Freeport-McMoRan Copper & Gold, Inc. Q2 2008 Earnings Call Transcript

Jul.22.08 | About: Freeport-McMoRan Inc. (FCX)

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

Q2 2008 Earnings Call

July 22, 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

Dave Thornton - President, Climax Molybdenum

Mark Johnson - SVP and COO

Analysts

David Gagliano - Credit Suisse

Michael Gambardella - JPMorgan

Jorge Beristain - Deutsche Bank

John Hill - Citi

Tony Rizzuto - Dahlman Rose

Oscar Cabrera - Goldman Sachs

Victor Flores - HSBC

Brian MacArthur - UBS Securities

John Redstone - Desjardins Securities

John Tumazos - Independent Research

Terence Ortslan - TSO and Associates

Operator

Welcome to the Freeport-McMoRan Copper & Gold second quarter earnings Call. At this time, all participants are in 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 the Freeport-McMoRan Copper & Gold second quarter 2008 Earnings Call. Our earnings announcement was released earlier this morning and a copy of the release is available on our website at fcx.com. Our conference call today is being broadcast live on the internet. We will also have several slides to supplement our comments this morning, and we will be referring to the slides during the call. They are accessible using the webcast link on our fcx.com website home page.

In addition to analysts and investors, the financial press is also been invited to listen to today's call and a replay of the call will be available by accessing the webcast link on our internet home page later today. Before we begin today's comments, I 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 materials, 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 have several of our senior operating team members here today, including Red Conger, who runs our Americas business; Mark Johnson, who runs our Indonesia and Dave Thornton, who runs our Molybdenum business. I will start by briefly summarizing the financial results and then turn the call over to Richard, who will be referring to the slides and discussing our operations and outlook. We'll then open the call for questions.

Today FCX reported second quarter 2008 net income applicable to common stock of $947 million that was $2.25 per share compared with $1.1 billion $2.52 per share for the second quarter of 2007. For the six months ended June 30th 2008, FCX reported net income totaling $2.1 billion $4.89 per share, compared with $1.6 billion or $4.80 per share in the 2007 first half. The results for the 2007 six-month period include the operations of Phelps Dodge, beginning on the acquisition date following March 19th, 2007 acquisition date.

Our consolidated sales for the second quarter of 2008 totaled 942 million pounds of copper, 265,000 ounces of gold and 20 million pounds of molybdenum. This compared with 1 billion pounds of copper, 913,000 ounces of gold and 15 million pounds of molybdenum for the second quarter of 2007. As expected, copper and gold sales volumes were lower than the year ago quarter because of where we're mining at the Grasberg mine. We expect to begin mining in the higher grades in the second half of this year and particularly in the fourth quarter.

Our sales were higher than our previous estimates of 930 million pounds of copper, 225,000 ounces of gold and 18 million pounds of molybdenum that were reported in our earnings release on April 23rd, 2008. Our realized copper prices were $3.85 per pound in the second quarter of 2008. Those were 15% higher than in the second quarter of 2007. At the end of June 2008, we had copper sales of 369 million pounds, priced at an average of $3.88 per pound that was the forward price at June 30th. Those sales are subject to final pricing over the next few months.

Each $0.05 change in the price realized from the June 30, 2008 price recorded would result in an approximate $11 million effect on FCX's 2008 net income. Our operating cash flows during the quarter totaled $1 billion. That included working capital uses of just under $800 million, we had large tax payments and increased inventory values during the period, which required a use of our cash.

Capital expenditures approximated $655 million in the quarter and our total debt was $7.4 billion and consolidated cash was $1.6 billion at the end of June. We also announced today that our Board authorized an increase in our common stock dividend from the previous annual rate of $1.75 per share to $2 per share and authorized an expanded open market share purchase program to 30 million shares from the prior level of 20 million shares.

Now, I turn the call over to Richard, who will be referring to the materials included on our website in the slide presentation.

Richard Adkerson

Thanks, Kathleen, and good morning, everyone. This is an important conference call. We've got a lot to talk about. I want to talk about first, our solid second quarter performance and the factors that resulted in the financial results that Kathleen just reviewed with you then take an outlook as we go forward as we return to the higher grade section of the Grasberg mine and look forward to earning significantly stronger cash flows.

And that forward outlook is what led our Board to take the action that's announced today to increase our dividend and increase our stock buyback program because, we're going to be in a position in the near-term to begin executing our financial policy that we set forth previously.

And then most importantly is to give you an update and an outlook about what we are so excited about here in the company, and that's our potential to significantly increase our reserves in the medium term and to work with those reserves to add cash flow for using properties. The results for the second quarter of '08 that Kathleen just referred to are affected significantly by the mining sequencing at the Grasberg mine. Those of you who have followed Freeport previously understand that how this works.

But I want to take a quick moment to review that because it is the principal factor that caused our volumes to be lower in the second quarter of '08 than in the second quarter of '07. In the back of your slides on page 36 is our mining sequencing chart of where we are in the Grasberg Pit. Now this is a major operation of pit that's a kilometer deep and 2.5 to 3 kilometers across, and as we mine it, we have to mine from the upper reaches where we have relatively low grades and mine downward to the high grade core of copper and gold that make this mine so great.

And if you look at page 36, you can see in the first quarter, we were mining in a section we call seven south in the upper reaches of the mine where we had low grades. And turn then to the next page, in the second quarter of this year, this current quarter, we are reporting on, we were lowering that seven south section and continuing to mine in relatively low grades. And the reason we have confidence in talking about our outlook for the second half of the year and into '09 and '10 is because we are making progress with our mine plan to lower that elevation down.

And in the third quarter on page 36, you can see we are moving to the higher grade sections. By the fourth quarter we will be in the high grade sections. We are talking about grades here of in excess of 3% copper equivalent. And then you can see in '09 on page 40 and '10, we'll be in high grade sections. So, what we are seeing is the results in the second quarter is the mining of this low grade material to set us up to access the higher grades and return to the kind of volume situation that we've characterizes this mine historically.

On page 4, the bottom right hand corner, you can see the consequence of that. In the second quarter of '07 in Indonesia, we had 334 pounds of copper drop significantly and you can really see the impact of the gold production which was at 880,000 ounces in the second quarter of '07, and while we did do more than we expected, it was still only 235,000 ounces this year. That is really what explains last years quarter to this years quarter variation. We are seeing higher costs. You're going to hear that from every company in our industry and other industries. Energy costs are up. Sulfuric acid costs are up. Labor costs are up. All of these are just factors.

The great thing about our assets is that we are situated, so that we can absorb the impact of these costs and with today's prices for copper, gold and molybdenum continue to have a very profitable and cash flow positive generating operation. When we were talking about our operations little over a year ago, after we did the Phelps Dodge merger, the notion that we would have copper prices in the summer, which is called the summer doldrums of the copper business at these levels and even with these increased cost levels, it is a fantastic story and one that we are excited about, about where we're positioned and where we can go.

Copper markets continue to be tight, even in the phase of the economic downturn in the United States and the issues that, that's causing elsewhere in the world. Demand has not been strong as a result of that, but with the continued challenges that the industry is facing in operating its mines and meeting production targets now coupled with the major increases in costs, that is going to make that factor even more significant. The market remains tight. China's economy continues to grow.

The world needs copper and we've got a Company that is positioned to provide it in the near term and provide growing volumes in the longer term. Our molybdenum business is a great business. We are the world's leader in producing that metal. Prices are strong. Demand is good. Our operations are performing very well and we are in a position to grow significantly our volumes with our Climax mine restart and of course, gold prices continue to be an important contributor to the financial situation of our Company.

In looking at the second quarter, we were able to achieve the guidance that we gave you for sales volumes. We did that in part by managing inventories at a very low level. You'll recall in the first quarter, we sold more than we produced, but we kept our inventories low and that will allow us to meet our sales target. We fell slightly short of production in North America. The Safford mine ramp up is proceeding, not as quickly as planned. The acid situation, the availability of acid has been a factor in that, and we've had to allocate available acid between our Safford mine start-up and our Morenci mine. The Morenci mine is an operation of when we've been stepping up mine production.

