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Copper

Copper. BUS 419 Presentation. Edward Ng, May Lu, Daphne Hou, Ken Vong, Raymond Au. Copper. Oldest metal known to humans One of the most used and reused metals Infinite recyclable life. Copper. Known resource 5.8 trillion pounds Only 0.7 trillion pounds (12%) are mined

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Copper

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  1. Copper BUS 419 Presentation Edward Ng, May Lu, Daphne Hou, Ken Vong, Raymond Au

  2. Copper • Oldest metal known to humans • One of the most used and reused metals • Infinite recyclable life

  3. Copper • Known resource 5.8 trillion pounds • Only 0.7 trillion pounds (12%) are mined • Also essential to human health

  4. Industry • Global production • Prices are determined at LME & COMEX • Prices might also be affected through speculative trading and currency exchange Source: http://www.unr.edu/sb204/geology/intro.htm

  5. Industry • 3rd most widely used metal • Sensitive to political situation • Producers store copper in warehouses until it is sold and shipped to buyer • Prices: Contango

  6. Industry

  7. Industry

  8. Products • Sources • Ore • Scraps • Forms • Rods • Cathodes • Concentrate

  9. Products • Wires • Substitution • Fiber Optics • Pipes/Tubes • Substitution • Steel • Plastics • Aluminum

  10. Production of Copper Source: http://www.nymex.com, http://www.copper.org, http://www.lme.co.uk

  11. Industry Suppliers • Energy (Electricity, Diesel Fuel, and Natural Gas) • Scraps • Ore • Capital Equipment (example: Machineries) Source: http://www.nymex.com

  12. Buyer • Used in highly cyclical industries Source: http://www.nymex.com, http://www.copper.org, http://www.lme.co.uk

  13. Rivals • 77 firms internationally competing • Compete on price/low cost production • Product Quality • Customer Service

  14. Key Success Factors • Economies of Scale • Refining technologies • Location

  15. Cost Structure • Research and Development • Exploration • Transportation • Storage

  16. Cost Structure • General Operation Cost • Sales and Administrative • Interest expenses • Depreciation, Depletion and Amortization

  17. Revenue Composition • Mining revenue • Financial activities revenue (example: Hedging)

  18. Risks • Economic and Political • Cyclical and Volatile price of Copper and other substitutes • Environmental Conditions • Licenses and Permits

  19. Risks • Availability of materials and equipment • Volatility in energy prices • Foreign Exchange • Interest Rate

  20. Risks • Laws and Regulations • Weather • Lower ore grades • Equipment failure

  21. Hedging Activities • Energy Prices • Copper Prices • Exchange Rates • Interest Rates

  22. Regulations • Global Environmental Protection Laws • Clean Air Act (CAA) • Resource Conservation and Recovery Act (RCRA) • National Pollutant Discharge Elimination System (NPDES)

  23. Regulations • Financial Reporting • GAAP • FASB 133 • Bureau of Land Management (BLM)

  24. Phelps Dodge Corporation

  25. Phelps Dodge • Phelps Dodge Corp. is the world’s second-largest producer of copper • World leader in the production of molybdenum • Largest producer of molybdenum-based chemicals • Leading producers of magnet wire and carbon black Source: Phelps Dodge Corporation case study, http://www.freemarkets.com/en/literature/ CaseStudy_PhelpsDodge.pdf

  26. Corporate Profile • Phelps Dodge (PD) is a producer of: • Copper • Carbon black • Magnet wire • Continuous-cast copper rod • PD consists of 2 divisions • Phelps Dodge Mining Company (PDMC) • Phelps Dodge Industries (PDI)

  27. PDMC • Comprises 11 reportable segments • 5 located in the U.S. • Morenci, Bagdad/Sierrita, Miami/Bisbee, Chino/Cobre and Tyrone • 3 located in South America • Candelaria, Cerro Verde and El Abra • Manufacturing and Sales • Primary Molybdenum • Other minings

  28. PDMC cont… • Includes the worldwide, vertically integrated copper operations from: • Mining through rod production • Worldwide mineral exploration • Development programs • Other mining operations and investments • Marketing and sales

  29. PDI • PDI comprises 2 segments • Specialty Chemicals • Wire and Cable

  30. Direct Competitors • BHP Billiton Ltd. (Melbourne, Australia) • Codelco (Corporación Nacional del Cobre, Chile) • Rio Tinto PLC (London, England)

  31. Cost Structure • High unit cost structure for copper production • lower ore grades • higher labor costs • stricter regulatory requirements • Lean-production program • Quest for Zero • Narrows cost disadvantages • Achieved $330 million of operating improvements during 2003

