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Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX)

Q3 2008 Earnings Call

October 21, 2008 10:00 am ET

Executives

Kathleen Quirk - EVP and CFO

Richard Adkerson - President and CEO

Jim Moffett - Chairman

Red Conger - President, Freeport-McMoRan Americas

Analysts

Jorge Beristain - Deutsche Bank

Tony Rizzuto - Dahlman Rose & Company

Michael Gambardella - JPMorgan

Amir Arif - FBR Capital Markets

Oscar Cabrera - Goldman Sachs

David Gagliano - Credit Suisse

Mark Liinamaa - Morgan Stanley

Brian MacArthur - UBS Securities

Victor Flores - HSBC

John Tumazos - Independent Research

Justine Fisher - Goldman Sachs

Sunil Gathader - Sentinel Asset Management

Bruce Klein - Credit Suisse

Aleem Ladak - Desjardins

Operator

Ladies and Gentlemen, thank you standing by. Welcome to the Freeport-McMoran Copper & Gold third quarter Earnings Call. At this time, all participate are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions).

I would now like to turn the conference over to Ms. Kathleen Quirk, Executive Vice President and Chief Financial Officer. Please go ahead, ma'am.

Kathleen Quirk

Thank you and good morning, everyone. Welcome to Freeport-McMoRan Copper & Gold third quarter 2008 earnings conference call. Our FCX earnings announcement was released earlier this morning, and a copy of the press release is available on our website at fcx.com.

Our conference call today is being broadcast live on the Internet. We'll also have several slides to supplement our comments this morning as usual and we will be referring to the slides during the call. The slides are accessible using the webcast link on our fcx.com website homepage.

In addition to analyst and investors, the financial press has also been invited to listen to today's call and a replay will be available by accessing the webcast link on our Internet homepage later today.

Before we begin today's comments, I'd like to remind everyone that today's press release and certain of our comments on this call include forward-looking statements. Please refer to the cautionary language included in our press release and slide presentation and to our risk factors described in our SEC filings.

On the call today are Jim Bob Moffett, Chairman of the Board, Richard Adkerson, President and Chief Executive Officer, and we also have several members of our senior management team with us today.

I'll briefly summarize our financial results, and then turn the call over to Richard who will discuss our operations and outlook using the presentation materials on our website. We'll then open the call for questions.

Today FCX reported third quarter 2008 net income applicable to common stock of $523 million, $1.31 per share compared with $775 million or $1.87. per share for the third quarter of 2007.

For the nine months ended September 30, 2008, FCX reported net income of $2.6 billion, $6.20 per share, compared with $2.4 billion, $6.58 per share in 2007 nine-month period and results for the 2007 nine-month period includes operations of Phelps Dodge beginning with our acquisition on March 20th, 2007.

Our consolidated sales from mines for third quarter 2008 totaled $1.016 billion pounds of copper, 307,000 ounces of gold and 19 million pounds of molybdenum. This compared with 949 million pounds of copper, 269,000 ounces of gold and 16 million pounds of molybdenum in the year ago third quarter.

Our third quarter publicly reported estimates for 2008, in which we reported adjusted in September following the small scale failure at Grasberg was 1 billion pounds of copper, 250,000 ounces of gold and 18 million pounds of molybdenum, so our sales for the quarter slightly exceeded our resized estimates.

The remediation activities that we undertook have been substantially completed, and we have regained access in October to the higher grade material previously restricted. The realized copper prices during the third quarter were $3.14 per pound. That was approximately 8% lower than the third quarter of 2007.

We did record an adjustment to our provisional pounds that were priced at June 30, 2008, that was 369 million pounds of copper that were provisionally priced at $3.88 per pound. We recorded those to the forward price at the end of September and adjustments to the prior period copper sales decreased revenues by $282 million and net income by $127 million, or $0.28 per share.

We also had open pounds at the end of September that remained open that based on the decline in prices in the fourth quarter would have an adjustment in the fourth quarter, Richard has got a slide to talk about the sensitivity.

Our operating cash flow totaled $1.5 billion for third quarter of 2008 and we generated operating cash flows of $3.2 billion for the nine months through September 30th. The year-to-date numbers were net of working capital requirements that we had earlier in the year, $1.5 billion for the year-to-date period.

Our capital expenditures during the quarter totaled $766 million and 1.9 billion for the nine months of 2008. We purchased under our open market share purchase program, we purchased in August and September 6.3 million shares of common stock at an average cost of $79.15 per share. That was a total of $500 million in share purchases.

We ended the quarter with no amounts borrowed under our bank credit facility, under $1.5 billion bank credit facility. Cash, consolidated cash of $1.2 billion and total debt of $7.2 billion.

I'd now like to turn the call over to Richard who will be referring to the slide materials on our website.

Richard Adkerson

Good morning, everyone. We'll start with the slide 3, which includes the third quarter financial highlights that Kathleen just reviewed with you and I won't repeat that. On slide 4, I want to talk to you a bit about how we're adjusting our business to the changes in our commodity prices that we are receiving and the issues affecting the financial markets.

It's pretty striking just how quickly this has changed. We went into the third quarter with prices at $4. By the end of July, they were at $3.75. At the end of August, they were roughly $3.50. They ended the quarter in the $3 level, and then in the first half of October traded at $2.50. And now, they're at $2. That's quite a change.

When we were at prices above $3, we were generating very large amounts of cash flow. We were also having high margins. That meant, we were investing in equipment and the resources to produce marginal volumes, we were pushing our organization all out to produce marginal volumes.

We were using our cash flows initially in 2007 to reduce the debt that we incurred in the Phelps Dodge acquisition, we were investing aggressively in organic growth and returning cash to shareholders, we increased our dividends and we bought some stock back.

Now we've had to change. And we know how to do this, we had been prepared for it, we knew that we were in a commodity business and there was the risk of the marketplace that we had to face, we've all lived through it before, so we are taking step now to preserve our balance sheet while maintaining the resource that we have available and the opportunities to grow that resource overtime to take advantage of what we continue to believe will be a great business to be in and that's providing copper to a world that's going to need it.

So what we're doing is we are limiting our investments in certain of our growth projects, reducing our capital expenditures, we are limiting our investments in our operations to produce those marginal high-cost pounds, we are taking steps with our financial policies to preserve our balance sheet. Markets aren't open for financing. Fortunately, we don't have to face refinancing in any of our obligations and we will earn enough cash to continue to invest in our business to maintain our resource and to go forward.

So that's what we're doing, we've taken these steps now. Our cost structure is changing very rapidly, major cost elements are declining. Our energy cost, which is 25% of our total cost are dropping, our diesel costs drop immediately. Some of the time it takes some time to work through some of our power cost.

Our input cost for operations, the steel cost for our grinding mills, the acid cost for our SX/EW operations are dropping. We are analyzing these, we are taking steps internally to stop spending, to reduce costs, to be take advantages of the new cost structure. We are going to be responsive to these current market conditions.

Our company is not financially stressed in any way, but there's no change in our long-term strategy. We're going to continue with our exploration program to understand the geology of our ore bodies and we're going to do exploration analysis, feasibility-type studies of how we can expand those ore bodies and develop growth projects that reflect the timing of when we pursue them. We are deferring certain projects, but the basic strategy of our business is unchanged.

Page 5 shows that the movement in our in our commodity prices. I've talked about the sudden drop in copper prices. It's in a world of where inventories, the stocks on exchanges, visible exchanges, inventories that our customers remain low by historical perspective, so it's really an unusual-type situation of where you've got such a drastic drop in commodity prices and yet basic marketplace still remains fairly tight.

Gold prices are strong, effective recent today. For example, by the strengthening dollar, and molybdenum prices continue to be strong but they have weakened from their highs as the steel industry situation has developed, and as demand factors can affect that business. But both gold and molybdenum are very supportive of our business during these times.

