Freeport-McMoRan 2003 Annual Report Download - page 26

24 FREEPORT-McMoRan COPPER & GOLD INC. 2003 Annual Report
Indonesia’s geologists and engineers reassess the
overburden-to-ore ratio and the remaining life of
the Grasberg open pit mine at least annually, and
we reflect any changes in our estimates prospec-
tively beginning in the quarter of change. We
expect the estimated life-of-mine overburden-to-ore
ratio to average 2.2 to 1 for 2004. The increases
in the ratio over the last several years primarily
relate to changes in the cutoff grade at the open
pit caused by a reassessment of the optimal
milling rate at our mill facilities including a greater
proportional contribution to our total ore processed
from our underground Deep Ore Zone mine.
If the life-of-mine overburden-to-ore ratio was 2.1 to
1, as in the fourth quarter of 2003, instead of the
1.9 to 1 ratio used through September 30,
2003, we estimate our deferral of mining costs
for 2003 would have been $7.3 million lower
and net income would have been $3.7 million
($0.02 per share) lower. In addition, if the ratio
was 2.2 to 1, as is expected for 2004, instead
of the average ratio used during 2003, we esti-
mate our deferral of mining costs for 2003
would have been $15.9 million lower and net
income would have been $8.2 million ($0.05 per
share) lower.
•Reclamation and Closure Costs – Our mining
operations involve activities that have a significant
effect on the surrounding area. Our reclamation
and closure costs primarily involve treatment of
acidic water (also known as acid rock drainage)
created by overburden, reclamation and revegeta-
tion of a large area in the lowlands of Papua
where mill tailings are deposited, reclamation of
overburden stockpiles and decommissioning of
operating assets. Through December 31, 2002,
we had accrued $29.2 million for estimated clo-
sure and reclamation costs on a unit-of-production
basis over our total estimated proven and proba-
ble recoverable copper reserves. For a discussion
of the assumptions that we make to estimate
proven and probable recoverable reserves, see
“Depreciation and Amortization” above.
Effective January 1, 2003, we adopted Statement
of Financial Accounting Standards (SFAS) No.
143, “Accounting for Asset Retirement
Obligations” (see “New Accounting Standards”).
SFAS No. 143 requires that we record the fair
value of our estimated asset retirement obliga-
tions in the period incurred, with the cumulative
effect of adopting SFAS No. 143 as of January 1,
2003, for all existing asset retirement obligations,
asset retirement costs and related accumulated
depreciation required to be reflected in earnings
as a separate line item. The accounting estimates
related to reclamation and closure costs are criti-
cal accounting estimates because (1) we will not
incur most of these costs for a number of years,
requiring us to make estimates over a long period;
(2) reclamation and closure laws and regulations
could change in the future or circumstances
affecting our operations could change, either of
which could result in significant changes to our
current plans; (3) calculating the fair value of our
asset retirement obligations in accordance with
SFAS No. 143 requires management to assign
probabilities to projected cash flows, to make
long-term assumptions about inflation rates, to
determine our credit-adjusted, risk-free interest
rates and to determine market risk premiums that
are appropriate for our operations; and (4) given
the magnitude of our estimated reclamation and
closure costs, changes in any or all of these esti-
mates could have a material impact on net income.
In 2002, we engaged an independent environmen-
tal consulting and auditing firm to assist in esti-
mating PT Freeport Indonesia’s aggregate asset
retirement obligations, and worked with other con-
sultants in estimating Atlantic Copper’s and PT
Smelting’s asset retirement obligations. We esti-
mated these obligations using an expected cash
flow approach, in which multiple cash flow scenar-
ios were used to reflect a range of possible out-
comes. We estimated these aggregate
undiscounted obligations to be approximately
$120 million for PT Freeport Indonesia, $17 mil-
lion for Atlantic Copper and $11 million for PT
Smelting. To calculate the fair value of these
obligations, we applied an estimated long-term
inflation rate of 2.5 percent, except for Indonesian
rupiah-denominated labor costs with respect to
PT Freeport Indonesia’s and PT Smelting’s obliga-
tions, for which an estimated inflation rate of 9
percent was applied. The projected cash flows
were discounted at our estimated credit-adjusted,
risk-free interest rates which ranged from 9.4 per-
cent to 12.6 percent for the corresponding time
periods over which these costs would be incurred.
The inflation rates and discount rates we used to
calculate the fair value of PT Freeport Indonesia’s
asset retirement obligation are critical factors in
the calculation of future value and discounted
present value costs. An increase of one percent in
MANAGEMENT’S DISCUSSION AND ANALYSIS