  32. Hedging Philosophy • Not purchase, hold or sell derivative contracts unless an existing asset, obligation is present or the occurrence of a future activity is anticipated and will result in exposure of market risk • Not enter into any contracts for speculative purposes • Use various strategies to manage market risks • Derivative instruments are used to manage well-defined commodity price, energy, foreign exchange and interest rate risks from primary business activities

  33. Derivative Financial Instruments • Metals Hedging • Metal Purchase Hedging • Foreign Currency Hedging • Interest Rate Hedging • Energy Price Protection Programs • Other Protection Programs • Credit Risk • Stock Option Plans

  34. Metals Hedging • Fair Value Hedges • Copper fixed-price hedging • At December 31, 2001, PD had net futures and swap contracts for approximately 25 million pounds of copper • Cash Flow Hedges • Copper price protection program • Copper scrap purchase hedging

  35. Metal Purchase Hedging • South American wire and cable operations may enter into aluminum swap contracts • These swap contracts settled during the month of shipment or receipt of metal • Hedge gains or losses from the swap contracts are recognized in cost of products sold • At December 31, 2001, PD had outstanding swap contracts for approximately 13 million pounds of aluminum

  36. Metal Purchase Hedging • Metal Hedge Programs in place: • 2001: 17 Millions • 2002: 16 Millions • 2003: 26 Millions

  37. Foreign Currency Hedging • Fair Value Hedges • Foreign currency transactions increase risks • forward exchange and currency option contracts • At December 31, 2001, PD had foreign exchange contracts in place with a total face value of approximately $13 million

  38. Interest Rate Hedging • Fair Value Hedges • Fixed-to-Floating interest rate swaps • In December 2001, PD entered into several interest rate swap contracts to hedge $400 million of fixed-rate debt • PD entered into interest rate swap contracts to convert fixed-rate debt to floating-rate debt • Cash Flow Hedges • Floating-to-Fixed interest rate swaps • At December 31, 2001, PD had entered into interest rate swap contracts to hedge $364 million of floating-rate debt

  39. Interest Rate Hedging Floating-to-Fixed interest rate swaps Swap Contracts

  40. Energy Price Protection Programs • Cash Flow Hedges • Diesel fuel price protection program • option and fixed-price swap contracts to price protect 82percent of the forecasted diesel fuel consumption. • Natural gas price protection program • call option contracts to protect 80 percent of the planned natural gas consumption • Feedstock oil price protection program

  41. Energy Price Protection Programs

  42. Other Protection Programs • Copper fixed-price rod sales program • At December 31, 2001, PD had net futures and swap contracts for approximately 47 million pounds of copper • Currency swap transactions • At December 31, 2001, PD had in place $15 million in currency swap contracts • Gold price protection program • Copper quotational period swap program • Other diesel fuel price protection programs

  43. Other Protection Programs

  44. 12/31/03 12/31/02 Fair Value Hedges Copper fixed-price (lbs.) 11 17 Foreign currency (USD) $ 19 16 Fixed-to-floating interest rate swaps (USD) $ — 375 Cash Flow Hedges Metal purchase (lbs.) 10 14 Floating-to-fixed interest rate swaps (USD) $ 121 274 Diesel fuel price protection (gallons) 37 24 Natural gas price protection (decatherms) 8 4 Derivative Financial Instruments Not Qualifying for Hedge Accounting Copper fixed-price rod sales (lbs.) 42 37 Copper quotational period swaps (lbs.) 14 — Other diesel fuel price protection (gallons) 13 — Summary of Price Protection Program *Units are in millions

  45. Credit Risk • PD is exposed to credit loss in cases where there is a default in the obligation of the protection agreement • Only use highly rated financial institutions • Review the creditworthiness periodically • The maximum amount of credit exposure was approximately $8 million

  46. Stock Option Plans • Executives and other key employees have been granted options to purchase common shares under stock option plans adopted in 1993, 1998 and 2003 • The option price equals the fair market value of the common shares on the day of the grant • An option’s maximum term is 10 years

  47. Compensation Plan • Restricted Stock Option Plan • Directors Stock Unit Plan

  48. Restricted Stock Option Plan • The issuance of the option to executives and other key employees, without any payment by them • Subject to certain restrictions

  49. Outstanding at December 31, 2000 Shares: 219,578 Granted 11,700 Terminated (26,533 ) Released (15,011 ) Outstanding at December 31, 2001 189,734 Granted 205,700 Terminated (19,800 ) Released (16,450 ) Outstanding at December 31, 2002 359,184 Granted 118,000 Terminated (6,200 ) Released (19,078 ) Outstanding at December 31, 2003 451,906 Restricted Stocks

  50. Director Stock Unit Plan • Provides to each non-employee director an annual grant of stock units to our common shares • This plan replaced the 1989 Directors Stock Option Plan

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