Marketplace

The Group’s businesses, and in particular the mining division, are heavily dependent on the copper and molybdenum markets which in turn are significantly influenced by the international economy.

• Our products

  The principal product of the Group’s mining business is copper. The Los Pelambres mine produces copper concentrate, through a milling and flotation process. The El Tesoro and Michilla mines produce refined copper cathodes, using heap-leaching processes (and in the case of El Tesoro also a run-of-mine leaching process) and then solvent-extraction electro-winning (“SX-EW”). The Group’s Esperanza mine, which is due to start operating at the end of 2010, will produce copper concentrate. Los Pelambres’ copper concentrate is normally sold to smelters for further processing and refining into copper cathodes. El Tesoro and Michilla’s copper cathodes are typically sold to copper fabricators, for processing into applications including copper wiring and tubing for use by industrial end-users. The principal end markets for refined copper are construction and electrical and electronic products, which account for more than 60% of global copper demand, followed by industrial machinery, transport and consumer products.

  Sales of copper are typically priced in line with London Metal Exchange (“LME”) market prices. A deduction is made from LME prices in the case of concentrate, to reflect treatment and refining charges (“TC/RCs”) – the smelting and refining costs necessary to process the concentrate into copper cathodes. Cathodes of a certain quality or from certain locations may attract a premium above the LME price. In addition, prices realised by the Group during a specific period will differ from the average market price for that period because, in line with industry practice, concentrate and cathode sales agreements generally provide for provisional pricing at the time of shipment with final pricing based on the average market price for future periods (normally about one month from the month of shipment in the case of cathode sales and on average three months from the month of shipment in the case of concentrate sales).

  A significant proportion of the Group’s sales of copper concentrate are made under long-term framework agreements. These framework contracts will typically set out the annual volumes to be supplied, with the pricing of the contained copper in accordance with market prices as explained above, and the TC/RCs to be determined annually, normally in line with industry benchmark terms. A significant proportion of the Group’s copper cathode sales are made under annual contracts, which again specify volumes to be supplied, and with pricing in line with market prices as explained above.

  Los Pelambres also produces molybdenum, a metal which is primarily used in the production of high-quality steel alloys, and to a lesser extent in the catalyst sector. This is sold in concentrate form to molybdenum roasters for further processing and refining. These sales are priced in accordance with market prices, and as with copper concentrate are subject to final pricing adjustments (on average one month from the month of shipment).

  The transport division provides rail and road services, with its main business being the transportation of copper cathodes from and sulphuric acid to mines in Chile’s Antofagasta Region. These services are typically provided to customers under long-term contracts, often with agreed pricing levels which are subject to adjustments for inflation and movements in fuel prices.

  The water division operates a 30-year concession for the distribution of water in Chile’s Antofagasta Region, which it acquired in 2003. It consists of two businesses – a regulated business supplying approximately 144,000 domestic customers and an unregulated business serving mines and other industrial users. Sales to domestic customers are priced in accordance with regulated tariff structures, while sales to industrial customers are generally priced in accordance with contractually agreed levels.

  Global copper consumption by market sector

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  Global molybdenum consumption by market sector

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• Global economy

  There was a pronounced, global downturn in industrial activity during 2009 which began in the second half of 2008. The decrease in global industrial production (“IP”) in 2009 has been estimated at approximately 7%, with the decrease particularly sharp in OECD countries, which experienced an average fall of around 11%. Some emerging economies, though, continued to grow, with Chinese IP growth estimated at approximately 11%. Prospects for 2010 are more positive, with initial forecasts for IP growth of approximately 4% in this year.

  World copper consumption

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  World molybdenum consumption

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• Refined copper market

  After three years of very strong prices, the copper price suffered a sharp fall in the second half of 2008 as a result of the global financial crisis and ensuing economic downturn. By the end of 2008 the copper price had fallen to approximately 130 cents per pound, its lowest level for more than four years, prompting production cuts and project delays across the industry. However, the relative speed and extent of the recovery in the copper price during 2009 was stronger than many had envisaged at the start of the year. This was driven mainly by strong demand from China as a result of underlying growth, restocking and support from the government-led fiscal stimulus package, but also an increased level of financial investment in commodities particularly in the second half of the year. The price rose relatively steadily throughout most of 2009, and by 31 December 2009 had reached 333.2 cents per pound despite rising visible inventory levels particularly in the final quarter. Over the course of 2009 the LME copper price averaged 234.2 cents per pound, compared with an average of 315.3 cents per pound in 2008. However, the Group’s average realised copper price actually increased by 1.5% to 270.6 cents per pound (2008 – 266.7 cents), despite this decrease in the average LME price. This was mainly due to the positive impact of adjustments to provisionally priced sales which offset the lower market prices and the impact of realised hedging losses. The general increase in the copper price during 2009 resulted in positive provisional pricing adjustments; conversely, the sharp fall in the copper price in the second half of 2008 had resulted in negative adjustments in that year.

  In the first two months of 2010 LME copper prices have averaged 323 cents per pound, just slightly below the position at 31 December 2009. Trade figures from China remain encouraging and several commentators expect Chinese demand to remain robust in 2010, while there are tentative signs of a recovery of demand in Europe and the United States. Current consensus estimates are for the copper price to average over 300 cents per pound in 2010, with the market expected to be in balance or possibly a small surplus. Nevertheless, concerns remain about the extent and sustainability of a recovery in the OECD, possible monetary tightening in China and the impact of eventual withdrawal of fiscal stimulus measures taken last year. With increased levels of financial investment in commodity markets, prices could remain sentiment-driven and therefore volatile through the year.

