 Freeport mining operations were now also coming under fire from several international environmental organizations. Under pressure from Wahli and the International Rivers Network, the Overseas Private Investment Corporation (OPIC), which had insured Freeport’s initial investment for $100 million, canceled its policy in October 1995. OPIC cited the severe degradation to rainforests by Freeport’s tailings management and disposal practices and the major environmental, health, and safety hazards posed to the rivers, the surrounding terrestrial ecosystem, and the local inhabitants. The next month a group of nongovernmental organizations (NGOs) at the Biodiversity Convention Conference publicly accused Freeport of damaging biodiversity and possibly releasing toxins into the rivers. The relatively primitive and unspoiled Irian Jaya contained a very rich and diverse ecology of flora and fauna, and critics charged that this natural wealth was being damaged or endangered by Freeport’s activities.3
!
During 1995–1996, environmental degradation issues associated with the Freeport open-pit mining project at Irian Jaya remained in the forefront of attacks on the company’s operations, which continued to attract considerable local, national, and international criticism for a variety of sociocultural and environmental reasons, including soil and groundwater contamination and the vast project’s impact on the local indigenous Komoros and Amungme people. There were five environmental issues that were attracting most attention: 1) project effects on the island’s Alpine glaciers, 2) storage of the excavated material, 3) treatment of tailings (waste ore after extraction), 4) water pollution, and 5) effects on culture of local peoples.
!
Critics at Wahli and the International Rivers Network were joined by other various American and Australian NGOs; in April 1995, the Australian Council for Overseas Aid produced a report that criticized Freeport for a history of bad relations with the local Amungme people, for appropriation of traditional lands, for the low percentage of Amungmes (13%) actually employed by Freeport, for the social and cultural fragmentation it had caused, and for pollution of the Ajkwa river.
1996–1998 !
4
Phase 2. Rumblings in the air
Freeport was now under pressure from both the commercial and environmental sides. Its new investment partner RTZ was pushing hard for a significant expansion of PT-FI’s output capacity, to at least 230,000 tons/day. Meanwhile on the environmentalist and human rights side the company was taking a lot of heat, both from the native population and from its own stockholders. The company dispatched Freeport lobbyists to Washington to persuade MIGA and OPIC not to terminate its insurance, while on the local scene back in Indonesia company officials were trying to deal on several fronts at once with environmental, social, and media “audits” of their mining operations. Native Irianese tribesmen staged a riot against the company in March 1996, charging human rights and environmental abuses. Hundreds of government army troops were sent in to quell the riots, resulting in three deaths and scores injured.
The Freeport Mine, Irian Jaya, Indonesia: “Tailings & Failings”—Stakeholder Analysis
504-061
!
Despite its continuing commercial prowess in its mining operations, Freeport continued to be bedeviled by image and credibility problems over the ecological impact of its mining operations. In November 1996 it faced an internal revolt from a group of its own shareholders in Seattle, who started a year-long proxy fight addressed to “all stakeholders” in the mining operations (see opening quote above). Their proxy resolution requested the Board of Directors of PT-FI to institute a comprehensive review of its Indonesian operations in order to address a variety of concerns about liability and remediation costs, including the dumping of mining waste into local rivers and associated risks to the environment, health, and safety; the provocative alliance between the company and the Indonesian army; the considerable financial liability represented by the $6 billion lawsuit brought against the company by resentful islanders; the absolute rejection by the Amungme Tribal Council of indigenous peoples of Freeport’s attempts to ameliorate the social and environmental damages by establishing a trust fund; and the company’s failure to make public its environmental audits.
!
Freeport fought the proxy proposals and in 1997 went ahead with expansion plans to triple the output at the seemingly limitless Grasberg mine to 300,000 metric tons of ore a day.
!
But 1997 also saw the company continue to attract national and international attention because of its controversial relations with President Suharto, his family, and business associates,4 and its alleged collusion with the Indonesian military authorities. It was reported that in 1997 Freeport was paying $35 million for barracks and other facilities for an 800-strong military task force that the government brought in following the 1996 riots. At the same time, courts in Irian Jaya found army officials guilty of ordering troops to shoot local villagers.
