Copper

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Copper

• BUS 419 Presentation

Edward Ng, May Lu, Daphne Hou, Ken Vong, Raymond
Au
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Copper

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

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Copper

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

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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

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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

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Industry
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Industry
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Products

• Sources
• Ore
• Scraps
• Forms
• Rods
• Cathodes
• Concentrate

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Products

• Wires
• Substitution
• Fiber Optics
• Pipes/Tubes
• Substitution
• Steel
• Plastics
• Aluminum

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Production of Copper
Source http//www.nymex.com, http//www.copper.or
g, http//www.lme.co.uk
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Industry Suppliers

• Energy (Electricity, Diesel Fuel, and Natural
  Gas)
• Scraps
• Ore
• Capital Equipment (example Machineries)

Source http//www.nymex.com
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Buyer

• Used in highly cyclical industries

Industry Building Electrical Gen. engineering Light engineering Transport Other 48 17 16 8 7 4
Total 100
Source http//www.nymex.com, http//www.copper.or
g, http//www.lme.co.uk
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Rivals

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

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Key Success Factors

• Economies of Scale
• Refining technologies
• Location

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Cost Structure

• Research and Development
• Exploration
• Transportation
• Storage

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Cost Structure

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

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Revenue Composition

• Mining revenue
• Financial activities revenue (example Hedging)

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Risks

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

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Risks

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

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Risks

• Laws and Regulations
• Weather
• Lower ore grades
• Equipment failure

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Hedging Activities

• Energy Prices
• Copper Prices
• Exchange Rates
• Interest Rates

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Regulations

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

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Regulations

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

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Phelps Dodge Corporation
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Phelps Dodge

• Phelps Dodge Corp. is the worlds 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
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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)

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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

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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

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PDI

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

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Direct Competitors

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

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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

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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

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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

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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

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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

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Metal Purchase Hedging

• Metal Hedge Programs in place
• 2001 17 Millions
• 2002 16 Millions
• 2003 26 Millions

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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

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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

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Interest Rate Hedging

• Floating-to-Fixed interest rate swaps
• Swap Contracts

2003 2002 2001
Unrealized Loss ( Million) 12 23 21
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Energy Price Protection Programs

• Cash Flow Hedges
• Diesel fuel price protection program
• option and fixed-price swap contracts to price
  protect 82 percent 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

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Energy Price Protection Programs
Option Premiums ( Million) 2003 2002 2001
Diesel fuel price protection program 1 0.9 1
Natural Gas Price Protection Program 3 2.2 3
Feedstock Oil Price Protection Program 0.8 0.7
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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

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Other Protection Programs
Unrealized Gain/(Loss) ( Million ) 2003 2002 2001
Copper Fixed Price Rod Sales Program 4.4 (0.5) (1.6)
Gold Price Protection Program (1.8)
Copper Quotational Period Swap Program 1.2
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Summary of Price Protection Program
Units are in millions
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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

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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 options maximum term is 10 years

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Compensation Plan

• Restricted Stock Option Plan
• Directors Stock Unit Plan

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Restricted Stock Option Plan

• The issuance of the option to executives and
  other key employees, without any payment by them
• Subject to certain restrictions

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Restricted Stocks
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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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Options outstanding for the combined plan
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Fair-Value of each option grant
Using a Black-Scholes option-pricing model to
estimate
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Exercisable options by range of exercise prices
Range of exercise price Options exercisable at Dec. 31, 2003 Weighted average outstanding option price
27-40 604,338 34.42
40-60 2,563,606 51.88
60-80 2,266,756 70.02
80-100 129,976 83.82
Total 5,564,676
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Financial Analysis

• PDs 2-year Financial Summary

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Financial Highlight

• Revenue (2003)
• PDMC 2,485.8 mil
• PDI 1,236.2 mil
• Operating income 197.6mil
• Net Income 94.8 mil
• Cash from Operation 470.50 mil
• ROA 0.33
• ROE 0.16
• EPS 0.046

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Financial Analysis

• Income Statement 2003
• Balance Sheet 2003
• Cash Flow Statement 2003

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Revenue History for PD
Quarters 2000 2001 2002 2003
Mar 1,119,700 1,100,700 918,500 978,000
June 1,112,900 1,063,500 966,800 962,200
Sept 1,193,400 937,000 941,200 1,031,100
Dec 1,099,100 901,200 895,500 1,171,400
Total 4,525,100 4,002,400 3,722,000 4,142,700
All figures are in thousands of U.S. Dollars
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PDs stock price (2000-2004)
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• Falconbridge Limited