To talk a little bit about our liquidity, page 6 shows that at the time of the Phelps Dodge acquisition in March of 2007, we had $17.6 billion of debt. By the end of September, we were down to $7.2 billion. Took $10 billion of that debt off of our balance sheet during 2007 through an equity offering and through cash generated by our operations, and that leaves us in a very strong liquidity position.

Page 7, we've included the maturities on that debt. As you can see, we have very small principal payments due with really only significant amounts coming in play in 2015 and after, so we are not in any sort of position where we have to go to the financial markets to raise new capital.

Page 8 gives a presentation on our cost situation. Now, this is the third quarter cost. And for the third quarter, our costs were higher than we had included in our plans going into this year. That reflected the significantly higher cost of energy that we were incurring and other input costs, increases in labor costs in recent times, so our cost average for the third quarter at $1.29, which reflected all of those factors plus the lower volumes that we had coming out of principally Grasberg, because of the small scale pit-wall failure we had in the third quarter, which has now been remedied.

We're back to essentially normal operations and have dealt with that situation. It's not any sort of broader concerns in terms of our geotechnical issues, or our long-term mine planning. But the volumes are down, and so our unit costs were up. These costs are changing. This is not the cost structure that we're incurring today.

Third quarter at times, we were paying over $4 a gallon for diesel, now it's $2.50 a gallon, and we burn over 225 million gallons of diesel a year in generating electricity and running our heavy equipment, so the cost structure is changing and that will be reflected as we go forward in terms of offsetting some of the decline in the copper price.

Page 9 deals with the issue you that Kathleen referred to, and that was the effect of the decline in the copper price in the fourth quarter and its impact our financial statements. I'll just reference this briefly. I think we've talked about this really pretty detailed in prior earnings releases, so I think most of you understand it but the spot price declined from $3.99 at June 30th, to $2.90 at the quarter end.

Approximately half of our sales of copper in any quarter are provisionally priced and subject to final pricing. That means that those volumes of prices are adjusted subsequent to quarter end. And the prices in place at the end of the quarter are major determinant of how we record our sales.

There were two impacts in the third quarter. The adjustments to the second quarter's provisionally priced volumes, which was the $3.88 at June 30th were priced during the fourth quarter and that had an impact of reducing our revenues by $282 million and $0.28 per share on net income. It also meant that we recorded roughly half or more of our third quarter sales at the quarter end price of $3.14, which was less than the average price during the quarter and that had a $0.38 per share impact on net income.

During the fourth quarter if we were to price those open pounds at roughly what the price is today, there would be a $200 million reduction. Each $0.5 change would impact this estimate by $13 million. Of course that's just for illustration, the price would be determent by whatever the price is during the quarter and at December 31st.

Looking for our full year, our current sales outlook is as we previously reported. We expect to sell 4 billion pounds of copper, 1.2 million ounces of gold and 74 million pounds of molybdenum. Modeling our operating cash flows and using prices of $2.15 for copper, $800 for gold, and $27 for molybdenum, that would generate operating cash flows of $3.5 billion and that's net of working capital uses, which we've talked about previously of $1.6 billion. And we have now an expectation of capital expenditures for the year after making some initial reductions of $2.7 billion.

We are adjusting our capital spending plans as I mentioned. We're giving you today our current estimates of what those adjustments will be, but we are working as we speak with our operating teams to look at all of our operations, making tough decisions on capital and operating costs, and that's going to be on ongoing process. And so today's report is a point in time estimate in general terms in some respects of where we expect to be, but we will be responsive to these conditions.

We do have certain projects that are advancing, and we will continue to advance those. The Climax mine restart, the $500 million brownfield project to reopen the mine in Leadville Colorado to mine in open pit operation, high-grade low-cost molybdenum resource is progressing very well. It's located on top of the Continental Divide in Colorado, so we have to make a lot of progress in the summer time and we did this summer, and that is on schedule for construction of a new mill with a restart still targeted for 2010. Permits are not an issue in terms of moving forward.

This project is designed to produce 30 million pounds of molybdenum in a year with a very attractive cost structure in the range of $3.50 a pound. It is, we believe the largest highest-grade lowest cost moly resource in the world today and it will be a great asset for us. Opportunities for further expansion, we have drill rigs working there today, and depending on market conditions, as times go forward, we will assess where to go in the future with this project.

We also have a major new mine being developed in the Democratic Republic of Congo at our Tenke Fungurume concession. You've heard me say in the past, express concerns about the ability to undertake our construction there because of the lack of infrastructure, roads, power, workforce, all the things that are evident in that country, but our team has made remarkable progress with this construction project. It is on track now to begin production during 2009. The physical construction has proceeded at a very good pace. We had updated our capital cost estimates for this project earlier in the year. Currently, our estimate is for $1.7 billion of capital, plus investments in power facilities there.

We continue to review this and look at this development. It is initially designed to produce annual aggregate production of 250 million pounds of copper and 18 million pounds of cobalt annually. The resources there that we anticipate will enable us to have significant development activities in the future as we go forward. It's a very large concession of 650 square miles with near surface mineralization. We're drilling aggressively there to understand what the resource is and how we can proceed with the development.

And all of these activities will be dependent on market conditions, and we are going to approach this project if we do all others in terms of being responsive to what the current market conditions are, but on page 13, you can see pictures of the progress we've made with the physical construction.

Turning to page 14, we have been talking immediately since combining the two companies, about expansion opportunities of the existing ore bodies in the Americas. Many of these ore bodies have been producing for many years, and we have been seeing opportunities to both expand them on an incremental basis, and then doing exploration and evaluation work that we believe will lead to opportunities to do large scale expansions at these ore bodies.

We still see that. The drilling that we are doing is very encouraging. You will see that when we report our year-end reserve this year. We're on target to report reserve increases that will be substantially higher than our current production levels and that's the work that we have done this year and that work will be continuing as we look forward.

So, all of that is good news. We are changing the timing of when we will be pursuing certain of these projects. We've already made decisions to defer the previously announced incremental expansion as Sierrita and Bagdad and the restart of the Miami mine that means we won't be doing this. We won't be spinning the capital now to purse those.

Those opportunities aren't going anywhere. We own these properties, and we will have the chance to deal with that as market conditions improve and we believe in future they will improve, but we just won't be doing it now and that will affect our near-term volumes, and we're giving you our current estimates on that, but we'll also preserve our balance sheet and allow us to continue to preserve our resource.

In South America, El Abra mine where the current oxide ore is reaching depletion in the next couple of years, we have a project that would extend the mine life by 10 years to develop the sulfide ore that's been identified and is in our reserves. This would provide 325 million pounds of copper annually. It's a $450 million project. It's one of the projects that we are again reviewing as to when should we pursue it in light of current market conditions, and that's something that we will be continuing to study.

In Peru, Cerro Verde, we are having incremental expansion project there, that's progressing economic even under today's conditions. We also have been doing drilling, doing feasibility analysis for our large scale expansion, opportunity to add significant reserves here. That expansion is attractive based on the footprint, the resource, the availability of power and water, which we're working towards. We're studying again, when that would be best pursued, but that's a tremendous opportunity for our company.

We talk about our company in terms of a world of opportunities, and those opportunities are still there. We have now a 100 drilling rigs operating around the world. You can see on the map where they are located. You can see in the US, South America, Africa, Indonesia. All of these are highly prospective areas, and we have increased now our expectations for exploration spending, page 16, to $275 million for the year. That's another $25 million of what we talked about at the end of the second quarter (inaudible) of exploration activities principally in Africa at our Tenke Fungurume project, and another exploration project there called Kisanfu.

We are going to be looking at our exploration spending like our other costs, focused on the activities that would be impactive in terms of adding reserves and identifying longer-term activities, but some of the costs will be reduced as we look at our total cost profile.