!
The strange goings-on in the Freeport environment began to attract the attention of The Wall Street Journal, which began to write lengthy analyses of Freeport’s business dealings in Indonesia.5 One piece,6 which noted that Freeport’s expansion plans were likely to fuel more social pressures among the nomadic tribes surrounding the mine area, described a dramatic succession of events in Irian Jaya during 1996–1997 as resembling “an action-adventure movie,” involving local anti-Freeport rioting, a combination of intertribal warfare and a shooting spree by an Indonesian military officer that resulted in many deaths, plus the emergence in the mine region of a rebel-led “Free West Papua” independence movement. Freeport’s insider dealings with Suharto were reported as part of a tradition of doing business “Suharto-style,” a tradition that the WSJ characterized as one whereby “nearly every foreign company investing in Indonesia has to assume the added role of adoptive parent to one of Suharto’s children.”7
1998–2003 !
Phase 3. Confronting a new reality
The bubble finally burst in May 1998 when a populist political backlash against Suharto’s autocratic, militaristic regime overthrew the dictator, beginning a period of national economic and political crises within which foreign companies like Freeport, whose fortunes were interwoven with the fate of the Suharto family, became targets of resentment and increased scrutiny. Yet, in response to critics, CEO Moffett said Freeport had no intention of leaving Indonesia. Freeport’s uncanny knack for survival was helped both politically, by its still having friends in high places in the post-Suharto government, and economically, by its still being able to pull $1.5 billion annually of copper, gold, and silver ore from the proven reserves of its open-pit Grasberg mine, on which it paid taxes, royalties, and dividends to the central government.
5
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The Freeport Mine, Irian Jaya, Indonesia: “Tailings & Failings”—Stakeholder Analysis
!
The year 1999 continued the economic and political uncertainty of the post–Suharto era; the new government wanted to review (and possibly renegotiate) all contracts granted by Suharto to foreign multinationals, with one regent of a remote province stating that “almost every contract signed between Jakarta and the multinationals was corrupt because they excluded the local people.”8 After 32 years of autocratic rule by President Suharto, new political movements, many nationalist and populist, were eager to benefit from the devolution of power from Jakarta to the provinces; the new millennium in Indonesia opened with new cries for freedom, for more democratization, more demilitarization, more regionalization of power, more independence, more self-governance, and even secession. The year 2000 also saw a rekindling of religious and ethnic strife and division across Indonesia’s diverse archipelago, and this added further fuel to the sociopolitical conflicts and rebellions that multinational companies like Freeport would increasingly find themselves embroiled in for years to come.
!
Nevertheless, during 2000–2001 Freeport continued to show itself remarkably adept in protecting its interests in Indonesia, and it made several moves, proactive and defensive, on both political and social fronts aimed at securing its business interests there. After a fatal accident at its Grasberg mine killed four workers in May 2000, the company accommodated an order from the new Indonesian minister of environmental affairs to scale back milling operations and cut output at the Grasberg mine and to abide by several environmental protection conditions, including the cleanup of all destruction and pollution caused by the mining sludge dumped into a local lake, together with compensation for residents of a nearby village; finding an alternative waste dump site contingent on government approval; and submitting a comprehensive new plan.
!
On the social front P.T. Freeport took an initiative to improve its local relations in Irian Jaya by signing a landmark agreement with the local Amungme and Kamoro tribes. For the first time since the company signed an initial land-rights agreement with local tribesmen in 1974, a new memorandum of understanding was signed to address issues that had long plagued the Grasberg mine operation, namely, human rights, land rights, environmental standards, and “socioeconomic resources.” While the local agreement did not affect Freeport’s long-standing contract with the Indonesian government, which would not expire until 2041, it represented a smart political move on Freeport’s part, for it appeared to stave off some of the warfare and bloodshed that continued to mark the struggles for independence on other Indonesian islands and provinces. For instance, another American multinational, Mobil Oil, operating in Aceh province on Sumatra Island in particular, had recently run into the same kind of resentment and opposition from natives that Freeport had known for years on Irian Jaya.
