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Copper

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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