Last week, BHP Billiton (BHP) officially announced the delay of the major expansion project at Olympic Dam. While not a complete surprise due to falling commodity prices and escalating costs in Australia, a prime beneficiary in Freeport McMoRan Copper & Gold (FCX) hasn't gained much from the announcement.
Freeport-McMoRan is a leading international mining company with geographically diverse assets with significant proven and probable reserves of copper, gold and molybdenum. The portfolio of assets includes the Grasberg minerals district in Indonesia, the world's largest copper and gold mine in terms of recoverable reserves; significant mining operations in North America and the Cerro Verde and El Abra operations in South America; and the Tenke Fungurume minerals district in the Democratic Republic of the Congo.
The Olympic Dam has one of the largest copper deposits and naturally any delays in expanding this project benefits existing copper producers and hurts mining equipment makers. With the price of copper and gold holding up better than most other metals, one might consider this project delay as inconsistent with market pricing and future demand expectations.
Olympic Dam Project
BHP is proposing to expand the existing mining and minerals processing operation at Olympic Dam, located in South Australia about 575 KM by road north-north-west of Adelaide.
Olympic Dam is one of the world's largest polymetallic (i.e. multiple metals) ore bodies and contains one of the largest copper resources, the largest uranium resource and a significant gold and silver resource.
Western Mining Corporation Limited discovered the Olympic Dam mineral deposit in 1975. BHP took over the mineral deposit in 2005.
Underground production mining at the complex started in 1988 at a rate of 45,000 tones per annum (tpa) of copper plus associated products: uranium oxide, gold and silver.
After several upgrades, production increased to the current 170,000 tpa of copper plus associated products of 4,000 tpa of uranium oxide, 80,500 ounces per annum (oz/a) of gold and 780,000 oz/a of silver. The mine has conditional approval to product 350,000 tpa of copper plus associated products.
The company is seeking government approval for the project configuration including the introduction of a new open pit mine and related infrastructure resulting in increased annual average production to 750,000 tpa of refined copper equivalent plus associated products (19,000 tpa uranium oxide, 800,000 oz/a gold and 2.9 million oz/a silver). The 750,000 tpa of refined copper equivalent would consist of:
- about 350,000 tpa of refined copper processed at Olympic Dam from 800,000 tpa of the copper-rich concentrate. This concentrate would be derived from higher-grade ore
- about 1.6 Mtpa of the copper-rich concentrate to be exported via the Port of Darwin for processing by overseas customers. This concentrate would be derived from the lower-grade ore and is expected to yield about 400,000 tpa of refined copper. The exported concentrate would also have recoverable quantities of uranium oxide, gold and silver (and is hereafter referred to as concentrate). At this stage, the most likely location for further processing is China.
As one of the world's largest copper producers, Freeport-McMoRan ultimately benefits from the delays in any major large-scale projects such as the Olympic Dam. The reduced future production comes at an odd time when the prices of the metals produced remain high. Sure the mining sector in general remains weak, but copper and gold prices remain near record levels.
The company sales from mines for the year 2012 are expected to approximate 3.6 billion pounds of copper, 1.1 million ounces of gold and 81 million pounds of molybdenum, including 885 million pounds of copper, 225 thousand ounces of gold and 20 million pounds of molybdenum for third-quarter 2012.
Q2 2012 Highlights
The company reported the following highlights for Q2 2012:
- Net income attributable to common stock for second-quarter 2012 was $710 million, $0.74 per share, compared with net income of $1.4 billion, $1.43 per share, for second-quarter 2011.
- Consolidated sales from mines for second-quarter 2012 totaled 927 million pounds of copper, 266 thousand ounces of gold and 20 million pounds of molybdenum, compared with 1.0 billion pounds of copper, 356 thousand ounces of gold and 21 million pounds of molybdenum for second-quarter 2011.
- Operating cash flows totaled $1.2 billion for second-quarter 2012 and $2.0 billion (net of $774 million in working capital uses and other tax payments) for the first six months of 2012, compared with $1.7 billion for second-quarter 2011 and $4.0 billion (net of $382 million in working capital uses and other tax payments) for the first six months of 2011.
- At June 30, 2012, consolidated cash approximated $4.5 billion and total debt approximated $3.5 billion.
Income dropped from 2011 as costs increased and prices dropped. This combination is part of the reason that BHP delayed the Olympic Dam project. Freeport-McMoRan though produced considerable cash flow for the first six months of 2012 suggesting new projects are worth the investment.
The market for copper remains mixed as the LME warehouse stocks remain near 4 year lows while China appears to be oversupplied. This CNBC report suggests though that while China may have over one million metric tons of copper in inventory, the country could use over 50 million metric tons in the next 5 years.
In that context, the copper market has a strategic shortfall says Andrew Keen, Head of Metals and Mining Equity Research for EMEA with HSBC:
"So there is a major strategic shortfall in the copper market from a Chinese perspective and those warehouses are really part of that longer-term solution…We don't think it's a big problem for the copper market going forward."
5 Year Chart - Copper Price
As you can see from the below chart from Kitco, the current spot price for copper is close to the 5 year high.
The chart for FCX shows a stock price near the 2 year low even with copper spot prices holding up strong.
2 Year Chart - Freeport-McMoRan Copper & Gold
Ultimately, the valuation for Freeport-McMoRan will depend on the demand for copper from China and whether housing rebounds in the U.S. With the downturn in U.S. demand back in 2007, the copper market has yet to experience a situation of strong demand from the largest two markets at the same time. Remember that China demand was significantly lower back in 2005-2006 when the U.S. last saw strong demand.
The delay of major expansion plans such as the one at the Olympic Dam should have beneficial consequences to existing producers of copper and hurt equipment suppliers such as Joy Global (JOY). Similar to during the financial crisis, it remains hard to explain why global mining companies make expansion plans based off short-term market fundamentals on projects that take anywhere from 5-10 years to complete.
Other copper producers such as Southern Copper (SCCO) will benefit as well, but investors are usually better sticking with the best operator in Freeport-McMoRan.
Additional disclosure: Please consult your investment advisor before making any investment decision.