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Section Agenda

• Company Background
• Financial Analysis
• Risk Management and Hedging Strategy
• Stock Option Plan

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Corporate Profile

• Founded in 1928
• Leading low-cost metal producer and metal-bearing
  processor
• Core businesses copper and nickel
• Ranking twelfth in terms of mined production
• Third-largest producer and account 8 of world
  nickel supply
• Market Capitalization 6.17 Billion
• 6400 employees in 13 countries
• Owned by Noranda Inc. of Toronto (59), and other
  investors (41) as 2002

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Subsidiaries and Associated Divisions

• Nickel
• Sudbury
• Raglan
• Nikkelverk A/S
• Falconbridge Dominicana (85.26)
• Custom Feed

• Copper
• Collahuasi (44)
• Kidd Mining Division
• Kidd Metallurgical Division
• Lomas Bayas

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Financial Highlights

• Revenues 2,394 Mil
• Operating Income 137 Mil
• Earnings 73 Mil
• Cash from operation 341 Mil
• Capital Exp and Def Cost 358 Mil
• ROA 4
• ROE 3
• EPS 0.34

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Financial Analysis

• Income Statement
• Revenue Source
• Balance Sheet
• Statement of Cash Flow
• 2-year stock price and historical data

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Future Outlook

• Remain focus on exploration, development and
  production of nickel and copper metals
• Continue to work closely with Noranda
• Cost saving operation efficiency
• Achieve efficiency, production, and cost
  objectives set by each operation.
• Projects are kept in budget and in schedule

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Risk Management Hedging Strategy
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Risk Management Philosophy

• Earnings are directly related to fluctuations in
  the price of its metal.
• Enters into contractual (derivatives) agreement
  to reduce (hedge) the exposure by creating offset
  position.
• Limited use of financial instruments for
  discretionary trading purpose.
• Primary hedges US/Can currency exchange rate.

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Risk Exposures

• Commodity price risk
• Nickel, copper, cobalt, and zinc
• Market prices can be affected numerous
  uncontrollable factors e.g., global demand
• Currency exchange risk
• Principally in Can/US exchange rate
• Operating cost in Canadian site are in Can
• Norway site are in Norway

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Risk Exposures (Cont

• Interest rate risk
• Cross-currency
• Principally in US and Canadian interest rate
• Highly related with interest payable
• Production process risk
• Risk and hazard in production
• Geographical factors
• Subject to monetary loss and possible legal
  liability

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Risk Exposures (Cont

• Energy price risk
• Represents a significant percentage of operating
  cost
• Contingency risk
• Estimation of future restoration
• is subject to the change of
• law and legislation and
• technology innovation

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Hedging Strategies

• Commodity price
• Futures and options contract for hedging
• Purchase call options to fix the price
  associated, and reserve upside potential
• Currency exchange
• To hedge these currency exposure
• Issuing debt in the foreign currency denominated
  as the investment
• Entering into foreign exchange forward and option
  contracts

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Hedging Strategies

• Interest ate
• Swap with terms range from 6.5 to 9.5 years
• Fixed to float and float to fixed are used
• Weighted average interest rate was 5.35
• Production process
• Contract with insurance companies
• Energy price
• Established the three-year 10 cost
• reduction plan
• Use the futures and options to hedge
• the energy prices

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Hedging Effects

• Foreign exchange hedging strategy gained 13.3
  million
• Reduced energy cost by 5.0 million from the part
  of the three-year 10 cost reduction plan
• Reduced other expenses by 3.2 million from
  futures/forwards and options positions in current
  year

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Sensitivities of the Change in Metal Prices
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Stock Option Plan
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Stock Option Plan

• Two classes of stock option plans
• Employee Stock Option Plan
• Granted to officers and employees
• Exercise price is priced at the fair value using
  B-S model since 2002
• Before 2002, exercise market value
• Deferred Share Unit Plan
• Effective in 2002
• Approved for non-employee directors

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Employee Stock Option Plan

• Terms and Vesting
• 10 year term
• vesting provision of 20 on the first anniversary
  date and further 20 per year thereafter
• Accelerated vesting feature was attached to stock
  options granted since 2000

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Deferred Share Unit Plan

• DSU is equivalent to common share
• Elect to be paid annual retainer fee in deferred
  share units (DSU) or in cash
• Dividend equivalent will be credited to DSU when
  dividend to common share is approved
• DSU is redeemable in cash or common shares after
  resignation

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Recommendation

• Hedge Copper, Fuel, Interest rate and Foreign
  Exchange
• Capital Intensive
• Better match for RD expenditures and future cash
  flows

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Questions?
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