At the time we made the acquisition of Phelps Dodge, we were operating at a rate of about, a mine rate of about 750,000; 800,000 short tons a day. We are now at 1.1 million. That means we are moving more rock to our leach pads and that's going to ultimately result in more metal.

It's a question of the timing and the way that the acid that we apply acid and water to the leach pads generates that metal. It didn't come along as fast in this quarter and we were slightly lower production than we had anticipated. Those factors have caused us to reduce our copper outlook for sales to 4.1 billion. That's a slight reduction. We're going to try to beat that as we work hard to meet these factors. But it's just more or less one of those adjusting factors that you have, when you are operating complicated mines like this.

At this level of sales outlook, our model cash flows for 2008 are significant, $6 billion of cash flows that's at $375 copper, $900 gold and $30 molybdenum. We've had significant working capital uses in the first half that we talked about at our last call the payment of the Phelps Dodge hedge obligation, the impact of costs on inventory levels and so forth, the payment of taxes.

We will be having cash from working capital during the second half. But still for the year a significant working capital use of an estimated $1.8 billion. It's a difficult number to estimate and it may vary as we go forward in the year.

But we will be looking to generate very substantial amounts of cash flows on this model at $4.4 billion for the year. Capital expenditures are estimated at our previous estimate of $3 billion. That capital is being spent on a series of current projects. The Safford mine was completed in terms of construction last year. We continue to ramp it up, the start-up issues are being addressed.

We expect to be at a full production rate next year of 240 million pounds of copper. We have a project to restart the historical Miami mine. We have incremental expansions, which is the first step of looking at expanding their existing mines in North America, Morenci, Bagdad, and Sierrita. These are now undergoing the engineering studies.

We are factoring in the new cost situation for those. But these are incremental expansions to existing operations, that don't have the same challenges and issues that you have with Greenfield startups. We are pleased to report that our development project at Climax, where we are reopening that molybdenum mine is proceeding. That mine is located in a high snowfall area and once we cleared snow, we begin through the construction and that's going very well.

Much of our equipment for this expansion was actually ordered roughly a year ago. So it's not experiencing the cost, recent cost pressures that the project otherwise would have been facing. We expect to restart in 2010 when our mill is constructed. The major permits received and construction is proceeding in a very positive fashion.

This mine would produce 30 million pounds of molybdenum a year. That's a significant volume from a market that's roughly 250 million pounds globally annually. It is the largest highest grade, lowest cost moly development project in the world and it is expandable. We have drills there working now, potential to perhaps double reserves of molybdenum at that operation.

And that will give us a chance to monitor the market and decide about whether to expand this and there are several different approaches that we could use in expanding it. In South America, the El Abra, oxide deposit is approaching depletion. But we are making significant progress in plans to develop a sulfide ore reserve there. We've received the major permits that are necessary. Our partners have approved it and we are proceeding to go forward with the project that would continue the life of this important mine for 10 plus years.

One of the incremental expansion projects, we are doing is at our large mine in Peru, outside Arequipa, at Cerro Verde and we will be talking about that more in a moment because, this is an ore body that is one where we can look at expansion in a very straightforward basis, and we're studying a major expansion to go forward with that currently.

In Indonesia, the fee to our mill currently comes from the Grasberg Pit that I referred to at the start of this presentation. But a significant part of our operation is our block cave underground mine called the Deep Ore Zone mine, the DOZ.

Our PTFI team has been engaged in block cave mining since the early 1980s and the DOZ Mine today is one of the largest, if not the largest single block cave mining in the world. Originally developed as a 25,000 ton per day mine, it operated at over 66,000 tons per day during the second quarter, that's a record. We had a single day which we operated it, at 86,000 tons per day during the quarter. We now are expanding it to have a sustained rate at 80,000 tons per day targeted for completion in 2010.

Now at the same time, we are progressing the development of the deep Grasberg Block Cave mine, which will come into production when the pit is completed its production in roughly 2015, and all of that is progressing. It's a major project. But one which we have a lot of confidence in because of our experience and also the really great experience we are having with the current operation of the DOZ Mine. We are upgrading the mill at Grasberg and all of that is proceeding very well.

Page 11, gives you an updated summary of where we are with our Tenke Fungurume project, in the Democratic Republic of Congo. We're very, very pleased with the progress that we are making there with construction.

One of the major projects that we focused on during this past year has been reorganizing our approach there, looking at the scope of the operations, adding personnel resources, management talent to move this project forward and we're seeing tangible proof of the success in doing that right now. The physical construction is going very well.

We updated our capital cost at our last call to $1.75 billion. This was in large part dealing with the scope of this project, so they could set us up to do future large scale expansions because of the available resource that's there for us.

We are doing a lot of drilling and geological analysis to understand where we're going with the development of this project. The initial project is on a schedule that would generate first production during the second half of 09. We are increasingly confident about the physical construction process that would lead us to meet that target.

It's a tough place to do business, no question about it, in Central Africa. But our team there is highly motivated and making a lot of physical progress for that. The real key here, though is, where we're going to be going beyond this initial project. This has the potential as we've said before to be a world class mine and that's our objective to develop it to that.

You can see a recent picture of the construction site, and the physical progress that we're making there. We are continuing to work with the government on the contract review; there really has not been any significant recent activity there. We received encouragement from the government to proceed with our project.

And we will continue to work to answer the government's questions and interested party questions about our contract. Our contract and we strongly feel is a binding one. It's a contract that stands scrutiny by international standards as being fair for the government and one that gives us the incentives to go forward. We share a view of the government of trying to develop this project, as large as it can be and as quickly as it can be. I want to talk about where we are with the project we started talking about immediately after the merger.

Immediately after the merger we began looking at each of our ore bodies, to try to understand what drilling had been done previously, what the mine plants were and what opportunities were there. We quickly reached to a conclusion that we needed to do a lot more exploration work.

We needed to do a lot more drilling to understand what the ore bodies were and as we have been engaged in that and developed plans, we are tremendously excited about what the future of this company is by focusing on our existing mines, our existing operations and what we can do to expand reserves, expand production, to provide copper for a world that needs it.

By the end of this year we are going to have 80 drilling rigs operating around the world and that's in North America, South America, Africa and Indonesia and you can see where our focus is going to be. We are reorienting exploration towards these ground field expansions because that's where in the near term, medium term we can add reserves and look to add production as quickly as we can. We've significantly increased our exploration spending. We believe this is the best way for our company, to be able to add value to our shareholders.

Our new expected spending for this year is $240 million. Our original budget was $180 million. That is half in North America and you can see we are focusing in Africa and at all the places where you saw those drill rigs work. This is a major expansion of what was being done historically with the exploration for these properties.

You look on page 15, you can see at the time of the merger there were 35 drill rigs working. By the end of this year it will be up to 80. You can see that reflected in the amount of areas that we are going to be covering through our drilling. Now, what will this result in?

We have progressed this work far enough to date to get an order of magnitude view of what might be available to us and it's very significant, it's very significant. The PD reserves, the Phelps Dodge reserves, at the time of the merger were 64 billion pounds of copper equivalence. That includes molybdenum reserves equated to copper. With this drilling activity, we believe in the medium term we have the chance to add in orders of magnitude 80 billion pounds of copper equivalence.

That's more than doubling the reserves that we saw at the time of our merger. These aren't reserves yet. We got to do a lot of work. But we thought it was important to the marketplace to understand why our strategy is focused in this area. It is focused because we can more than double our reserves by looking at our properties and do that without having to pay the premiums that you would have to pay if you were in an M&A structure. Now, these are as I said, associated with our existing properties. We are drilling them.

First step is focusing on doing the necessary work from drilling, engineering studies, permitting, power, water studies to be able to meet the SEC classifications for calling those reserves. And these are available at a number of our mines, just not one big project. There are a number of mines around the world.

What do we mean by medium term? We expect to be able to add reserves this year and next year and continue do that over the next four to five year period. And we're going to be reporting to you, clearly about these at each one of our earnings calls.

At the Morenci mine on page 17. This is a mine that's been producing over a 100 years out of multiple pits overtime and continues to operate at multiple pits. Drilling to date is being focused on how the mineralizations of these different areas that have been mined are related to each other.