2003
6
!
The World Bank issued a report on October 20, 2003, expressing concern over the thriving culture of corruption that persisted in post-Suharto Indonesian governance.9 In February 2004, Transparency International labeled Indonesia one of the world’s most corrupt countries. The WB noted that while Suharto had gone, those he favored (including his children as well as military and business groups) continued to flourish, exploiting opportunities to reestablish power. The Indonesian government was facing political problems similar to those of transitional democracies in Eastern Europe, but half-hearted efforts by the government to fight corruption, graft, and bribery were being rendered ineffective due to poor follow-up and weak implementation.
!
Throughout the post-Suharto years Freeport continued to demonstrate its uncanny ability to run a profitable mining operation in the face of political and social unrest (Exhibit 3).
504-061
Exhibit 1
Freeport’s Ownership Structure
Public RTZ
88.6%
PT-Indocopper Investima
49%
9.36%
PT-FI
Contract of Work Source:
RTM Smelter
81.28%
9.36%
Government
FCX
11.4%
Richard Vietor, “Freeport Indonesia,” HBS Case No. 796-124, Exhibit 15.
20%
New Smelter Mitsubishi Flour-Daniels
-7-
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Exhibit 2
Financial Benefits to the Government of Indonesia from P.T. Freeport Indonesia Companya
Direct Benefits: Dividends from PT-FI to the Government Production royalties paid to the Government Corporate Taxes: PPh 22 PPh 23 PPh 25 PPh 26 PPh 29 Individual Taxes (PPh 21): Indonesian Expatriate Value-added tax (PPN) Luxury tax (PPN BM) Land rent/Dead rent PBB Customs duties (BM) Additional customs duties (BMT) Sugar and tobacco excise tax (Cukai) Tax on foreigners (PBA) Retribution on mineral “C” Motor vehicle tax (PKB) Training fund contribution (WPL) Total direct benefits Indirect Benefits: Wages, salary and benefits paid to employees in Indonesia Goods purchased in Indonesia Services purchased in Indonesia Local area development and charitable contributions Domestic reinvestment in PUT-FI’s operations Total indirect benefits Total direct and indirect benefits
1989
1991
1993
1995
$11,053,640 15,659,777
$12,013,200 9,503,147
$15,825,900 9,425,805
$13,546,800 29,309,980
58,952 50,000,000 0 2,496,380
942,776 22,600,000 72,632 0
2,384,764 14,229,000 17,581,306 3,816,150
16,995,601 5,976,739 83,539,326 32,176,652 0
2,925,086 4,352,048 205,487
4,620,394 6,869,050 393,750
8,671,554 9,288,662 5,140,608 1,756,347
7,598,317 9,676,072 7,141,333 1,113,035
20,000 0 0 0 0 304 0 0 0 $86,771,674
20,000 0 2,964,335 70,320 5,440 10,020 100,000 0 968,650 $61,153,715
160,009 1,354,258 3,436,071 67,998 1,781 7,887 100,000 0 551,800 $93,799,900
257,903 1,108,942 4,513,502 1,703 30,476 12,278 100,000 126,813 269,400 $213,494,872
$16,994,944 22,862,049
$27,221,496 50,179,902
2,728,285 138,811,000 $181,396,277 $268,167,951
5,710,674 246,456,000 $329,568,072 $390,721,787
$41,790,875 76,605,195 126,968,588 13,014,220 485,792,000 $744,170,878 $837,970,778
$97,405,906 183,109,231 339,260,745 22,818,724 434,383,300 $1,076,977,906 $1,290,472,778
Source: Richard Vietor, “Freeport Indonesia,” HBS Case No. 796-124, Exhibit 13. aIn its 2002 annual report, Freeport claims that, since 1991, direct benefits to the government of Indonesia (taxes, royalties, dividends, fees) have totaled approximately $2 billion.
