Freeport McMoRan Copper (NYSE:FCX) is one of the world’s leading copper mining companies. It is now a diversified natural resources company with the acquisition of oil and gas assets in 2013, in addition to its gold and molybdenum mining operations. However, copper is still the mainstay of the company’s operations, with copper sales, including both in the form of concentrate and refined products, accounting for nearly 69% of the company’s revenues in 2013. 
In this article we will take a look at Freeport’s copper mining division with focus on its high copper volumes strategy to combat low prices and rising costs.
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Freeport’s copper mining operations are geographically widely spread with mines located in North America, South America, Indonesia and Africa. The company’s major mines include the Morenci mine in Arizona, the Cerro Verde mine in Peru, the Grasberg mine in Indonesia and the Tenke Furugame mine in the Democratic Republic of Congo. Together, these four mines accounted for nearly 60% of the company’s consolidated sales from copper mines in 2013. Freeport had consolidated proven and probable copper reserves of 111.2 billion pounds at the end of 2013. ((Freeport’s 2013 10-K, SEC))
Copper prices have fallen sharply over the last year. London Metal Exchange (LME) spot prices have fallen from average values of around $7,800 per ton in Q1 2013 to around $6,800 per ton in Q1 2014. ((LME Copper Prices, LME)) A slowdown in China and fears of unwinding of financing deals using copper as collateral have led to a fall in copper prices.
China is the world’s largest consumer of copper, accounting for nearly 40% of the total world consumption of copper. Copper has diverse applications in industry, particularly in the manufacturing, power and infrastructure sectors. Slower economic growth in China has led to a moderation in copper prices. According to data from China’s National Bureau of Statistics, growth in investment, factory output and retail sales has slowed to multi-year lows in the first two months of the year.  Further, a proposed structural transformation of the economy from investment and export led growth to consumption driven growth may lower Chinese demand for copper in the long run. Recent Chinese customs data confirmed the drop in demand, with ore and concentrate imports at their lowest levels in a year.  In addition to weak demand, the expansion in production by major copper mining companies has resulted in oversupply, which will put pressure on prices. 
Copper is also used as collateral for financing deals by Chinese firms. Smelters, refiners and fabricators have been using copper inventory as collateral to obtain financing. It is estimated that up to a third of China’s copper imports may be tied up in financing deals. Thus, an unwinding of these deals could result in large quantities of copper being dumped in the market. The uncertainty regarding the financial health of Chinese firms and falling copper prices are forcing banks to demand more collateral from borrowers. This is forcing borrowers to sell their copper stocks in order to meet these obligations. In some cases, the banks themselves are selling copper to recover their money. This is worsening the already existing oversupply situation. ((China Fears Trigger Dramatic Drop In Copper, Financial Times))
The results of a recent survey by Thomson Reuters have revealed expectations of low copper prices for the rest of the year, in the range of $6,000-$7,000 per ton. Lower copper prices will negatively impact the fortunes of Freeport’s copper mining business. 
The falling copper price trends have been reflected in the average realized copper prices for Freeport from its copper mining operations. Average realized copper prices per pound stood at $3.86, $3.60, $3.30 in 2011, 2012 and 2013 respectively.((Freeport’s 2013 10-K, SEC)) Average realized prices fell further to $3.14 per pound in Q1 2014 and are expected to remain subdued in the near term. 
Freeport measures cash costs related to copper production using the unit net cash costs metric. This metric encompasses site production and delivery costs, by-products credits and treatment charges. Unit net cash costs per pound for Freeport rose from $1.01 in 2011 to $1.49 in 2013. ((Freeport’s 2013 10-K, SEC)) The increase in this metric reflects rising mining costs for Freeport. Some of the drivers of these costs pertain to labor costs, energy costs and access to scarce fresh water resources for mining operations. Energy costs, which accounted for approximately 20% of consolidated copper production costs in 2013, are expected to rise to 21% in 2014. ((Freeport’s 2013 10-K, SEC)) Further, access to fresh water sources is often a problem for Freeport, whose mining operations are mainly located in areas with scarce fresh water resources.  Mining costs rise when lower-grade ores are mined, which has been the case in the last few years.
With falling prices and rising costs putting pressure on the margins of Freeport’s copper mining operations, the company has undertaken major expansion projects at a number of its copper mines. This may seem counterintuitive at first. The company believes that it can reduce unit costs by diluting them over larger production volumes. Further, the mining of higher grade ore will also reduce mining costs.
The Morenci mill expansion project, which is scheduled for completion in 2014, will add incremental annual production of 225 million pounds in 2014. Copper production is expected to approach 1 billion pounds in 2015, as compared to 564 million pounds in 2013. The Cerro Verde expansion project will expand concentrator facilities and provide incremental annual production of approximately 600 million pounds of copper. The second phase of the Tenke Furugame expansion project, which will be completed in 2016, will also boost copper production. The mining of higher grade ore, starting in 2014 at the Grasberg mine complex, will lower production costs as well as boost production. ((Freeport’s 2013 10-K, SEC))
As a result of these expansion projects, Freeport’s consolidated copper sales volumes will rise from 4.1 billion pounds in 2013 to 4.3 billion pounds, 5.0 billion pounds and 5.7 billion pounds in 2014, 2015 and 2016, respectively. ((Freeport’s Q1 2014 Earnings Presentation, Freeport McMoran website)) The company believes that demand for copper will remain strong in the medium to long term to absorb the expansion in production.
The Road Ahead
We expect copper prices to remain subdued in the near term due to weak demand and a supply glut. Much of the success of Freeport’s high volumes strategy will depend on a recovery in demand for copper in the medium to long term. Trends in urbanization and industrialization in major emerging economies, particularly China and India, will drive the demand for copper in the long term. Thus, the sooner the demand for copper recovers and the greater the magnitude in the recovery of demand, the more successful Freeport’s strategy will be.Notes:
- Freeport’s 2013 10-K, SEC [↩]
- China Premier Warns On Economic Slowdown As Data Fans Stimulus Talk, Reuters [↩]
- Copper Caps Longest Slump Since March On China Imports, Bloomberg [↩]
- Copper Miners Forecast Years Of Surplus, The Financial Times [↩]
- Copper Prices May Fall Below $7000/Ton On Oversupply, The Economic Times [↩]
- Freeport’s Q1 2014 10-Q, SEC [↩]
- Miner Freeport Pressured By Water Costs As Copper Prices Slide, The Wall Street Journal [↩]