We see very significant long-term potential at drilling in field between these ore deposits and at depth. We are engaged in expansion studies, these are primarily sulfide ores, which will require new processing facilities. But it has the potential to this very significant mine to add roughly two thirds of reserves in this medium term.

And another mine that's been operated for decades and decades, the Bagdad mine in Arizona. We have significant potential in looking at expanding the cone of this ore body and the opportunity through doing drilling and engineering work to potentially triple the reserves in the medium term. There are opportunities beyond this, but this is the ones that we can see on today's horizon.

At Sierrita, which is a mine that is processing probably the lowest copper grade of any mine in the world and yet in today's world because of the very significant molybdenum content it is the lowest cost mine in the world. And this ore body gives us a chance through this exploration opportunity to potentially double its reserves. We are drilling now to extend the delineation of the ore bodies and engaged in near term expansion studies.

I mentioned Cerro Verde, and Cerro Verde because of its footprint and because of the mineralization that we are seeing, major expansion was completed right at the end of 2006. The ore is showing us a potential to double reserves and we believe that, that can be identified very quickly by the end of '08 and certainly by '09. And it gives us a chance to consider building another mill facility that would likely be just a replication of the new mill that we just built and a chance to significantly expand production from this mine.

In Tenke, we in connection with the construction that you saw the pictures up earlier, we are now stripping the ore at Kwatebala and doing significant drilling focusing on Goma and other prospects that are nearby. This is a large concession that is not yet been explored. Initial project is an oxide project.

We are working to maximize the opportunity from the initial facilities, that would likely be another oxide expansion and then we would be dealing with mixed ore and sulfide ore in the long term. But this all indications are that this ore body is one that can sustain rapid expansions which we've had experienced in the past.

We are dealing with the logistics issues, the power issues of doing business in the Congo. It is a very high grade deposit, high grade of copper by itself, supplemented by significant amounts of cobalt and we are working on marketing that cobalt. But it is something that idea of having this kid of ore body at Tenke Fungurume matched up, with what we have at the Grasberg is one that's a dream come true for a Company like ours.

In Papua, we are continuing to drilling in Block A, where we are currently producing the new access that we have through our new common infrastructure added system, which is now completed into the Grasberg, is giving us drill sites to drill in areas at depths we haven't been able to drill before. And that drilling is showing significant mineralization in the area between the Grasberg, the old Ertsberg pit, and the DOZ Mine.

This has the opportunity of providing reserves and the opportunity then to maximize the value of our operations, as we will be factoring in the potentially new reserves we have with our existing operations, and getting the most out of our mill production and recoveries as we go forward.

Page 23, talks about where we are with our outlook. Our company has been growing reserves because of the existing expansion projects, with what we've done to date, we see the chance to increase production in the near term as we ramp up Safford, as we get the benefits of the expanded mining rate at Morenci.

And as we have higher grades at Grasberg beginning in the second half of the year, particularly in the fourth quarter, we see the opportunities significantly increase our volumes going forward. You can see the change in the goal production at Grasberg, between our outlook between 2008 and 2009, that 700,000 ounces of gold, today's gold price is a lot of revenues.

And then with molybdenum, you can see the impact of bringing the Climax mine into production in 2010. So the outlook for our company from our volume standpoint is very strong. Fourth quarter looks to be a very good quarter for us because, of returns of grades at Grasberg. Significant increase in copper volumes, gold volumes and so this outlook is what gives our board the confidence of announcing the dividend increase and stepping up our stock buyback authorization, which we'll be executing as we earn cash.

Page 25 shows, the outlook for sales by region; North America, South America, Indonesia and at the bottom it shows our current outlook for cost. I mentioned costs are up, with the sales volumes, commodity prices we have we can absorb these costs and still have a very, very profitable and cash flow generating operations. At the end of the first quarter, we gave net cost guidance, net of byproduct credits of $1 a pound.

Our current outlook taking into account recent increases in energy and other input cost would be at $1.10 a pound. You can see with the results in the second half, the unit cost at Grasberg, coming down from what we've been experienced into the first half of the year to $0.80 a pound on a net basis.

Then on page 26, we've factored all of these things in and updated our outlook for cash earnings at $3 to $4 a pound. You can see that EBITDA ranges from roughly $10 billion on an annual run rate basis to about $14 billion and cash flow from operations ranges from $3 at $6 billion up to $9 billion.

And so even with the higher cost, our company's cash earning opportunities are significant, that's because the level of our production volumes, our reserves were highly levered to copper, $0.20 change in copper, means $575 million plus or minus in terms of operating cash flows.

Capital expenditures are on page 28. I had indicated that current outlook for this year is $3 billion. That number would be coming down as we complete the projects we are currently working on. The expansion projects would involve new capital and we will be updating those as we get those into our schedule.

As a practical matter, this is going to take sometime to get these reserves define and then projects define. So in the very near term, we'll have substantial amounts of cash earnings over our capital expenditures requirements. As result of that, today we have announced that we are taking another step. We took one last fall, taking another step to increase our common dividend.

The cash dividend on our common stock will now be at an annual rate of $2 per share. We increased our open market share purchase program to 30 million shares. That ties in, roughly with that available cash over the near term for that $3 copper price, which I said was $3 billion. We are committed to maintaining a strong financial position.

Our debt is now at a level that we had targeted. We have minimal debt principal payments required for the next several years. And this gives us a chance of looking and maximizing shareholder value, through our long standing condition of returning cash to shareholders in form of dividends and share buybacks. The extent of that is shown on page 30, where we've taken our operating cash flows and looked at our annual dividend requirements, taken into account the new dividend level.

In this you can see at $3 a share over a forward-looking model basis for the next two years at $3 would have $3 billion of excess cash flows, at $4 a share it would be just under $8 billion. So a substantial amount of excess cash.

We are focused on continuing to operate this company for the long-term view, maximize current operations by producing volumes, dealing with costs, controlling costs, generating cash, keeping a strong balance sheet, investing in current expansion projects and continuing to have this very exciting opportunity that's before us, in terms of building long-term reserves and long-term growth with our company.

So with that, I would like to open the line for questions. Jim Bob is here with me and rest of the team. So operator, could you please open the line for questions.

Question-and-Answer Session

Operator

(Operator Instructions)

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

David Gagliano - Credit Suisse

I just have a quick question, and actually it relates to, I think its, slide 30 in the current slide deck. By the way, first of all, thanks very much again for the typical detailed overview, and explaining what goes on at Grasberg and elsewhere. In terms of slide 30, it looks to me like your targets for excess cash flow for 2009 and 2010 have actually gone up by a total of about $600 million.

It looks to me like its, despite no volume increase, $100 million increase in CapEx in 2009 and a $0.25 per share increase in the dividend. So obviously, my question is what's going on in 2009 and 2010 to drive the increase in the free cash flow expectations? Thanks.

Richard Adkerson

Okay, Dave. Thanks a lot. I appreciate your comments about the presentation. When we were looking at this cash flow presentation earlier, we were taking into account 2008 and 2009. And 2008 had the very significant working capital uses that were factored during the first half of the year, those are now behind us. And now what we have done, we basically have a model that's starting at June 30, 2008 and going forward to the last half of '08, all of '09 and first half of '10.

David Gagliano - Credit Suisse

Okay. Got it. That's what I thought. So it's just the roll-forward to you forward and now that the big negative drag is out of the way, how it goes up?

Richard Adkerson

That's correct. And this is the modeled results in which we're basically taking it's an order of indication of what we think we will be able to do. Obviously, as we go forward, this is going to be driven by commodity prices, input cost and so forth. But we always run our business on cash flows. We always managed our debt level that's the way we talked about, the way we financed the merger. And now we are looking at what we looked have available to us over cash on the two year period looking forward.

David Gagliano - Credit Suisse

Okay. And then just the quick follow up. On that $144 billion potential reserve that you noted, I didn't see this. What's the copper price assumption for that?

Richard Adkerson

It's an interactive copper price assumption that we are working with cost. We are really focused right now on $1.60 pound. But like everybody else in the industry, we're looking at what these input cost changes are doing to the economics of production and the economics of development projects. We want to first understand physically what's available to us, and that's what Jim Bob has been working so hard with our, geologist and our engineers to say, don't be constrained in thinking about possibilities by the price itself.