Page 17 shows our updated sales profile estimates. This is going to be a moving target as we go through our year-end planning for existing operations as well as we look at the impact of deferring certain of these projects. I previously indicated we expect to have sales of 4 billion pounds this year. We have reduced projected sales for 2009-2010 by 200 million pounds in each year to 4.3 million pounds and 4.6 million pounds.

You can see our gold estimates; this is a down year for gold at Grasberg because of where we were mining in our pit in the upper sections of the pit where there are lower grades.

If you're in the fourth quarter, we'll be moving into the higher grade section, and we should have higher volumes for gold in '09 and '10 and then in the molybdenum sales, the 2010 shows the impact of adding Climax to our production profile.

On the quarterly basis, on page 18, the fourth quarter in terms of copper sales and gold sales, our strongest quarter in terms of volumes. We're looking at roughly 1.2 billion pounds of copper, just under 400 million ounces of gold during the fourth quarter.

And page 19 updates our unit sales, our unit cost activities we show in our sales by region and showing what our costs would be. This is a bit higher than what we had in the second quarter, principally because of the lower volumes at Grasberg. And I want to emphasize again that this cost structure is changing and we're unable at this point to incorporate all of these changes into the structure because of the timing and then as we look forward into 2009, our unit costs will be substantially lower because of this substantially higher volumes, principally at Grasberg and the expectation of flowing through the effects of recent changes in energy costs, steel costs, equipment component costs, contractor costs, all of these cost elements are coming down. And they will have an impact on our costs as we look forward.

Page 20 shows our cash earnings and operating cash flows. Now we are giving variations in this presentation ranging from $2 to $8 a pound. You can see operating cash flows at $2 or roughly $3.5 billion, over $4 billion at $2.50 and upwards to $6 billion at $3 a pound. We don't know where prices are going. We always say that, and we mean it. We don't run our business on an expectation of any particular prices and we prepare ourselves to deal with prices on varying levels.

On page 21, we give you sub guidance in terms of variances on cash earnings, net income and operating cash flows. $0.20 of copper plus or minus is $575 million of operating cash flows. Our business is highly leveraged to the price of copper, we're seeing that impact today. We saw it when prices were higher and that's where we've positioned our company to take advantage of what we believe is going to be a good copper market in the long run.

On page 22, we have our revised capital expenditures. Again, this is where we are today. We're working on this to make decisions as we go forward, but we have reduced our estimate for 2008 capital from $3 billion to $2.7 billion, from 2009 from $2.5 billion to $2.3 billion and we will report on that as we go forward.

In summary, we're committed to maintaining a strong financial position. Our company is positioned well to deal with this period of lower prices. We'll continue to invest in development projects with higher rates of return. We'll prudent in how we commit capital, how we spend money and how we manage our operating costs and our volumes. We have positioned the company to earn significant cash flows as we go forward. We are focused on providing returns to shareholders and we do that through dividends and whenever you have excess cash flows in terms of share buybacks, our financial policy is something we talk with our Board about it, at every one of its meeting and it will be responsive to market conditions.

We like our company. We like the assets we have, the operating team. We are the world's premier publicly traded copper company. We believe the future of copper is a good one. We're the world's large lowest-cost molybdenum producer and we operate the largest gold mine in the world. We have a set of world class assets, geographically diverse to generate cash flows even at today's much lower prices. We have financial strength in our balance sheet. We have a good project pipeline now and we have opportunities to grow in the future. And we do that through our exploration.

That's our report for this quarter. And operator, we now open the line for questions.

Jim Moffett

Richard, before we open the line for questions. This is Jim Bob. Let me make just a couple of comments on exploration. Everybody hear me okay?

Richard Adkerson

Yeah, you're loud and clear.

Kathleen Quirk

Yes.

Jim Moffett

Richard emphasized the exploration budget. The reason why this company is the largest publicly traded copper company is because of the asset base behind it. As we've drilled the exploration and exploitation wells over the last year since our acquisition, what we've found is we've tried to report to you on several occasions and I guess it's more important than at any time that we've made our reports to you since the acquisition. With the prices trending downward, everybody looks good in the high-priced markets. All the mines are producing at full throttle, but what you're going to see at the end of the year, and we'll be able to continue doing this, is that we're going to be able to further define the assets that are in the ground.

We feel that the drilling program has accomplished everything that we set out to do. We found that the ore bodies that we have all over the world with just few exceptions, have a sheet of ore that exists around the ore bodies, both deeper and on the extremities. So when you see the increases in reserves at the end of the year and see the ability for us to continue an active program of spending money on exploration, understand that most of our exploration is being done around our existing major world class mines meaning that we've got greenfield type of opportunities in brownfield type of projects.

The important part about that is when we're drilling these reserves, we can bring them to reserve status for two reasons. We're increasing the drill spacing to be able to comply with the standards for reporting for reserve, but more importantly we have the existing infrastructure to be able to mine those ore bodies. If you didn't have that, you would have to have a plan, a feasibility plan to build new facilities that would allow you only to bring these in as mineralized areas and resources as opposed to reserves.

We add reserves and just add lots of mines and that gave the company under Richard and Kathleen's financial leadership, the complete flexibility to take and take the best projects and continue them even if there were price declines, the other projects that may be higher cost can be moved around, so we're delineating the landscape so that we can take the best of the word class mines that we have in order to obtain the kind of returns you want us to deliver regardless of price structure.

I think we are unique in that case. Nobody in the world has the kind of strategic reserves that we have and the kind of backlog of drilling that we can do immediately adjacent to the ore bodies. These are interesting times when people start to focus on what they can value, and you can reach out and touch these assets. That's why we're identifying them for you, and bringing them into reserve classification, and when all the smoke clears, people and our shareholders will be able to see which companies have the real assets that have stood the test of time.

With that I'll turn it back over to Richard, and we'll entertain questions.

Jim Moffett

Thanks, Jim Bob.

Question-and-Answer Session

Operator

Ladies and gentlemen, we will now begin the question-and-answer session. (Operator Instructions). Our first question comes from the line of Jorge Beristain with Deutsche Bank.

Jorge Beristain - Deutsche Bank

Hi. Good morning, guys. As you mentioned the speed at which things have changed. I guess that it's a tough question, but if you had to choose at this point would you rather make further cuts to your CapEx plan, or potentially shutdown existing operations, which are high cost, which way would management be leaning in this current environment?

Richard Adkerson

Jorge, it's really a question of taking a series of steps. The first step is to look at the capital expenditures, because those are the dollars that can be most impactive initial terms of reducing the cash outflow. And that's what we've gone through, we've looked at which projects can we defer, where can we reduce capital without having adverse impact on our resource base or our future long-term growth opportunities. So the first stage of this process is to look at the capital projects and put the brakes on, gear down, defer and reduce that cash outflow. Then we look at our operating costs.

Now, we have been taking steps in our operations beyond just capital projects of spending money to produce incremental. We were having such strong margins that it was advantageous to us to drive our cost structure up and get those incremental pounds because we were earning the margins.

Now with the copper price down, we're making adjustments in what we spend money on in our operations. We have made some commitments for assets to make sure we had enough assets to put on our operations. The price of assets coming down, we'll make changes in the way we do that then we'll start reviewing our operations in terms of which ones are subject to being curtailed, because of the low prices.

So it's not either or, but a coordinated step to deal with capital costs, deal with operating costs, and then we look at those marginal operations and be prepared to curtail those if necessary.

Jorge Beristain - Deutsche Bank

Thank you, Richard. And just a follow-up to that, I mean, obviously you've given already some pretty sharp fourth quarter guidance about the headwinds there, but if we were to just continue to assume fairly low copper prices as they are at current, it would even seem that your current CapEx budget for 2009 would be at risk.