  Over the medium term the outlook for copper is positive. Copper faces supply side pressures over the forthcoming years, which have been increased by the project delays and cancellations seen in the second half of 2008 and early 2009. Limited major new production coming on stream, combined with declining ore grades at existing mature mines, could result in a tight copper market, particularly if a sustained recovery in demand occurs in the OECD. Consensus views are for the copper market to move into deficit in 2011.

  LME copper price

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• Copper concentrate market

  The concentrate market has continued to be in deficit, with available smelting capacity significantly in excess of mine supply, resulting in low treatment and refining charges (TC/RCs) which favour mine producers. Current consensus estimates are for a deficit of approximately 1.5 million tonnes of contained copper in 2010, with a deficit expected to continue for a number of years. This has been reflected in improved terms for miners with settlements for the annual negotiations for 2010 at the level of US$46.5 per dry metric tonne of concentrate for smelting and 4.65 cents per pound of copper for refining, compared with US$75 and 7.5 cents respectively agreed for 2009. However, the impact of this improvement in annual terms is staggered by the “brick system” in many contracts whereby the benchmark is often averaged over two years.

• Molybdenum market

  Realised molybdenum prices in 2009 were US$11.3 per pound, which was broadly in line with the average market price of US$11.1 per pound but significantly lower than the average 2008 realised price of US$23.9 per pound and average market price of US$28.9 per pound. Poor demand in Europe and the United States for most of the year was mitigated, like copper, by a strong supply response through production cuts and project deferrals in late 2008 and a high level of imports into China, which had previously been a net exporter of this metal.

  The first two months of 2010 have seen a further recovery in the price, reaching over US$17.0 per pound at the end of February 2010. Europe and the United States have shown an improvement in the level of spot activity following a poor year for demand in 2009, with little current sign of the return of excess supplies for export from China. Consensus estimates suggest prices close to the current level could be sustainable during 2010. Nevertheless, prices remain well below the peak levels of 2007 and early 2008. While several molybdenum projects were put on hold during 2008 and have not been re-initiated, some idled production capacity could become available should prices strengthen. The LME started trading three-month molybdenum futures in February 2010. This new market still remains at an early stage, but could provide greater depth and transparency to molybdenum prices in the longer term as it develops.

  Molybdenum market price

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• Key inputs

  The Group’s mining operations are dependent on a range of key inputs, such as mining equipment (including the supply and maintenance of vehicles and replacement parts such as tyres), electricity, labour and fuel. In the case of a copper concentrate producer such as Los Pelambres, steel balls used in the milling process are also a significant input cost. With cathode producers using the SX-EW process, such as El Tesoro and Michilla, sulphuric acid is a key input. The availability and cost of these inputs can be key operational issues, particularly during times of strong demand for commodities.

  There was a general easing of market cost pressures in the latter part of 2008 and early 2009, in line with the general economic downturn and fall in demand for commodities. The improvement in the commodity markets seen during the course of 2009 and into 2010 has, however, also seen a return of market cost pressures.

  The Group enters into medium and long-term contracts for a range of key inputs to help ensure continuity of supply and in some cases to guarantee cost levels. Labour agreements are in place at all of the Group’s mining operations, generally covering periods of between three to four years. In May 2009 Esperanza reached a two-year collective agreement with its labour union, and now all of the labour agreements in the mining business run until at least 2011. The Group has long term electricity supply contracts in place at each of its mines. In most cases the cost of electricity under these contracts will be linked to some degree to the current cost of electricity on the Chilean grids or the costs of generation of the particular supplier.

  The Group also normally contracts for the majority of its sulphuric acid requirements for future periods of a year or longer, at specified rates. The average price per tonne of acid for the Group during 2009 was approximately 20% lower than in 2008, reflecting the general easing of the acid market. Spot acid prices were starting to rise towards the end of 2009 and at the start of 2010. However, the Group has been able to contract for its 2010 requirements at rates significantly below those achieved in 2009, which could further reduce the average price per tonne of acid by approximately 30% compared with 2009.

  The Group benefitted from the reduction in oil prices in 2009. The average market price for oil during 2009 was US$62 per barrel (WTI), compared with US$100 in 2008, a decrease of approximately 40%. Again, though, prices were rising during 2009 and into 2010, increasing from US$45 per barrel at the start of 2009 to US$80 per barrel by 31 December 2009, with prices remaining at these levels in the first two months of 2010.

  The Group’s costs are also impacted by the Chilean peso exchange rate, as on average across the Group’s mining operations approximately 35% of costs are denominated in Chilean pesos. However, the economic exposure to fluctuations in the Chilean peso exchange rate is partly mitigated by a natural hedge, as the copper industry is a major component of the Chilean economy, and movements in the copper price and Chilean peso tend to be correlated. The exchange rate at the start of 2009 was Ch$640/US$ a weakening in the Peso of almost 50% from its high point during 2008 of Ch$430/US$. However, the peso strengthened relatively steadily throughout 2009, finishing the year at Ch$507/US$, and the average exchange rate during 2009 of Ch$560/US$ was only 7% weaker than the 2008 average of Ch$522/US$.

  2009 Group weighted average cash cost excluding by-products credits by type

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