We are going to allocate prices on the market basis. But the analysis that you saw was really based on $1.60 price. But that’s going to be a dynamic consideration as we go forward. We believe that these construction costs and higher production costs are going to be another barrier to the delays that the major Greenfield projects are facing in this industry.

And everybody is thinking and what we think will give us a chance do is to come in earlier with brownfield expansions, and be able to profit from the overall situation that the industry is facing from a supply development standpoint.

David Gagliano - Credit Suisse

Great. Thanks very much.

Operator

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

Michael Gambardella - JPMorgan

Good morning, Richard and Jim Bob.

Richard Adkerson

Hey, Mike.

Michael Gambardella - JPMorgan

Good. I have a question on the cost front.

Richard Adkerson

Right.

Michael Gambardella - JPMorgan

In your slide that talks about the second quarter '08 costs. The unit costs, where you have consolidated say in delivery costs of about 59 per pound for the three regions. Can you quantify for us the energy-related component of that and how much the energy-related component increased on a quarterly basis?

Richard Adkerson

The energy costs are of course dramatically increasing. They now represent 30% of our cost we expect for 2008. When we look out for the year based on current cost increases that have affected diesel, the purchase power and coal, we are looking at that being $0.75 more in '08 at current levels than it was in '07.

Michael Gambardella - JPMorgan

Okay.

Richard Adkerson

75%.

Michael Gambardella - JPMorgan

75%. Okay.

Richard Adkerson

Right, and most of that variance in from '07 to '08 is in terms of price. If you can go back three years, our cost of energies has tripled.

Michael Gambardella - JPMorgan

Okay.

Richard Adkerson

Energy prices during the second quarter, from the second quarter to first quarter, rose about $1 a gallon for diesel, and we used 225 million gallons of diesel per year. So that impact for the year is $225 million and it didn't all occur at one point in the second quarter. But it's that order of magnitude type of increase in purchase power in the Arizona, and South America has increased, everyone's heard about the change in the power situation in Chile.

We weren't really as affected relatively as much as other companies, because we didn't have the access to some of the lower cost power that people historically have done for. But our coal price contract in Indonesia has rolled over and coal prices are double there. So all of these things factored into it. But I think, Mike while in the second quarter when you are looking at net unit cost there was the increase of inputs, a big part of the issue there was the volume impact of Grasberg.

Michael Gambardella - JPMorgan

Sure.

Richard Adkerson

It had an impact on that number that you referred to in the second quarter. As you can see, by the change for the year and that's going to come down significantly. We're going to be showing in Grasberg, very positive results during the second half of the year, because we're going to go on average from 132 in the second quarter to $0.80 for the year. To get down to $0.80, you're going to see some eye poppingly low net unit cost at Grasberg, during the second half of the year.

Michael Gambardella - JPMorgan

Got it, all right. Thanks a lot, Richard.

Richard Adkerson

Seen historically.

Michael Gambardella - JPMorgan

Great, all right.

Operator

Your next question comes from the line of Jorge Beristain with Deutsche Bank.

Jorge Beristain - Deutsche Bank

Good morning, gentlemen. A few questions, one is, if you could give us a sense of when the charges from the Phelps Dodge acquisition will cease to impact your income statement? That's my first question.

Richard Adkerson

Jorge, that's going to occur over a long period of time, because a significant portion of that purchase price allocation went to our property plant and equipment. So that gets amortized on a unit of production basis in large part over the life of the ore reserves. Now the inventory impacts are shorter range.

Kathleen Quirk

Those are essentially have been taken into earnings over the last several quarters. So going forward, really, what we are dealing with is what Richard talked about, the step up in basis, and that's depreciated over the life of the reserves. So we are having roughly $900 million a year in increased depreciation associated with that. And we're also accreting the environmental obligations, and that's resulting in roughly $100 million a year, all this pretax in additional non-cash amortization.

Jorge Beristain - Deutsche Bank

Okay. But I guess order of magnitude, my question is would we expect to see similar kind of quarterly charges related to PD? I understand they are no longer inventory related, but similar to what we saw in 2Q order of magnitude?

Kathleen Quirk

Yes, we're going to be continue to have increase in depreciation and amortization that you saw in 2Q.

Jorge Beristain - Deutsche Bank

And my second question is just related to management's thought process, as it relates to how you are gradually stepping up your dividend. We obviously see the grass where you are indicating the massive potential of surplus free cash flow going into second half of '08, 2009, and yet your increase in dividend is basically $0.25, which I think, not even a few hundred million dollars.

So, just to get an idea of what is it that management is waiting for before you would commit to a larger dividend payout, both in terms of your yield and/or your payout of earnings?

Richard Adkerson

Our Board wanted to have a regular dividend, that one was well situated in terms of other mining companies and other companies in the S&P 500. And we have looked at setting that dividend at that level that could easily be sustained over a wide range of prices. Now to the extent we have extra cash, we now have this significant authorization to buy stock buybacks.

Our company has declared special dividends in the past and what we can tell you, Jorge, is we have no needs of retaining cash in the company. And we are going to be looking at the most efficient way of returning that cash to shareholders, through a combination of the regular dividend, the stock buyback program, very comfortable in buying our stock back at these levels, and we have the opportunity to consider special dividends as we go forward.

Jorge Beristain - Deutsche Bank

Okay. And just lastly, where are you with the stock buyback, how many shares are held in treasury, and of the 20 million that you were authorized a few months ago, how many have actually been acquired at this point?

Richard Adkerson

We have not acquired any shares during the first half of '08, because of the working capital situation that I referred to earlier. We will be generating the excess cash flows beginning at the second half, and principally in the fourth quarter of this year, and that's when we will have the chance to exercise on the stock buyback program.

Jorge Beristain - Deutsche Bank

Thanks very much.

Operator

Your next question comes from the line of John Hill with Citi.

John Hill - Citi

Thank you and congratulations on strong progress across a very impressive suite of projects. I was wondering if we could spend a moment or two on the issues at Safford. Some of the comments made it sound that the difficulties were centered on the availability in cost of acid. Just curious, are there other things we should be aware of in terms of recoveries, lead cycles, mining, fragmentation, block models, etcetera or is it a series of issues we put behind us?

Richard Adkerson

There are a series of issues. The stacking system there is a new design. It's one of the world's largest, if not the world's largest, and there have been some issues with that. But I am going to let Red Conger comment on your questions, John.

Red Conger

John, the mine primary crushing and SX/EW systems were all performing well and according to plan. As Richard mentioned, the screening and stacking equipment is required some field fit modifications based on our performance to date. So that work is being and being done, in a way to have it operate reliably, long term. Our leach chemistry has not yet reached steady state. We've had some high acid consuming host rock that's been encountered there.

That material is now being excluded from the leach pad and we are getting that chemistry balanced out. And then, we had one unusual incident here at the beginning of the month, where there was a fire on a conveyor belt that damaged some equipment and had us out of production for five days.

So the combination into those things were leading to the forecast for this year. And we're very confident and upbeat with our property going forward, once we get that last piece of start-up work behind us on the stacking equipment.

John Hill - Citi

Do you think you will have enough acid, or is that an issue that we are going to be wrestling with for a long time, in terms of both availability and cost? Is that going to be a real constraint to either Safford or the other parts of the system?

Richard Adkerson

Well, we've permitted; we are going to be constructing a sulfur burning unit at Safford. I know, John, you know, but for others who may not know. Historically, these operations have been balanced in terms of acid, because of the acid that we produce at our Miami smelter that has essentially provided all the acid that was used in the operations. Safford requires more acid and with this just incredibly dramatic change in the acid market that we have experienced in 2008, we like others, were scrambling to get acid.

And there were some decisions that had to be made about where could we get the biggest bang for use of that acid at Morenci versus Safford, and that had an impact on Safford's operation. Longer run, we are going to construct this sulfur burner and then we'll be buying elemental sulfur. And the outlook in the world or in the US is that there is a good supply of elemental sulfur as we go forward from natural gas production and refinery ruins. And so we don't expect this to be a long run problem for us.