And under that scenario, would you consider drawing down some of your near-term credit lines in order to keep funding CapEx, or at that point, do you think you would probably even cut the CapEx further? I guess my question is, does net debt rise from this point forward if copper prices continue to trend at 2 bucks a pound?

Richard Adkerson

One of the great things, as we look at this is the strength that we have now by combining the legacy Freeport assets with the Phelps Dodge assets. Both the companies are much stronger together than they were apart, so that give us some flexibility in doing those.

We are continuing to look at our capital spending, as I pointed out what you see today is what we have been able to accomplish in a very short period of time, but we have teams working today to deal with equipment suppliers and plans and partners in terms of where we go with capital expenditure, so if prices stay weak or weaken, we will deal with our 2009 capital program and reduce it.

We have the full availability of our $1.5 billion credit facility, and that we see that as a cushion overtime to help us deal with the timing of where some of these things occur. We may draw on the credit facility, but we would develop plans to repay that overtime and then we would be examining our financial policy, so we want to be committed to maintaining our financial flexibility and I don't see our credit facility as a form of long-term financing of a capital program.

Jorge Beristain - Deutsche Bank

Okay, and sorry if I could have just one last question. You've been telling this earlier in the call about how you're already aware that diesel costs have plummeted sharply and things like that. You had about $1.29 reported unit cash cost in the third quarter, could you give us some kind of personal flavor as to where you could kind of see the 2009 unit cash cost heading, given the rapid decline in a lot of the input costs you are also seeing?

Richard Adkerson

Well, you see diesel costs. Energy is 25% of our total cost, so we spend a $1.5 billion on energy. It's $0.36 cents a pound on the current cost structure. Half of that is diesel and so half of that cost is going to be reduced by wherever the energy prices settle down. The averages today are that it's dropping. Power costs, diesel affects power in South America, coal cost and diesel affects power in Indonesia.

Coal contracts are not something that changes on a day-to-day basis like diesel costs, but all of these thins are coming down. I just can't, Jorge, today tell you because of how they are moving, what the numbers are going to be. We're going to have a clear view on that in the fourth, but these costs are substantially coming down and we will work our way through some of our contracts that we have for asset for example, some of our steel purchase requirements and all of these things will get adjusted and we will have a clear view for it.

The thing we can tell you, it's going to have an impact on our cost structure and it will be positive.

Along with the fact that we look at unit cost, Grasberg's volumes are going to be higher for copper and gold next year, principally for gold, because that's where the biggest percentage increase will occur and that depending on gold price will have a big impact on what we report as unit costs.

Jorge Beristain - Deutsche Bank

Okay. Thanks very much, Richard.

Kathleen Quirk

Just a follow-up to that Jorge, in terms of the cents per pound in diesel, we consume about 230 million gallons of diesel per annum. We've seen diesel cost go from over $3.50 per gallon in third quarter, recent purchases have been about $1 less than that, and that roughly works out to just under $0.06 per pound on an annual basis. And then purchase power works out to a $0.01 change per kilowatt hour, they are works out to just under $0.02 per pound, so we'll be watching all of this as we go forward to model all of this into our results, but there is, as Richard was talking about, a correlation between copper price and these energy costs.

Jorge Beristain - Deutsche Bank

Okay. Thanks, Kathleen.

Operator

Your next question comes from the line of Tony Rizzuto with Dahlman Rose & Company.

Tony Rizzuto - Dahlman Rose & Company

Thank you very much. Hi, Richard, Kathleen, and Jim Bob. I have a couple of questions, the first one is regarding the various cost inputs, how quickly are these expected to be felt on your bottom-line? I mean what are the various lags?

Richard Adkerson

Well, diesel cost is immediate. I mean we buy diesel, it depends on when we make our purchases, but those are purchased at market. Coal cost depends on when our coal contract gets triggered and that's generally adjusted on an annual basis. Purchase power varies by high utilities handling. Asset cost is fairly immediate, although during the third quarter we made some commitments to purchase acid for our US operations, and so that has a lag.

The cost component that's least resistive to change is labor cost. We've had significant increase in labor cost; they're in the structure now that will affect future labor negotiations. So taxes, of course, change immediately. In terms of the amount of tax it's owed, there are some changes in timing for that. Royalties go down, so a lot of our core costs do adjust rapidly.

Tony Rizzuto - Dahlman Rose & Company

Thanks. And then Richard, I wonder if you could elaborate on your decision-making process at El Abra with regard to the sulfide development. Are there any other factors besides the more challenging industry and financial environment that are causing you to more closely evaluate, i.e. are there region specific issues, the water, the acid issues?

Richard Adkerson

No. Our permitting process was essentially complete. Our working relationship with our partner CODELCO is a positive one. We have arrangements for this project for the power and water. You know quite frankly what we are looking on was how we might work to get more recovery out of this sulfide ore than the current leach project provides us, and we'll continue to work on that because that's a great opportunity for us because drilling opportunities either through a joint venture or otherwise would be economic.

So those sorts of things will continue, but there is nothing with the project fundamental itself, that has any impact on us, other than the fact that we are trying to preserve the timing of when we spend capital.

Tony Rizzuto - Dahlman Rose & Company

Okay. And what about the solvent extraction portion of the output there? We've got it pretty steady over the next couple of years. What type of life is there still remaining there for the SX/EW?

(John Morrison)

Through the complete sulfide project as we have it anticipated now, we have SX and EW capacity to support that full project.

Tony Rizzuto - Dahlman Rose & Company

All right. Is that John?

(John Morrison)

It's John Morrison, right.

Tony Rizzuto - Dahlman Rose & Company

Yes, all right, John. So we should continue to expect that's going to be maintaining at a very high level, but it sounds like there could be some push-out of the development of the sulfide expansion?

Richard Adkerson

That's the thing we're looking at as we are looking at all of our projects, the oxide ore goes and it just doesn't stop at one point in time, but basically through 2010, and then we were having sulfide that we were designed to come in there, and the timing of that will depend on how we spend capital.

Unidentified Company speaker

And just to be clear, Tony, the sulfide project is the sulfide leach, the production from the sulfide project would be processed through the existing SX/EW facility.

Tony Rizzuto - Dahlman Rose & Company

Understood. Just a final question if you could just update us on the Tenke process. We understand that the mining review was pushed out a little bit. Is there anything you can tell us, bring us up to date there, Richard?

Richard Adkerson

You're asking about the contract review process, right, Tony?

Tony Rizzuto - Dahlman Rose & Company

Correct.

Richard Adkerson

Yeah, here is where we are today. The government had initiated a process of having our company and other contractors review their contracts with the [Jeckomeens] the state owned mining company, and we have participated in that part of the process. Our position has been clearly articulated to the government overtime, and currently, that we view our contract as one that's a binding contract on us and on the government that it's fair by international standards with respect to the government's interest in terms of its taxes, royalties, and equity participation and we have made those points.

The process was designed to go from the stage of talking with Jeckomeens, to be reviewed by the government. Now the current delay has been resulted from the fact that the Prime Minister of the Congo stepped down. A new Prime Minister has been named, and a new a new government is being formed of ministers and that has not been completed. So that's the current stage of the delay in the process.

We continue to be encouraged based on our discussions with the government about our project. Senior government officials are impressed by what we've done. We have done what we said we would do. We are developing this project under world-class standards, and building infrastructure for expansion, and all that's being very positively received. So we've been encouraged by our discussions with the senior government officials.

Tony Rizzuto - Dahlman Rose & Company

All right, just one final comment, we're very pleased to see you guys as a leadership company demonstrating discipline in the market.

Richard Adkerson

Thanks, Tony, appreciate your comments.

Tony Rizzuto - Dahlman Rose & Company

You're welcome.

Operator

Your next question comes from the line of Michael Gambardella with JPMorgan

Michael Gambardella - JPMorgan

Yes, good morning.

Richard Adkerson

Good morning, Mike.

