Freeport-McMoRan fails financial soundness test
Freeport-McMoRan fails financial soundness test
Company must meet financial assurance rules or start reclamation
By Harry Browne, GRIP Treasurer/Secretary
On March 18, New Mexico’s Mining and Minerals Division (MMD) sent Freeport-McMoRan (FCX) a shocking letter. “Unless the Third-Party Guarantee(s) are adjusted to meet the financial soundness test,” the division’s director, Fernando Martinez, wrote, “or (are) replaced with another form of financial assurance, within 90 days, FCX shall cease mining and shall immediately begin to conduct reclamation, closeout, and closure…”
Due to a steady decline in copper prices and the company’s risky, leveraged investment in oil and gas properties, the corporation no longer passes this Mining Act test that guarantees that money is available to clean up a mine even if a mining company goes out of business.
A Brief History (or, Mining the Public Treasury)
The principle that companies that profit by digging large holes in the earth should set aside money for eventual cleanup seems eminently reasonable. But for more than a century under the 1872 Mining Act, there has been no legal requirement that they do so, nor does the federal government charge royalties on hardrock mining to cover clean-up should mine operators walk away. As a result, the American West is pockmarked with tens of thousands of abandoned mines that are as dangerous and damaging as they were the day miners stopped digging. They contaminate billions of gallons of water each year and are largely responsible for the fact that 40 percent of the headwaters of western rivers are contaminated, according to the Environmental Protection Agency.
Liability for this pollution can be extremely difficult to determine, and even when that is possible, resources for clean-up are nonexistent or shielded by bankruptcy rules. Efforts to clean up one such mine were the cause of last year’s Gold King Mine disaster near Silverton, CO which contaminated hundreds of miles along Concrete Creek, the Animas River, and the San Juan River. The fact that the EPA was in charge of the Gold King clean-up efforts, and that taxpayers are now on the hook for the damages caused by that spill, highlight the extent to which private industry has transferred the financial liability of mining to the public after reaping its private profits.
Closing the Barn Door – a Bit Late
The 1991 New Mexico Mining Act aims to protect state taxpayers from being stuck with the cleanup bill when mines here close down. It requires companies to develop and obtain state approval of plans for closing their mines, cleaning them up, preventing ongoing pollution, and returning the land to other productive uses or to self-sustaining ecosystems. The cost of doing all that work must be estimated and that amount set aside as “financial assurance.”
Pressuring the state to enforce these provisions was the primary focus of GRIP’s work for its first seven years. After years of technical study, hearings, law suits and appeals, direct negotiations, and indirect public pressure, we reached an agreement with the Chino and Tyrone Mines and with state agencies to require $500 million in financial assurance.
Although this was a huge victory – and resulted in the mines finally beginning to reclaim tailing ponds that had been inactive for decades – there were a number of devilish details that weakened it. One such detail was the form of the financial assurance. Whereas landlords generally require cash deposits to cover possible damages, and contractors post bonds to cover their liabilities, the Mining Act allows mining companies to be more creative. Among other things, they are allowed to use “third-party guarantees” as financial assurance.
The idea here is that an independent company promises to pay the bill if the miner goes bankrupt. As long as that “third party” is large and financially stable, the guarantee should protect taxpayers. Over GRIP’s strong objections, the Mining and Minerals Division (MMD) agreed with Chino and Tyrone that Phelps Dodge (predecessor of Freeport) itself could act as a “third party” to the mines and could provide the guarantee for its subsidiaries.
To qualify as a third-party guarantor, Phelps Dodge had to pass a “financial soundness test,” and had to provide quarterly updates verifying it continued to meet the test. A financial guarantee from a company that is itself financially unstable is not much of a guarantee, after all.
There are actually two financial soundness tests that are used, and the company just has to pass one or the other. The first is a complex comparison of the company’s tangible net worth, its working capital, its total U.S.-based assets, the value of all of its third-party guarantees, its total liabilities and net worth, its current liabilities and assets, and its net income plus depreciation, depletion, and amortization. (Interested readers can find the requirement in the New Mexico Administrative Code at 188.8.131.528.G(8)(a).) The second test is simple: the guarantor’s most recently issued senior credit obligation is rated “BBB” or higher by Standard and Poor’s or “Baa” or higher by Moody’s.
Fixed Debt in a Variable Industry: Didn’t we already know that’s a bad idea?
The first shoe dropped in late January of this year. Citing “deterioration in FCX’s debt protection metrics and increase in leverage as a result of the more precipitous drop in copper prices in 2015, … as well as the collapse in oil prices,” Moody’s dropped Freeport’s senior bond rating three notches to B1 – commonly known as “junk” status. Two weeks later, Standard and Poor’s dropped its rating two notches to BB.
The second shoe quickly followed. In early March, Freeport notified the MMD that, based on its fourth quarter results from 2015, it did not pass the other financial soundness test. Its working capital was too low for the value of its environmentally-related financial guarantees, which totaled over $534 million (about $200 million of which was for the Chino and Tyrone mines). Its total liabilities were more than twice its net worth. And its net income was less than ten percent of its total liabilities (in fact, it was negative).
Thus it was that the MMD sent its warning letter to Freeport. The company had anticipated the letter, proposing to replace $10 million of “third-party” guarantee with earnings from the cash trust set up to cover part of its financial assurance. At the time, this would have brought all three mines into compliance. But Freeport’s financial condition has continued to deteriorate, and when 2016’s first-quarter results came out, the gap between the third party guarantee and what the state’s formula requires had grown to $67 million. The MMD sent a second noncompliance letter, threatening the mines with closure, based on the worsening situation.
Onward through the Fog
Superseding the March 18 letter, MMD’s June 9 notice gave Freeport 90 days to return to compliance with the financial soundness test. But under the Mining Act, the company can apply for up to two 30-day extensions. MMD is evaluating Freeport’s proposal to replace part of the third-party guarantee with increased collateral from ranching properties pending conclusion of an independent review of appraisals of those properties to verify the company’s claims that they are worth more now than they were when they were first pledged as part of the financial assurance package. Neither GRIP nor the Division have any opposition to increasing the amount of the cash portion of that package, which will happen when interest earned by the cash trust is credited back to the fund.
Replacing another $57 million of third-party guarantee could prove considerably more troubling for Freeport. Raising cash by selling more bonds is at best a very expensive possibility, given the firm’s junk rating. And the added debt would only move the company further from meeting the financial soundness tests. As GRIP argued 13 years ago, allowing a parent company to guarantee its subsidiaries’ cleanup obligations has proved an untenable situation, since the same economic forces that might force the mines to close also weaken the parent’s ability to come up with cash.
GRIP will continue to closely monitor this situation. A mine closure would be a huge blow to workers, contractors, and the local economy. It would also imperil cleanup, reclamation, and long-term protection of groundwater from what is projected to be hundreds of years of acid mine drainage. In the event of forfeiture, the state would have the challenging job of taking over the mine sites and keeping all water balanced and contained, protecting Grant Co from spills and pollution. But a failure to enforce the financial assurance provisions of the Mining Act would do little to prevent the firm’s financial demise if copper and oil prices remain low and Freeport’s debt obligations remain high. And in that case, New Mexico agencies’ first obligation is to ensure that a bankruptcy doesn’t leave state taxpayers holding the bill for Freeport’s poor investment decisions.