John Hill - Citi

Great perspective. Thank you.

Operator

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

Tony Rizzuto - Dahlman Rose

Thanks very much. Hi, everybody.

Richard Adkerson

Hey, Tony.

Tony Rizzuto - Dahlman Rose

Got a couple of questions, Richard. First of all, just to pursue Tenke for a bit here. I wonder if you can give us an idea in terms of how long you've been on the queue for the SAG mill required there, and if you can just give us an idea of what size the SAG mill will be there?

Richard Adkerson

I tell you substantially all of the equipment has been ordered some time ago. I will have to get back with you on the specifics of that, Tony. But the engineering procurement work for Tenke is well along and we are in good shape there. The challenges have been more in the logistics area in terms of getting diesel and concrete and steel through the road system on the site. But let me see...

Tony Rizzuto - Dahlman Rose

The reason I asked Richard, is we've been hearing some reports of the SAG mills, particularly the 30 feet diameter that could be up to four years and I was just --?

Richard Adkerson

No, our SAG mills are actually on site. It's there.

Tony Rizzuto - Dahlman Rose

It's there? Okay.

Richard Adkerson

It's there. I mean the physical part of this as such coming along very well. So the SAG mill is there ready to be installed and we want to show you these pictures, just to see how remarkable the changes have been. And our team has just done a great job in operating a very difficult place. And now we are working on roads.

We're got a consortium of companies there that are restoring the national roads. We're working on longer term transportation issues. All of that is making good progress. And I want to say that in an encouraging way, and then to say it in the context of the obvious challenges of doing business at that location.

Tony Rizzuto - Dahlman Rose

Excellent. And the other question, just to follow-up on your negotiations with the government there, is there a timeframe that we should be watching that we would expect a decision by, or is this going to be an ongoing kind of a negotiating progress, a little give and take on both sides?

Richard Adkerson

I wish I could tell you, Tony. I mean, the government has been encouraging all along in conversations with different members of government at both the national government level and provincial level, all the way to the President himself. And we are in the process of having government officials see the site. We are visiting with them. The government itself is going through apparently considering changes in the structure of the government, and as a result of that, there has really been no current official activity from that standpoint.

But we continue to get encouragement to go forward, and that's what we are doing. So, I can't really tell you, give you an outlook for timing on that.

Tony Rizzuto - Dahlman Rose

All right, Richard, and just one final one, if I may. In the assumption, I know, you said a lot of that working capital issues are behind the company. I just want to see what was implicit in your assumption of the $4.4 billion operating cash flow projection?

Kathleen Quirk

Tony, this is Kathleen.

Tony Rizzuto - Dahlman Rose

Hi, Kathleen.

Kathleen Quirk

Hi. $2.1 billion in uses in the first half for the year, and that's based on our assumptions of volumes and our pricing. We're estimating $1.8 billion in total. So that's a makeup of like $300 million, in that we had 4.4.

Tony Rizzuto - Dahlman Rose

Excellent. So you got a source in the second half, basically?

Kathleen Quirk

Right.

Tony Rizzuto - Dahlman Rose

Great. Thank you very much. I appreciate it.

Richard Adkerson

And Tony, just want to reflect back on your comment about SAG mills is absolutely accurate. We are benefiting from the fact that we ordered our mill at Climax last summer. We also have preordered some trucks and shovels to allow us to look at our expansion, and we are planning our business around this significant condition of timeline challenges and availability challenges of equipment, suppliers and people. That is a challenge for this industry right now.

Tony Rizzuto - Dahlman Rose

A good foresight on both you and your team, so, great job there.

Richard Adkerson

Thanks.

Operator

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

Oscar Cabrera - Goldman Sachs

Good morning, everyone. Just and your increase of 80 billion pounds copper equivalent, and your reserves at Phelps Dodge, could you provide us with a segmentation, like I mean, is this or most of it's coming from Tenke Fungurume?

Richard Adkerson

Not most of it. It is a significant component of it. When we look out on this timeframe, the most significant potential additions are from Tenke and Cerro Verde and then that's followed by Sierrita, Bagdad and Morenci. The reserves are likely to come first from Tenke and from Cerro Verde. And then, as we continue to do our engineering work, significant additions come from all of those.

But it's more like in the order of magnitude of 25% from Tenke, 25% from Cerro Verde, and then significant amounts from the other operations. The good news Oscar, it is not just one big project that we are focused on, because, each of these projects are going to have their own issues and challenges that are going to vary across a wide range of things. And so we have the opportunity to grow despite what we might face in any particular project.

Jim Moffett

Richard, this is Jim Bob, let me just add to that. I think it's important for everybody to see that we've tried to enumerate and some increases at each of these orders of magnitude at each of our projects. We said continuously, as people have talked about our ability to grow the Company, that we have brownfield projects that are as big as most Greenfield projects you look at. And the importance of the presentation today, we have shown that all of our major mines have significant potential of depth on the parameter.

And then in most cases, one of the things that I hope you will get to see, although some of these costs are just pretty small. As we go forward, you will see that many of the bridges, those areas between the existing pits at Morenci and the bridge between the two pits at Cerro Verde.

All those pits in the bridge areas, we are seeing mineralization that had just never been explored. So what we have done is to see, if you will just imagine a balloon laying on the ground, that's deflated, and just start pumping that balloon up and it only starts bottom side.

All of the major mineralized districts that we have, we are finding higher grades than had ever been thought would continue below the bottom of the pits. We are seeing extensions on the parameter of the pits. So this balloon that we are blowing up and you can take it at different price, where actually you can look at it at $1.50 copper, $2 copper, you can do all those kind of things.

But, I hope what you have seen is, just with the drilling and activities that we have done by changing the exploitation philosophy after the merger of the two companies, that all of these reserves that are adjacent to these mineral districts are just what we expected, because when you have a major mineralized district like this, in every case, that's why many of these old mines that were operating around the world, being in canyon or [guarantee] you go all through the big mines that still provides a major copper around the world, these mines have been operating for 100 years.

And they didn't know, until they got into the bottoms of all these major mines that these reserves would continue to go at depth and in breadth. So we have seen it at every one of our operations, as we had expected because they all are major mining districts, and that there's a lot more ore than had ever been perceived by just drilling one year's of mining reserves.

So, I hope you understand that in just over a year, we have been able to confirm with the increased drilling that these presumptions are not just presumptions anymore. We are presenting you with data that shows that the core holes that we have drilled deeper in the pits, on the extremities of the pits, and these bridges, is just exactly what we had expected and in some cases more and it's going to continue.

Oscar Cabrera - Goldman Sachs

Thanks.

Richard Adkerson

Oscar, I want to just note, this does include the longer-term opportunities that we have, like at Lone Star, the longer-term opportunities at Morenci, at Grasberg, and our exploration outside Grasberg, at (inaudible) and the longer-term potential of Tenke Fungurume. What we are trying to do here is give investors a view of what we can see that's on the horizon from the work we are doing right now. But longer run, there’s just more potential than we are disclosing here.

Oscar Cabrera - Goldman Sachs

And now Richard I mean, it's a tremendous potential, and thank you for providing the detail. Just a follow-up to that, do you have like measures or indications for Grasberg?

Richard Adkerson

The Grasberg situation is one where we have a long-term mine plan, that sequences in, bringing in our undeveloped current proved and probable reserves overtime. We have laid that out in a good bit of detail in our 10-K. What we are seeing now, with our blockade drilling, is sort of the thing that's characterized at Grasberg from its discovery. At each stage, and I can think back on the times when we were talking with our team about what was there, drilling has provided us more.

And every time we've gotten more, whether that was the drilling at Deep Grasberg, where it's at Kucing Liar, where there was a major expansion of the DOZ and MLZ mine, these resources continue to grow. And as it grows, then we revise our mine plans to maximize the value of it.

And we are seeing new mineralization now in this gap area that we called it between the pit and the DOZ, and that will give us the chance to go forward. It is a different situation than at the expansions we are talking about in the Phelps Dodge operations. These are large, low grade deposits that cover big areas.