Michael Gambardella - JPMorgan

I have got a follow up question to Tony on Tenke and just in general for other copper development projects around the world. In your opinion does the drop in copper from higher $4 down to $2, what does that do to the mentality of the guys in various governments around the world you have to deal with on negotiating contracts? Does it give them a little bit more reality in terms of the contracts or does it entrench them even more by saying, okay now that the price has dropped, we have to get even a bigger percentage on taxes and royalties?

Richard Adkerson

Well Tony, I think it is fair to say that the.

Michael Gambardella - JPMorgan

You called me Tony again.

Richard Adkerson

Sorry, Mike. Mike. It's fair to say that this price drop has brought reality to all of us and it will bring reality to governments, to workers, to everybody that deals with the industry. Suppliers, contractors and they remind us which we've known because we've been in this business a long time, that we are in a commodity business.

Now, from the perspective of our project in the Congo, the Congo is in such need of economic development. The country has a very small economy. Its GNP for 65 million people is roughly $10 billion. Natural resource development is the opportunity that company has to develop its economy.

And so at the end of the day, I'm convinced that they are going to be supportive of a project like ours, where we'll have the chance to build a project that will have substantial employment to create the follow-on economic activity that a mine look ours would generate in a country that needs it so badly. It would be totally self defeating for them to try to make a project like ours uneconomic by having too high a tax rate, royalty rate, or economic terms that would discourage us from investing. And so I don't believe that is likely. I believe we will be encouraged by it and in my conversations with the President and others there, that's what I'm hearing.

Michael Gambardella - JPMorgan

And how much have you spent so far of the $1.75 billion capital cost?

Richard Adkerson

Roughly, Mike, $1 billion dollars.

Michael Gambardella - JPMorgan

And when do you say enough is enough, we have to get a decision from the government on that?

Richard Adkerson

We are pursuing this current project. The real issue is where do we go from there? But if we felt that there was the case of where enough is enough or that we were not confident that we could go far, we wouldn't have gone this far.

Michael Gambardella - JPMorgan

All right.

Richard Adkerson

It is a place of where we're taking business risk. We believe that business risk is justified because of the resource, that's an extraordinary resource that's available to us.

Michael Gambardella - JPMorgan

Okay. Thanks a lot, Richard.

Richard Adkerson

Sorry, Mike.

Jim Moffett

Mike Gambardella, this is Jim Bob. Let me give you one other example of what happens with these governments when prices are bound to drop or something that impacts the number of people that are applying for permits to mine the resources in these various countries. One of the things I can remember best is when the BUSAN fraud took place in Kalimantan and it was discovered that their mine was not really a gold mine. You had maybe 500 junior miners in Jakarta. They were setting up shop because they were playing off with this reported discovery, which as I said turned out not to be valid and the next week, when that announcement was made that that mine did not exist, all those 500 companies in unison, disappeared overnight and the department of mines had no people standing in line to develop property.

So when you see these prices go down, the junior miners and people that might have been going forward with projects pull immediately. They just basically turn out the lights and leave in the middle of the night. That will have an impact on the government.

Thanks, Jim Bob.

Operator

Your next question comes from the line of Amir Arif with FBR Capital Markets.

Amir Arif - FBR Capital Markets

Good morning, guys. I had to drop off the call, so I apologize if you've answered the questions. But this just focuses around your hedging strategy. Just given the copper prices have dropped so much and you're actually getting to the point where it's starting to impact some of your production and capital spending decisions, any thought on revisiting your hedging strategy?

Richard Adkerson

No, the answer is not. We can manage our business through the way we've managed our balance sheet, through the way we managed our capital programs and operations. We have a positive view of this marketplace and there is no interest by our Board or our Company in pursuing hedging at these levels.

Amir Arif - FBR Capital Markets

And the second question on the capital numbers that you put out there and the guidance, the volume guidance for '09 and '10. I'm assuming it's predicated on the capital numbers you've put out there which are still under review?

Richard Adkerson

That is absolutely correct. So as we go forward, we'll be making other decisions on capital and operations and all those things are subject to change, including our volume outlook.

Amir Arif - FBR Capital Markets

And just one final question. If you do make cuts on the CapEx, would you favor cutting your exploration stuff that wouldn't show up in your numbers for a few years anyway or would it even include development or you're just looking at return on capital of the project to look at?

Richard Adkerson

To tell you the truth, the focus has been on development capital. Because of some of the development, capital was based on incremental production of high cost units and also in terms of, it is more impactive. The focus is going to currently be principally on development capital.

We are going to continue to explore aggressively. We'll find some ways of reducing costs, but we are certainly not backing off from exploration because of the time lag that exploration generates for you. We need the information that exploration provides to us to know where we are going to go in the future and we're not going to back off on that.

Amir Arif - FBR Capital Markets

Sounds greats. Thanks.

Operator

Your next question comes from the line of Oscar Cabrera with Goldman Sachs

Oscar Cabrera - Goldman Sachs

Good morning, everybody. Just got a couple of questions. In terms of the copper sales, the reduction of 200 million pounds in 2009 and 2010. Is that attributable to US operations or is there something else in there?

Richard Adkerson

US operations.

Oscar Cabrera - Goldman Sachs

US operations? And Richard in terms of there had been a delay in terms of sulfur production because of assets. You guys had talked about increasing or building up a sulfur plant, obviously with the changes in the market, that was the under review, but do you guys have enough visibility to see if you are going to just not build that?

Richard Adkerson

Red, why don't you comment on that?

Red Conger

That's one of the projects that under review as Richard mentioned. We'll assess the availabilities of acid and the price, and our ability to do that capital project.

Oscar Cabrera - Goldman Sachs

Right, and then in the Phelps Dodge's operation, the US used to be a swing producer. Based on your comments, are you expecting to decrease the amount of production you think in terms of concentrate versus SX/EW, can you comment on that?

Red Conger

Well, it's going to be a combination waited to SX/EW operations. And one of the things that has changed that goes into theses analysis has been the molybdenum market, because back in the 2000 timeframe, when the industry last faced the curtailment activities, the price of molybdenum was below $5 a pound.

Now its price has fallen some, but it's still an important contributor to revenue. So the interaction of by-product credits, things like asset costs, energy costs, all come into play, but it's going to be an analysis of what production makes sense and what doesn't.

Oscar Cabrera - Goldman Sachs

Right. Okay, thanks very much.

Operator

Your next question comes from the line of David Gagliano with Credit Suisse.

David Gagliano - Credit Suisse

Hi. I was wondering if you could just drill down into the commentary on the North American operations with regards to roughly 45% of the volumes producing at $1.90 per pound, or higher? Could you just give us a little more color on which of those operations fall into that $1.90 per pound bucket?

Kathleen Quirk

The biggest one that's in that range right now, David, is Morenci. We're going to be looking at it as we go forward with acid prices coming down and energy prices coming down, but during the third quarter it was in that range, between $1.90, and $2. And then, of course as you know that's about half of or so of our North American production comes from Morenci.

David Gagliano - Credit Suisse

Thanks, Kathleen. That was actually my follow-up question which is with the latest changes in input cost, where does that number go to if everything stays where it is now in terms of the cash cost of Morenci?

Richard Adkerson

It will go lower, because we're moving a million short tons of material in our there. We have significant acid cost. Let us see if we can respond to your questions, but it's just too early right now, David, to give you a number, because the cost situation is moving so quickly. I don't want to put a number out there now.

As we look at this thing next week, it changes. But because of the nature of that operation, costs will go down. We're looking at our mill operation there, which we started up last year. We're going to be adjusting those operations, coordinating the activities with the nearby Safford mine and those costs will come down.

David Gagliano - Credit Suisse

Okay, and then just switching over to the CapEx targets in relation to El Abra, I just want to confirm. The CapEx for El Abra is still in the targets for 2009, is that right?