-8-
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Freeport McMoRan Copper & Gold, Inc., Statement of Income ($ in thousands except per share amounts), Years Ended December 31
Exhibit 3
Revenues
1992
1995
1998
2000
2002
$714.3
$1,834.3
$1,757,132
$1,868,610
$1,910,462
308.9
932.4
796,017
1,012,962
938,462
Cost of sales: Production and delivery Depreciation and amortization
48.3
124.1
277,407
283,556
260,446
Total cost of sales
357.2
1,056.5
1,073,424
1,296,518
1,198,908
Exploration expenses
12.2
13.9
13,033
8,849
3,112
General and administrative expenses
68.5
169.7
87,780
70,950
68,305
437.9
1,240.1
1,179,185
1,376,317
1,270,325
276.4
594.3
577,947
492,293
640,137
--
--
(4,948)
(13,593)
(4,181)
(18.9)
(47.9)
(205,588)
(205,346)
(171,209)
7.2
(1.6)
(10,933)
(114)
(15,085)
Total costs and expenses Operating income Equity in PT Smelting losses Interest expense, net Other expense, net Income before income taxes and minority interests
264.7
544.8
361,426
273,240
449,662
(103.7)
(234.0)
(170,566)
(159,573)
(245,518)
Minority interests in net income of consolidated subsidiaries
(31.1)
(57.1)
(37,012)
(36,680)
(36,441)
Net income
129.9
253.7
153,848
76,987
164,654
Provision for income taxes
Preferred dividends
(7.0)
(54.2)
(35,531)
(37,487)
(37,604)
Net income applicable to common stock
$122.9
$ 199.5
$118,317
$
39,500
$ 127,050
Net income per share of common stock:
$
$
.66
.98
Basic
$
.67
$
.26
$
.88
Diluted
$
.67
$
.26
$
.87
Average common shares outstanding
187.3
204.4
Basic
175,353
153,997
$ 144,649
Diluted
175,354
154,519
146,418
--
a
Dividends paid per common share
Source:
$
.60
$
.675
$
Richard Vietor, “Freeport Indonesia,” HBS Case No. 796-124, Exhibit 10; Freeport annual reports, .
aNot provided.
.20
$
-9-
504-061
The Freeport Mine, Irian Jaya, Indonesia: “Tailings & Failings”—Stakeholder Analysis
Endnotes 1 Compiled from a variety of media sources, including: The Wall Street Journal, 3/13/96, 3/14/96, 3/25/1996, 4/22/96, 5/06/1996, 9/23/96, 10/14/96, 1/31/97, 2/18/97, 2/28/97, 3/27/97, 3/28/97, 5/5/97, 7/28/97, 8/13/97, 9/29/98, 10/13/97, 11/5/97, 1/14/98, 4/7/98, 5/13/98, 5/20/98, 5/27/98, 8/17/98, 9/29/98, 10/21/98, 10/27/98, 10/29/98, 11/2/98, 11/10/98, 11/27/98, 3/8/99, 4/21/99, 6/7/99, 4/11/00, 4/20/00, 5/5/00, 5/8/00, 5/11/00, 5/18/00, 5/24/00, 6/6/00, 7/13/00, , 8/21/00, 9/7/00, 10/18/00, 11/6/00, 11/29/00, 4/23/01, 5/3/01, 10/9/01; The Financial Times, 11/16/01, 10/21/03; and other Internet sources, including Commonwealth of Australia 2001; Earth Wire/ANTARA/Pacific Islands Development Program/East-West Center With Support From Center for Pacific Islands Studies/University of Hawaii; ; . 2
Source: Richard H.K. Vietor, “Freeport Indonesia,” HBS Case No. 796-124 (Boston: Harvard Business School Publishing, 1996).
10
3
See note #2.
4
See note #1.
5
See note #1.
6
The Wall Street Journal, September 29, 1998.
7
The Wall Street Journal, August 13, 1997.
8
The Wall Street Journal, November 5, 1997.
9
The Financial Times, October 21, 2003, p. 6.