With Grasberg, we have this benefit of having the very high grades. That's why you have this significant swing in our quarter-to-quarter volumes, because of when we accessed that high grade. So when we hit an ore body at the Grasberg, you are talking about tremendous grades like what we were dealing with at Tenke Fungurume. And that gives us a chance to alter your mine plans, to getting more value out of the operations.

Oscar Cabrera - Goldman Sachs

Well indeed. Thanks very much for the detail, and congratulations on the strong results.

Richard Adkerson

Thanks, Oscar. Victor is next, so.

Operator

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

Victor Flores - HSBC

Thanks. Good morning, everybody and thanks for taking my question. My question goes to Cerro Verde, and the expansion that you are contemplating there. Are you in the position, other than to say that it looks like a doubling of production, to give us a sense of what the alternatives are that you are considering, what the timing might be and how the capital of an expansion there would compare to the expansion that was recently completed?

Richard Adkerson

Let me make it clear, Victor. Thanks for the question. We see this as order of magnitude outlook, a significant expansion reserves. We are talking about the potential of replicating the mill facility to ahead there. That wouldn't necessarily mean an exact doubling of the operations, because we do have a leaching operation that goes along with that. But it would be a very significant increase.

And right now we have engineering firms and our internal people are working on this, this cost estimate. It's an interesting one, because we just completed an expansion, and now we are seeing what it would cost to redo that facility in today's world and I can tell you it's significantly higher. But we will be reporting that to you. We are trying to get this done, so that we can add reserves by the end of this year.

When we talk about things like these high pressure grinding roll mills that we have, and about the processing facilities and so forth I would say in orders of magnitude, between costs that were incurred in '95 and '96 and costs that would be incurred in 2009, 2010, you're looking at a doubling of cost for similar sized facilities.

Victor Flores - HSBC

But if that is significant?

Richard Adkerson

That's 2005, 2006.

Victor Flores - HSBC

2005, right.

Richard Adkerson

So yeah, it was when the Cerro Verde project was done.

Victor Flores - HSBC

Right. I realize when you said doubling you meant the mill, not the entire project.

Richard Adkerson

Yes. Thanks.

Victor Flores - HSBC

Now, if I could just ask the follow-up on the reserve potential. How much of that reserve potential, and I’m not trying to pin you down here. But say order of magnitude, how much of that is due to doing much more drilling and just finding more material of a similar grade to what you have now at the various projects? And how much of it is from the copper price assumption? And will that lead you to adding a lot of lower grade reserves that, by definition would have a higher production cost?

Richard Adkerson

No. It's substantially all through drilling activity. And it's what we are identifying as additional mineralized areas. Now we're going to need grades to justify developing or get these things in reserves with today's cost levels. So it's interaction between the prices, the cost levels and the identification of the reserves, and then you add onto that, in various project-by-project, how do you deal with land right issues, how do you deal with power availability, with water availability and with the technology of producing this?

Because today, Morenci is essentially an SX/EW operation, and with the sulfide ore we are adding there, we got to think about how do we design a mill to most efficiently process that? So it's a lot of factors that go into it. But the thing like Jim Bob talked about. The thing that's allowing us to do this is the extent of the mineralization, and the fact that it had not been adequately drilled and evaluated in the past and we are committed to doing that now to see what opportunities are there for us.

Victor Flores - HSBC

Great. Thank you very much.

Jim Moffett

Just to add on to that, I think it's important to emphasize that when you are talking about expansion and adding reserves, in some cases what we would initially do is to add the reserves, which will appear to extend the life of the mines. And after we get those kind of numbers considered then we can talk about how much of that we want to accelerate.

If you were operating in a Greenfield operation, you couldn't take any of those things into reserves immediately, because you would have to look at your mine and when it could be planned and come on production. So in our case, we can go right to reserves, as opposed to put it in the resources, because we have the facilities on site on all of these brownfield type operations.

It's just a question of whether we want to extend the life of a mine, or whether we want to accelerate the production. That's the thing that makes these additions that we are talking about, so valuable to the company. They will immediately come into the reserves, whereas it might take you a number of years, if you were starting and had all Greenfield's type projects. I hope that really comes across.

That's why we're able to give you these numbers today that are short term outlooks in 2008 and 2009. If these weren't brownfield type operations, what will confuse an exploration is are our mining guys, as you see all these big numbers and you say, well, how could all this ore be available if it's not a Greenfield project? And the answer is, as we drill deeper, we're seeing actually, in some cases, grades of the ore increase.

And especially in these bridges between the existing pits, some of this ore is much higher grade than that have been given any credit for. And the only way you prove that is with the drillbit. That's why you see the increase in budget and drill activities, and that's the magic that we are talking about here. These reserves here, you just have to define them.

Victor Flores - HSBC

Right. It's that sort of second derivative of actually doing the exploration work.

Richard Adkerson

Exactly, thanks.

Victor Flores - HSBC

Thank you.

Operator

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

Brian MacArthur - UBS Securities

Good morning. Not to come back to the reserves again, and some of my questions have been answered. But can I just confirm first of all, there's a little footnote talking that molybdenum was the equivalent of 5 pounds of copper and cobalt was 6 pounds, and I think you said to use the $1.60 copper. So can I assume you used $8 moly and $10 cobalt for this analysis?

Richard Adkerson

That's roughly, that's right.

Brian MacArthur - UBS Securities

Okay.

Richard Adkerson

That's roughly right but…

Brian MacArthur - UBS Securities

And just to comment, there's a slightly different way, especially you, apparently, answered I guess with 25% of the addition being Tenke. Just if you had the ballpark, how much of this equivalent that is cobalt, I am thinking more in Tenke, I don't know whether half of that at Tenke is cobalt equivalent and how much, roughly is moly? Do you have that number?

Richard Adkerson

Let's see. The cobalt factor at Tenke is very small.

Brian MacArthur - UBS Securities

It is. Okay.

Richard Adkerson

Because of that, you know, I would say the three quarters of it is copper, or more.

Brian MacArthur - UBS Securities

Okay. So there's not just a big cobalt credit here or anything, is what I am after at Tenke, given that stuff is pretty rich in cobalt historically and, obviously a lot of cobalt there directs the cobalt market at the end of the day.

Richard Adkerson

Right.

Brian MacArthur - UBS Securities

And just one more question on it, and I think its part of been answered here. Obviously then, Tenke and Cerro Verde, which is the big part is pretty simple, probably very simple metallurgically, in the sense we are just expanding turn operations. But you made a comment just on Morenci we talked on about how we are going from leach to sulfide.

Is any of the stuff we are talking about that Bagdad or Sierrita assume to use concentrated leach or anything is there, they're just playing more of the same material. So it's the same sort of metallurgy going forward.

Richard Adkerson

Well, we are going to have the availability of considering that. But in today's technology, you have the chance of looking at additional SAG mills, as well as the mill that we have at Cerro Verde, the high pressure grinding roll mills, and as we continue to work on issues relating to concentrated leach, it might have some application.

So the good thing about it is the experience that this organization has had over the years in dealing with these different processing technology, gives us flexibility to consider what makes sense for each particular ore body and it maybe a combination of all of those.

Brian MacArthur - UBS Securities

Okay. But there's north, I am assuming anything new at all. Basically, I can assume that most of this is theoretically all off the shelf technology that you've used before, and your assumptions in converting this stuff?

Richard Adkerson

Absolutely, and obviously for us to get it to reserves, you have to have it down to a feasibility study type analysis using today's technologies, today's cost and so forth, exactly.

Brian MacArthur - UBS Securities

Okay, great. Thank you very much and just switching gears on a different topic. You mentioned your coal contract in Indonesia. Can I just confirm that that's an annual contract. So obviously, you are getting hit right now. But it's something that is not something that you've locked in now at new prices for five years or anything. So the cost structure will kind of adjust as the world adjusts going forward whether that's up or down?

Kathleen Quirk

Yes.

Richard Adkerson

It's a long term supply contract, with negotiated prices that have annual changes to it. It doesn't necessarily totally equate to a worldwide spot price by any stretch of the imagination. But there are annual adjustments to it. The factor that I've talked about was that the recent increases in coal prices has resulted in our prices doubling from like $45 a ton to $100 a ton. We use 750,000 to 800,000 tons a year.