Richard Adkerson

That's right.

David Gagliano - Credit Suisse

Okay, and how much of the 450 million has been spent thus far at El Abra?

Kathleen Quirk

Very little.

Richard Adkerson

Very small.

David Gagliano - Credit Suisse

Okay. All right, Perfect. Thanks very much.

Richard Adkerson

Okay. Thanks, David.

Operator

Your next question comes from the line of Mark Liinamaa with Morgan Stanley.

Mark Liinamaa - Morgan Stanley

Just a couple of comments, I'd be interested in getting some comments. The price drop in copper that we've seen has come in conjunct with very dramatic conditions in the financial markets. Is there anything that you're seeing in the copper supply chain that's over and above just cyclical change in demand that are unique to lack of credit availability what have you?

Richard Adkerson

Well, there's no question that the lack of credit availability is going to affect some companies, but a lot of the companies that are pursuing supply projects are strong financial companies. But my sense is that even those companies risk tolerance for investment is just clearly it's going to be affected by what's going on now. And a number of the projects that the industry are pursuing face challenges that we've talked about before, even when the price of copper was at $4.

In terms of things that weren't economically driven, and that had to do with community acceptance, environmental permitting, technical, logical challenges because of where the ore is, either deep underground, or with complex mineralogy, so even the companies that would have financial resources potentially to invest clearly are going to be mow are disciplined about what they spend money on and when they spend it.

But fundamentally you raised a good point. It's unusual that you have this kind of price drop and inventories haven't responded more than they have. Inventories increase some on exchanges, but remained pretty low, very low by historical standards and the issues that have supported copper prices at higher levels from a supply standpoint have even become more evident with the recent announcements of the issues that the world largest copper mine Escondida and the continuing production problems that are reported.

So the supply side fundamentals remain strong. And from a longer-term perspective, what's going on now is going to be more supportive, because copper is not going to be developed as aggressively as it otherwise would be.

Mark Liinamaa - Morgan Stanley

And at the customer end, is there any de-stocking, and then one of the things you hear chatted about every once in a while is SRB coming back in, any thoughts there?

Richard Adkerson

Well, from a customer standpoint with the credit market, obviously everybody is trying to convert working capital into cash. And so all of our customers, we touch the US market by providing 50% of the raw to in US market and as we talk to our customers, they are having weak year this year, but they had weak years last year and they are adjusting to it by adjusting their operations and their inventories to deal with it.

I really don't have any particular insight to your second question, but overall with the lack of credit in the world today and the risk in the financial marketplace, I think it's clear that people, we are doing it, everybody is trying to reduce working capital.

Mark Liinamaa - Morgan Stanley

Okay. Good luck with everything.

Richard Adkerson

Thanks a lot, Mark.

Operator

Your next question comes from the decline of Brian MacArthur with UBS Securities.

Brian MacArthur - UBS Securities

Good morning. I just want to go back to the CapEx budget for the next two years. You sort of got about $1.8 to go in discretionary CapEx plus whatever you got left over this year. You let's call it 2 billion. You said it's 800 less than call it 400 on El Abra. What else is in there? I mean is Cerro Verde in there to big hunker? Are you considering some of the CIP as part of that, because we sort of taken out the US Southwest stuff right now, can you just maybe give me a little more color exactly what's in those?

Richard Adkerson

Well, you left out Climax.

Brian MacArthur - UBS Securities

Climax, sorry. You are right.

Richard Adkerson

That's a big one. We are starting to spend money in Indonesia on the Grasberg Block Cave development. And so I think when you add all that up, that's covers it.

Kathleen Quirk

We've got a project at Cerro Verde that's underway to incrementally expand. That's in there, but we don't have any sort of broader expansion at Cerro Verde in the numbers.

Richard Adkerson

We don't have a new mill at Cerro Verde in those numbers.

Brian MacArthur - UBS Securities

In those numbers, okay. And then if I just turn it around and say the $800 million or $900 million of what we call sustainable CapEx, how much flex is there not going forward?

Richard Adkerson

That's where we're working on, and that's where a lot of our cuts have come. That's where we were spending money on equipment to produce marginal (pounds) in some cases, so we're dealing with truck orders and things of that nature, to defer and of those costs, and that's where we're going to be continuing to work on, Brian.

Brian MacArthur - UBS Securities

Okay. So the four big ones basically make up, call it Cerro Verde increment, small increment or Climax, El Abra, Tenke make up the discretionary CapEx, if you want and then we basically adjust the $900 million going forward if we can to adjust the lower copper prices. Is that kind of simply where it comes out?

Richard Adkerson

Yeah, with Cerro Verde being a much lower element of that picture than the others.

Brian MacArthur - UBS Securities

Okay, great. And maybe just quickly, there is a comment in the press release talking about you expect a significantly exceed your production replacement reserves. I think Jim Bob talked a little bit about it, but it also makes a comment that you're finding, obviously there will be projects like Tenke where you find potentially lots of resource and reserves, but there is also general comment that you're finding it everywhere at a lot of these big sites. Is that a fair comment that all the regional areas are showing good results and not going to be just (weighted) to one area?

Richard Adkerson

That's absolutely correct. We're seeing it at our big ore bodies in the US. We're seeing positive drilling results at Cerro Verde, which all of those will translate into reserves in the near term and we're seeing positive drilling results at Grasberg as we drill in the area between the Ertsberg and the Grasberg pit in that gap area. So that's the encouraging exciting thing we have. We have these ore bodies that are turning up new information that's going to lead to reserves and ultimate to future expansion projects.

Jim Moffett

Richard, let me comment on that for a minute. The reason why that opportunity is there is because in the price syndrome that people are operating on over the last five years, and the people who are not drilling reserves cut offs more than $0.85. They had very conservative cut off grades, and so they just didn't drill beyond that level and that's what [OpEx] that was based on the price that they were getting for copper. So what you had is a number of ore bodies, almost all of the major ore bodies that had only been drilled to a limited extent. You put a dollar curb or cone, as we call it, all it means is the ore body just was undrilled. So you have all of these opportunities, any major ore body with a major mineralizing system is going to generate as you drill it deeper and drill it laterally, is going to expand. That's why many of the ore bodies that you see like you see like [Bingham Canyon at Kennecott (inaudible), these things have been in operation for a hundred years.

That's because they kept going out and finding new ore. What we did after these acquisition, we made an important part of our plan to bring in the exploration from greenfield and focus on our brownfields projects, and so we've seen that just every one of our properties, with few exception because the limited drilling that was done outside the permitter of the pit, it did not only did refine more ore that was isolated but the ore grades have been surprisingly higher than would have been anticipated.

In other words, as you go out and you go deep, the ore grade doesn't go down like some people have thought. But I felt that it was like a rain of water holds up as you further away you got from little water hose, less sprinklers you would have, but that's not what we're seeing in drilling deeper and drilling laterally, we are getting some more grades that are higher than some of the grades it’s been mined in the pit. So that's why the opportunities are there. No surprise. It was just the methodology of how the pits have been developed, and how we're approaching it.

Brian MacArthur - UBS Securities

And maybe just one other quick follow-up, just Outside of Grasberg and the other areas, have you had any luck finding any new areas or new discoveries that you want to put it up direct towards Wabu or anywhere else?

Jim Moffett

Well, Wabu is there and Wabu is just a matter of defining it further. We continue to look at it. We've been in there and done some work to the west (inaudible), which is the next big feature that we were drilling before we shutdown five years ago and some of the security issues become important. We're now back to work over there, and there is a so-called magnetic high, which looks like the Grasberg, and we've had several hits, so that's a very encouraging area. And I think you were either the first, somebody said we're now moving and going miles out from the original pit that's being designed in Tenke. We've gone out 10 mile, 12 mile, 15 mile, 16 miles after finding ore there. Once again, no reason why we don't have any big brand new greenfield start to announce to you is almost all of our money has been spent on these brownfield extensions that we just discussed.