Brian MacArthur - UBS Securities

Great. That's very helpful, that gives me a magnitude of the impact. Thanks very much, Richard.

Richard Adkerson

Yeah. Thanks, Brian. That equates roughly to a $40 million $45 million a year impact on an annual basis.

Operator

Your next question comes from the line of John Redstone with Desjardins Securities.

John Redstone - Desjardins Securities

Good morning, everybody. I have two quick questions. First of all, I wonder if you could clarify something for me. In your release, you talk about taking your costs down from $1.25 to $0.92 a pound in the fourth quarter, so that's a $0.33 reduction. As far as you can, could you give us some more detail on how that $0.33 breaks down, how much of that is because of better grades, better throughputs, better performance at Grasberg and so on?

Richard Adkerson

It's Grasberg.

John Redstone - Desjardins Securities

It's all Grasberg?

Richard Adkerson

Not all, but Grasberg is what drives the tremendous change, and you can see that on the charts, where we have the volumes broken out, and Grasberg's driven, a lot of Grasberg's values attributable to its goal component.

John Redstone - Desjardins Securities

Right.

Richard Adkerson

And when you get that kind of swing in gold from 200,000 ounces to 800,000 to 900,000 ounces; that's a tremendous impact on your cost structure.

John Redstone - Desjardins Securities

Okay.

Richard Adkerson

Or as a copper volume. So it's one thing to look at these changes, but its cost changes when you and that was my point when I was discussing with Mike Gambardella earlier in the call. The unit cost factors are driven so much by these volumes and nowhere in operations do we have the kind of volume swings of such significance than we do at Grasberg and that's because of its extraordinarily high grades.

John Redstone - Desjardins Securities

Okay. All right, that's great and switching gears as I say. It's great to see you increasing your exploration programs. Now, I wondered if you had any idea or any rough idea of just how big you want Freeport to be in terms of copper production. I mention this because, if you think about it, if copper continues to grow at around 5% per annum, that's almost a million tons a year.

So even if you were to double the size of your production, that increment will be absorbed in the course of two years. So, there is a great demand out there for copper going forward. So just how big do you want to get?

Richard Adkerson

Well, I am going to refer back to a quote Jim Bob said several years ago, when somebody asked us a question about that's we were drilling Grasberg. He said he hoped he could be the guy whose tombstone said, this is the guy that found so much copper, he drove the price down in the marketplace.

We are going to be aggressive in trying to find every opportunity we can to develop copper. The world's going to need it, because when you look at and I know everyone today is focused on the US market and the problems of the US economy.

We provide half the copper to the US. So we see that every day in our business. But when you look at the big picture numbers with the size of the growths of the Chinese economy, and even though growth rates are a little bit smaller now. The amount of copper that's consumed because of the increasing base is so large. India is growing faster than any country in the world, and yet it uses less than 5% of the world's copper.

And Eastern Europe is beginning to wake up with Russia's developing all the funds they have there, South America with the growth rates and the countries down there longer run, when you look at the numbers that the world is going to need in terms of copper.

The challenges that people are having with the current production levels, and the barriers for new projects that are there to get them developed in terms of cost technology, environmental community acceptance, resource nationalism of countries.

I mean, we think the world is going to need all the copper that we can find and produce, and that's what our focus is. We're going to be disciplined about how we allocate capital to make sure that we are not doing anything that's imprudent or unreasonable. But we are approaching this whole thing about our long term view, that the world needs copper and we have the property that's going to allow us to take advantage of that.

Jim Moffett

Richard, let me just comment on how big we want the company to get. We want the company to be as big as it should be. In other words, with all these major mineral districts, what we want to do in this effort to redefine the Company is to make sure that we take these mineralized districts, all of which we've said are major mineralized districts, which is why they have been producing in some cases so long. We want to make sure that all the shareholder value is understood by being in here and defining the size of these reserves.

We are not going to limit that as to what a target is. We want the definition of these mines across the company to define what the value of this company is, so there's no limit to how high that will go. The only thing limited is the geologic conditions as we drill deeper. Remember, we don't have geophysics or any of the other type of technology that can get out in front of your drillbit. You have to drill this ore to understand it, and what we can tell you is in these major mineralizing districts.

Don't ever underestimate the amount of mineralizing fluids that were being brought to surface by the plumbing system. And that's why you see all of these mines grow and grow and grow, because the mineralizing systems were coming from the bottom and not the top. And unfortunately, these ore bodies are all drilled from the top. So we've got brownfield projects.

We want to reemphasize, that the infrastructure is already in place, and almost all these numbers that you are seeing and we want to be sure that we define the asset base and it will be as big as it is. The geology will determine how big the reserve gets. We are not setting a target as saying, we want to prove up X number of reserves. We want to define this and tell you what the reserves of this company are and what the magnitude is and then also talk about when they're mine them.

So that's our goal in this exploration project is to be sure that shareholders don't ever have to wonder whether or not we understand the asset base.

John Redstone - Desjardins Securities

Okay. Thank you.

Operator

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

John Tumazos - Independent Research

Good morning and congratulations on all of the very good work. Several questions, first, could you describe the factors that cause the Grasberg mill tonnage to drop a little over 30,000 tons from a year ago? Second, well you described your copper grade at Tenke at 2.3%. Several years ago PD had characterized it as 3% and there was academic literature that used 3% to 5%. We presume that you are drilling to extent must have reduced the grade a little bit as the information was more.

Third, I am trying to calculate cost of goods sold per ton, and the mill tons rose about 10% from a year ago companywide, and the leach tons about 50%. Other than purchase accounting, was there anything going on in cost of goods sold, because the cost of goods sold hasn't risen a lot more than the tons processed. I am just trying to understand cost and grade? Excuse me.

Richard Adkerson

Okay. Let's start and Mark Johnson is going to talk about the mill situation.

Mark Johnson

Yeah, John. In the Grasberg, primarily we have three different types of ore for SAG and mill throughput. We have the material, that's the stock wok material when we get into the high grade portions of the Grasberg, it's very easy milling. We get very good con grades, everything clicks. We're in a lower grade section right now, which is the harder material for us to mill. We are going through our targets are being met. It's not anything mechanical or anything else. It's purely the characteristics of the rock.

We'll end up in the fourth quarter of this year, as we talked about, as we get into this higher grade, we'll be into the better milling material. Also, we will be up to 250,000 tons a day in the fourth quarter. And in 2009 we have a mill rate projected of around 245,000. We've also completed the pressure master plan which added about 15,000 tons per day of milling capacity in our north, south mill. So that will be an asset or a feature, a capacity attribute that we'll have going forward. So that's really the answer. Does that make sense to you?

John Tumazos - Independent Research

Yes, perfectly. Thank you.

Richard Adkerson

And, John, with respect to the Tenke grades, when you are taking cobalt equivalence, you do get it up to 3% or better. And part of the grade definition is going to depend on your size and your scope of your project, both in terms of current production levels and the length of the mine life. We've taken steps with the first project to incrementally increase volumes, but to extent the mine life.

And as we go forward we are going to be evaluating what minerals available to us to allow us to maximize the overall ore body. So this grade situation will be affected by that. But grades are very high. There has been nothing we have seen in our drilling that's caused us to look at the project differently in terms of the grades available to us. The real long term opportunity here is going to be what we find as we do more drilling, in terms of what we believe will be a very large sulfide opportunity for us.

And that's probably the third stage expansion and it would be the third stage expansion for us. Now to get there we have to really then start dealing with some logistic issues, in terms of having rail accessibility and other things. But we've been talking with other companies, talking with the government and we are confident that we are going to find a way of dealing with those.

John Tumazos - Independent Research

Excuse me, if you're not praising 2.3%.

Richard Adkerson

Yeah. That's, ten times the grades to some of these other significant expansion projects we are looking at, so. Let's see, Kathleen, do you want. John, could you?

John Tumazos - Independent Research

The cost of good sold or the site delivery costs in the quarter were 2720 million, and if you exclude the purchase accounting adjustment, it was 2708 compared to 2271 a year ago second quarter. And the corporate tons milled rose to 645 from 636 a year ago, and the corporate tons leached rose to 1.1 million tons a day from 743 a year ago. So that it's not obvious that the cost per ton rose, but of course there was all this inflation.

Richard Adkerson

Hey, John. Let me just make a general comment. And then this is probably something we are going to need to do some work beyond this call on. The numbers that you are working off of include things like Atlantic copper. It includes some purchased tons that we have in our North American operations, where we actually buy copper cathodes to deal with our wire rod operations.

And so we are going to need to separate out these downstream operations from those numbers to get back to the kinds of analysis that you are talking about. And why don't you give us a call later and we will.

John Tumazos - Independent Research

So excuse me for taking your time, Rich.

Richard Adkerson

Not at all, not at all. It's a reasonable question and cost per ton is higher. I mean, that's as obvious as the sun coming up in the east because of the world we live in. And we will work through the analysis with you.

John Tumazos - Independent Research

Thank you.

Operator

Your next question comes from the line of Terence Ortslan with TSO and Associates.

Terence Ortslan - TSO and Associates

Thank you. So Kathleen, assume Tenke is $1.75 billion at the end of the day, what would be your cost in your books, including acquisition costs and everything expensed so far?

Kathleen Quirk

We have incurred $700 million to date, and that's on an aggregate basis, including our partners and the $175 would be essentially our cost. We do have some concession costs that we've paid. But it's roughly that 1.75, and then addition to that, we have $140 million that we are advancing for as a loan for power infrastructure.

Richard Adkerson

But that's the 88s cost, and we account that on a consolidated basis, and we also have some purchase price allocation, Terry that would be incremental book value for that. Why don't you give us a call, we'll talk about that. But, obviously, we went through the purchase price numbers. We had to allocate value to that Tenke as part of our accounting allocation of purchase price.

Terence Ortslan - TSO and Associates

Okay. One other question quickly again. What is your view about the copper concentrate markets, when do you think markets may turnaround, Richard?

Richard Adkerson

I tell you, Terry, that's an interesting situation, because the market is just so tight today. I mean there is such an excess of smelter capacity around the world in relation to available concentrates that it's a tough situation.

Now a lot of smelters are obviously benefiting from product credits, sulfur prices in managing their operations. But smelters continue to be expanded in Asia, in China, and in other places in Asia, where they are in some cases supported by government policies or incentives. And there's no clear cut particular point in time of where you’re going to see this things turnaround.

There's analysis that shows situations changing. But when you look behind that analysis, it's dependent on certain large scale mines getting brought on stream within timeframes, and you've seen how that's happened as we progress through time and there are continuing to be barriers. We are getting those mines that produce concentrates on stream. So all I can say in the foreseeable future, the world looks to be continued to be long in smelting capacity.

Terence Ortslan - TSO and Associates

I'll agree. Thank you.

Richard Adkerson

Okay. Thank you, Terry.

Operator

Your next question comes from the line of John Hill with Citi.

John Hill - Citi

Hello, everyone and thank you for your endurance on the call. I just was curious about one of the statements made during the prepared comments about the common infrastructure in such and some intercepts of mineralization. I was wondering what have we learned down there in terms of structure? What are we seeing terms of grade? How would we rank the type of geologic potential?

It's obviously a great address there between Ertsberg and the Grasberg pits in such. What are we seeing down there? And I suppose also, while we're at that, if you could just comment on any of the initial characteristics we are seeing in the area of the Grasberg block cave itself?

Jim Moffett

You are talking about the gap area that we discussed?

John Hill - Citi

Yes.

Jim Moffett

Well, what's happened there, if you remember, we've been talking about how Kucing Liar, which is just south of the Grasberg, is in east, west oriented deposit. It's not part of the original periphery, it's basically fault controlled. And when we drill that, it was obvious that they have been mineralized by the deep mineralizing fluids from Grasberg. So that got us looking at the Ertsberg.

And the more we examined the growth of the Ertsberg, which was growing now it's over $0.5 billion, we were convinced that there should be a basically symmetrical alignment on a northwest, southeast to connect the two. By having the underground common infrastructure access to the lower Grasberg, we're drilling out of that access, and what we've done is to intercept very high grade copper and more important than the high grade, and some of it in the range of 3% is a style mineralization.

And what we are seeing is we are seeing some stock work which indicates there may be the possibility of another periphery type of deposit there, that would be similar to, say, Grasberg, but just not at the same level.

There were just buried or [free] that is not like the Kucing Liar, not like the Ertsberg, but more like the core of the Grasberg. And we've only got a limited number of holes in there, and that's because we were able to get in there, as I say and drill these almost horizontal holes in some cases, to look at the grade of this.

So we just got to stay tuned on it, John. But suffice it to say, when you see stock work that's gotten ore grades as high up to 3% copper in the middle of that gap area. It's trying to grow to be the size of a larger deposit than we had thought. We've got the ability to mine it, with the existing infrastructure. So it's a significant hit. I wish we had more core holes into it as we define it, we'll bring you up to date on it.

John Hill - Citi

Great. Thanks, Jim Bob.

Operator

Your next question comes from the line of Katherine (inaudible) with Shinkin Capital.

Unidentified Analyst

Good morning. I just had two quick questions. The first one regarding your share buyback program. Would you be able to just give us a little bit of a range as to what you are expecting to repurchase second half '08, would it be in the $10 million to $15 million range or $25 million to $30 million, any color there?

Richard Adkerson

Katherine, we're really not in a position to give you any kind of indications of order of magnitude. It's going to be dependent on these cash flows, on how copper prices do. And all we can say is as we earn available cash we working with our boards are going to be making decisions about how to efficiently return that to shareholders. But I don't think it wouldn't be appropriate for me to give you any kind of ranges like that at this point, because those future conditions could change and our decision will be made on the future conditions.

Unidentified Analyst

Okay. And then just a second question. Do you plan on taking out the floating rate notes which become callable April '09, got a little bit of time on that, but?

Richard Adkerson

Yeah, all I can say, Katherine, in response to your first question. I think you can go forward with your models in looking at Freeport returning available cash flow to shareholders. I mean that's really what we'll be doing. Kathleen, why don't you comment on that?

Kathleen Quirk

On the floaters, we'll be looking at that. We have the ability to call those next year. But we'll just be looking at that on an economic basis. And whether it makes sense to repay those or refinance those or leave them in place. So that's a decision that we'll be looking at on an opportunistic economic basis.

Unidentified Analyst

Okay.

Richard Adkerson

We are very comfortable with the level of debt we've had now. We've been upgraded to investment grade now by S&P and Fitch. We are very comfortable with our debt levels and whereas a year ago we were talking about our financial objective of reducing debt. We are comfortable for our debt is right now.

Unidentified Analyst

Okay. Thank you.

Richard Adkerson

Thank you.

Operator

Your final question comes from the line of Brian Macarthur - UBS Securities.

Brian Macarthur - UBS Securities

Once again, thank you for taking all the time today. But just Jim Bob, following up on John Hill's question, when you started to talk about the stock work in the gap, you mentioned 3% copper. Can you tell us whether there was any gold in there holes as well?

Jim Moffett

Yes. I am sorry. I should have been more specific. When we talk about copper, we talk about copper equivalent. Let's just put it this way. As you know, the gold and copper and silver have been pretty consistent from the top of the Grasberg to the bottom in our stock work part of the pit and we would be expected that this stock work is so similar looking. When you look at the sample, it almost looks like the Grasberg ore. So you can expect in any of these you will have the similar type of mineralization in terms of copper, gold and silver and almost the same proportion that we're seeing in the Grasberg.

Brian Macarthur - UBS Securities

Great. Thanks very much. That's what I thought, but I just wanted to confirm that with you. Thank you.

Jim Moffett

That is correct.

Richard Adkerson

All right. Thanks, Brian. I started this off by saying this was an important conference call for us. We have covered a lot of ground. We appreciate the good questions that everybody has had. As always, we are available if you have further questions in working through the numbers and our outlook. We would be pleased to respond to those questions. We appreciate your interest in our company.

We are very excited about where we are and we look forward to reporting our results for the remainder of 2008. Thanks.

Operator

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

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