Brian MacArthur - UBS Securities

Great, thank you very much.

Operator

Your next question comes from the line of Victor Flores with HSBC.

Victor Flores - HSBC

Yes, thank you. Good morning. I would like to come back, if I could to some of the cost declines that you are experiencing. And I realize you can't be drawn into giving specifics because you're still trying to work it out, but you give us some helpful information with regard to what the impact of falling diesel prices has done to the business. Can you give us a sense of what some of the other input costs have come down? How much has steel come down? How much has acid come down and maybe some big picture numbers on how much you consumed so that we can tinker with our models?

Richard Adkerson

Well, steel is particularly difficult to get your arms around right now because of the rapid move upwards and the adjustment downwards, so we really not in a position of giving and it affects several elements of our business, most directly on our grinding balls, but also on all of our equipment component costs and construction costs and so forth. Kathleen, why don't you comment on acid?

Kathleen Quirk

Just in terms of our external purchases of assets, they're just over a million tons, roughly 1.3 million tons. Acid prices at least in North America have come down. We were buying acid above $450 a ton and they have recently come down floated in $200 per ton level.

As Richard mentioned we did commit to some acid purchases going into next year because there was a big shortage of acid. In South America, we don't really purchase acid on a spot basis and those are under contract. But in terms of the overall acid consumption that we buy, it's about 1.3. Of course we sell acid as well. We have a smelter here in the US that we consumer internally, but in Spain we have a smelter that produces close to a million tons of acid as well and that's typically done under a long-term contract.

Victor Flores - HSBC

Kathleen and I guess what you're seeing, then is that those sales prices will probably come down as well and sort of offset a bit of the lower input cost on the other side?

Kathleen Quirk

That's correct. Coal, we purchase about 800,000 tons per year. That's in our Indonesian operations where we consume coal for power. As Richard mentioned, that's done on an annual basis. Our contract this past year essentially doubled from roughly $50 a ton to $100 a ton. But that comes up on an annual basis.

Victor Flores - HSBC

Great. Thank you so much.

Richard Adkerson

I do want to just repeat something Kathleen said. While we produced a lot of acid in Europe at our Atlantic Copper smelter, that has been sold under a long-term contract and did not benefit from the run-up that we had. We had some spot sales, you can see it in our commentary on Atlantic Copper, where even in the face of TCs/RCs, it was benefited by some spot sales, but it's not a question of taking a million tons of acid and ingesting it down by the price change.

Operator

Your next question comes from the line of John Tumazos, Independent Research.

John Tumazos - Independent Research

Good morning and congratulations on all the progress. On pages 8 and 4, you indicated a $0.22 reduction in your fourth quarter cost per pound. A little bit of that might be a penalty from lower by-product prices and then there's probably a benefit from higher ore grades. Could you try to walk us through the $0.22 cent cost reduction?

Kathleen Quirk

It's really, John, a function of what we're seeing at Grasberg. It's got some benefits from input costs, but, we've been talking about this all year in terms of being able to get to the high volumes of copper and gold out of Grasberg. So that will drive our unit costs down at Grasberg and the overall unit costs down.

Richard Adkerson

Kathleen, is it fair to say, really the only real input cost savings that we reflected in those numbers has been our diesel.

Kathleen Quirk

Right.

Richard Adkerson

Our diesel costs, so we haven't factored in any other factors other than adjusting the diesel costs down to $2.50 a gallon.

John Tumazos - Independent Research

If I could just offer a comment, I hope you can really pressure some of the suppliers that have been robbing you the last couple of years and charging crazy prices and I hope you get your exploration and capital spending done for 20%, 30% less than you forecast.

Richard Adkerson

We're going to work as hard as we can to reduce our costs and part of it will be dealing with all of our suppliers and contractors in all elements of our business.

John Tumazos - Independent Research

Good luck and good hunting.

Richard Adkerson

Thanks a lot, John.

Operator

Your next question comes from the line of Justine Fisher with Goldman Sachs.

Justine Fisher - Goldman Sachs

Good morning.

Kathleen Quirk

Good morning.

Justine Fisher - Goldman Sachs

The first question is just a clarification on the CapEx program. So I know that you said that you've reduced your CapEx budget for '09 thus far by about $200 million and you reduced your copper production as well. And that seems as though that's all coming away from North America.

And just so that I can clarify this strategy, I know that you haven't said exactly where you're going to cut, but you would still consider cutting South American expansion projects even though they may bring on lower cost production that could then displace some of the currently high-cost North American production?

Richard Adkerson

Well, it's more of a question of timing. When do we do this spending? And to tell you the truth, the analysis is done ore body-by-ore body, project-by-project. So it's not a question of doing one thing to replace another. We're looking at each one of our operations and the production we're dropping out would be our lower margin production.

So even though you see numbers that are added up to 4 billion pounds or 4.3 billion pounds, within that production portfolio is some production that's very high margin because of its cost structure, because of its by-product credits. And so we're going to be looking at every one of these. We are going to manage the financial profile of the company in terms of keeping our balance sheet strong and do what it takes to do that in whatever environment we have to live with.

Justine Fisher - Goldman Sachs

Okay, right. So it seems to make sense to me that you don't cut North American production that even though it's less profitable, it's still profitable.

Richard Adkerson

Absolutely.

Justine Fisher - Goldman Sachs

Okay.

Richard Adkerson

We're looking at this thing on the cash flow contribution to our business and how do we manage our expenditures and the first way as I said when I answered the earlier question. Then I think maybe Mike Gambardella asked, was to take the steps where we can be most impactive in reducing cash going out the door and thus with capital projects.

Justine Fisher - Goldman Sachs

Okay and then another question on the credit facility. I know that it was posed previously whether you would draw on the credit facility to pay for CapEx rather than cut CapEx and my question is would you cut the dividend before you drew on the credit facility?

Richard Adkerson

Well, our credit facility is designed to give us the financing ability to time expenditures. I mean we can't efficiently take these management actions in what our credit facility allows us to do at an efficient way. That means we may draw on the credit facility at a certain time with a plan to repay it over time.

My point was, we don't see the credit facility as the right way to finance long-term capital projects. We do that through other means in our balance sheet. And then the Board will be reviewing financial policy based on the overall situation and where copper prices are and on our other commodity prices.

Justine Fisher - Goldman Sachs

So you're definitely not buying back stock now, but it also seems like a cut in the dividend is not on the table either?

Richard Adkerson

We did make a statement in our press release that we bought some stock back, basically through the middle of September. We haven't bought any back since and with these conditions we are not likely to do that. The Board really is going to be reviewing the dividend policy and will do so as we do at every meeting and considering things as we go forward and it's just not appropriate to comment any that right now.

Justine Fisher - Goldman Sachs

Okay. And then just to clarify, Kathleen, maintenance CapEx, you said that within $800 million to $900 million. That was maintenance cap next?

Kathleen Quirk

Well, that's what we have that's not identified as a major project or an expansion project. The real sustaining number on a barebones basis is lower than that. And that's the process we're going through now to go through and see in a lower economic environment, commodity price environment, what should our CapEx be and what can we take out. Some efficiency projects that we've got in those numbers may come out, so that's what we're going through right now to see what can we pull out. It's sustaining, but a lot of it's discretionary.

Justine Fisher - Goldman Sachs

Okay, and then sorry, last question. If you do cut pending on Tenke. I'm just wondering how that works. You officially said that you spent $700 million in Africa already. If you decide to cut Tenke, or to delay it, would it just mean that you sort of leave it on the ground and go back home until you decide to go back to into the Congo, or does it mean that you sort of intentionally slow things down such that you still got people on the ground there, but maybe it won't be developed, how the mechanics work with you already having put $700 million in the project?

Richard Adkerson

Actually it's more than that. I said today we've spent $1 in total. Now, our partner paid for part of that, but with a project like that, we wouldn't just stop it and live it on the ground. We are continuing to progress to develop the initial stage of the project. We're working with our suppliers and looking at how we might manage those costs going forward in this current environment, how we can do what we need to do for less, but the real focus there would be then what do we do with the further expansions.

We're not doing this project just for this one project, but we are going to progress it, and then we will time where we go beyond that based on market conditions.

Justine Fisher - Goldman Sachs

Thanks so much.

Richard Adkerson

And with this project and all of these projects, John Tumazos has talked about trying to work to try to do the same things for less, because of the change in the market conditions, so some of that will be a question of how can we continue to progress things, but spend less money and do the same feasible activities, and then we're going to carefully scrutinize activities to see what kind of capital cost could be deferred or pushed out without undermining the goal of where we want to get to with the projects overtime.

So this is a test of management right now. The times we're living in is going to reflect how good we are at managing our business and that's what we're responding to aggressively, and that's what we're challenging everybody in this organization to say how can you do what we need to do for less money?

Operator

Your next question comes from the line of [Sunil Gathader] with Sentinel Asset Management.

Sunil Gathader - Sentinel Asset Management

Thanks. Richard, can you give us a perspective on what China doing in the copper markets? Are they active in the markets at these price levels, or they are just absent from the market given there is low inventory in the Shanghai exchanges?

Richard Adkerson

Could you repeat the question, Sunil? I'm sorry, I didn't catch it.

Sunil Gathader - Sentinel Asset Management

Yeah. Could you give us a perspective on the China's activity in the copper market? Are they actively buying in the market given low exchanges on Shanghai?

Richard Adkerson

Yeah. I thought that's what you said.

Sunil Gathader - Sentinel Asset Management

Yeah.

Richard Adkerson

The truth of the matter is, we don't do that much direct business in China. We sell some concentrates there, but PTFIs had long-term , and because that's our principal concentrate producer in Asia had long-term relationships with the Japanese smelters and with smelters elsewhere in Asia, in Korea, in the Philippines and in India.

And those relationships have been maintained as China's need for concentrate and copper has grown and it is done because our traditional customers have met the market in terms of the TCs and RCs that they pay. And so we're not a good source of information of what's going on day to day within China in terms of buying activities.

The real key to the copper price near term in the marketplace is what goes on in terms of China's consumption of copper. And there's an article in today's Wall Street Journal about China's economy growing at 9%, which is down from 10% plus that it's been growing and it talks about the relative difference between the Chinese country as a consumer and the US as a consumer. But for our product, for copper, it's the reverse of what the Wall Street Journal points out, that China is the key to the market place. They've been consuming 25% to 30% of the world's copper and it's been the source of growth.

So as we go forward from here and this is the question. Is China going to be committed to continue to develop its internal economy to build its infrastructure and cities? It has the financial resources to do it, but that's really going to be the near-term key to the marketplace.

Business is weak in the US and has weakened in Europe and China which has been the source of growth since 2003 is really going to be the key. Internal buying practices will affect it at any point in time. But overall, are they going to be doing things that will consume copper? And that will affect the world price.

Sunil Gathader - Sentinel Asset Management

Okay. On your share buyback, you still had 23.7 million shares outstanding to be bought back and you haven't done any purchases since September 15 and there was a comment also saying that you may not do in the near term.

At what copper price, do you think that you may resume those share purchases? Looking at the cash flows that you have a chart on there, $2.50 per pound, you generate about $4.2 billion in cash flow. Even after paying your common dividends, if you maintain the common dividends in the stock preferred dividends, you just have about $700 million left. So do you think that you need about $3 per pound in copper price in order to resume your share of purchases? So in that case which may take some time for copper price to go back to that level?

Richard Adkerson

Well let us see. I just reacted to that sometime comment and think about how quick it went from $3 to $2. It wasn't even a month. So who knows where the price is going to go. It's too dynamic a situation to try to pin it to copper price. We've talked about the movement in the input costs. We've talked about the changes in capital programs. All this is a very dynamic situation

We have the assets that can generate cash flows in excess of our growth plans, and when that happens, our Board has set a clear cut policy of returning that cash to shareholders.

Jim Moffett

Richard, this is Jim Bob. Let me just add something of emphasis to that. The price of copper is just one of the factor that we've been discussing today. The margin that we get for selling copper is what's going to determine our cash flow. That's why as Richard has been emphasizing, this management team, mostly the Freeport and the Phelps Dodge people of this company have put together is the best at doing what we're doing now and that is making sure that we take the anatomy of these mines and get the most efficient that we can cost wise. So if our margins change, that's more important. What is your margin, if you're getting $4 for copper and you are spending $3 to produce it, it's a $1 margin. You're getting $3 for copper and you're spending $2, that's a $1 margin. And that's what Richard has been trying to say that we're focusing on trying to control our margins.

Sunil Gathader - Sentinel Asset Management

Okay. If I may ask one last question. Your average cost update is around 8.25 and above. Are you thinking of refinancing that debt, of course the debt repayments are not until 2014 or 2015, a significant portion of that. But in order to bring that average cost of debt down, are you thinking that you can take advantage of the debt markets and refinance it?

Richard Adkerson

I will tell you the debt markets are very, in today's world, I feel reluctant to say something like this to you. But if you look at what investment grade credit, there have been very few debt deals done in recent times. And if you look at the spreads that investment grade credits are paying for, for new debt and the answer becomes pretty obvious to you, that we'll look for market opportunities when they are there, but they are not there today.

Sunil Gathader - Sentinel Asset Management

Great, okay. Thanks, Richard.

Richard Adkerson

And Sunil, going back to the other point. Look at our variance spread. $0.20 in copper is $575 million based on where we are today in terms of margins. So we are highly leveraged to copper prices and we see that effects on where we are now with the downward movements and there will be the effect if prices go forward, go up. And we're confident that the market is going to be a good one for us.

Sunil Gathader - Sentinel Asset Management

Okay, great. Thanks.

Operator

Your next question comes from the line of Bruce Klein with Credit Suisse.

Bruce Klein - Credit Suisse

My question was answered. Thank you.

Richard Adkerson

Thanks, Bruce.

Kathleen Quirk

Thanks, Bruce.

Operator

Your next question comes from the line of with Aleem Ladak with Desjardins.

Aleem Ladak - Desjardins

Yes, good morning. You say in the press release that the Climax molybdenum mine should be commissioned in 2010. When do you expect the mine to be in full production? How much will this full production will be and how much do you expect it will be produced in 2010?

Richard Adkerson

The annual production rate is designed to be 30 million pounds a year. Dave Thornton is here. Dave, why don't you talk about our schedule?

Dave Thornton

Yes, our schedule will continue to be sometime in 2010. Climax, like Richard said, is at the continental divide and our engineering is about 50% complete on the project. We're on schedule. However, we'll know more as we go forward based on the weather conditions and our continued progress on that project when the start-up will actually occur in '10.

So I think we're on schedule for 2010. When that will be, it's a little too soon for us to say right now.

Aleem Ladak - Desjardins

Okay. Thanks.

Operator

There are no further questions at this time. Are there any closing remarks?

Richard Adkerson

Well, I just want to say how bad a mistake a CEO can make by mispronouncing the name of Mike Gambardella when he was just named the number one analyst by institutional investors. So I'll try not to do that a again, Mike.

We appreciate everybody's participation in our call. We're going to work hard to deal with the current situation and build values for our shareholders. As I said, we like our company, our team and our asset. And we're enthusiastic about going forward. Thanks for your interest.

Operator

Ladies and gentlemen, that concludes our call for today. Thank you for your participation. You may now disconnect.

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Source: Freeport-McMoRan Copper & Gold Inc. Q3 2008 Earnings Call Transcript
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