Freeport-McMoRan 2007 Annual Report Download - page 57

Financial & Operating Information 55
Management’s Discussion and Analysis
In addition to the debt maturities and other contractual obligations
shown above, we have other commitments, which we expect to fund
with projected operating cash flows, available credit facilities or future
financing transactions, if necessary. These include (i) PT Freeport
Indonesia’s commitment to provide one percent of its annual revenue
for development of the local people in its area of operations through the
Freeport Partnership Fund for Community Development, (ii) Cerro
Verde’s local mining fund contributions equal to 3.75 percent of
after-tax profits and (iii) other commercial commitments, including
standby letters of credit, surety bonds and guarantees (refer to Notes 15
and 16 for further discussion).
HEDGING ACTIVITIES
In connection with the acquisition of Phelps Dodge, we acquired
certain derivative instruments entered into by Phelps Dodge. The most
significant of these derivatives are the 2007 zero-premium copper
collars (consisting of both put and call options) and copper put options
that matured on December 31, 2007 (refer to Note 17). These derivative
instruments did not qualify for hedge accounting and were adjusted to
fair market value based on the forward price curve and implied volatility
as of the last day of the respective reporting period, with the gain or
loss recorded in revenues.
The zero-premium copper collars covered approximately 486 million
pounds of 2007 copper sales. Mark-to-market accounting adjustments on
these contracts resulted in charges to revenues totaling $175 million
($106 million to net income or $0.27 per share) from March 20, 2007,
through December 31, 2007. The 2007 zero-premium copper collar price
protection program matured on December 31, 2007, and in January 2008,
we paid $598 million to settle the program. We also had in place
copper put options at a strike price of $0.95 per pound for approximately
730 million pounds of 2007 copper sales, which expired on December 31,
2007, without settlement. FCX does not currently intend to enter into similar
hedging programs in the future.
ENVIRONMENTAL AND RECLAMATION MATTERS
Environmental
In the U.S., we are subject to stringent federal, state and local
environmental laws and regulations that govern emissions of air pollutants;
discharges of water pollutants; and generation, handling, storage and
disposal of hazardous substances, hazardous wastes and other
toxic materials. We also are subject to potential liabilities arising under
CERCLA or similar state laws that impose responsibility on persons
who arranged for the disposal of hazardous substances, and on current
and previous owners and operators of a facility for the clean up of
hazardous substances released from the facility into the environment,
including damages to natural resources.
Phelps Dodge and many of its affiliates and predecessor companies
have been involved in mining, milling and manufacturing in the U.S. for
more than a century. Activities that occurred in the late 19th century and
the 20th century prior to the advent of modern environmental laws were
not subject to environmental regulation and were conducted before
American industrial companies understood the long-term effects of their
operations on the surrounding environment. With the passage of CERCLA
in 1980, companies like Phelps Dodge became legally responsible for
environmental remediation on properties previously owned or operated by
them, irrespective of when the damage to the environment occurred or
who caused it. That liability often is shared on a joint and several basis
with all other owners and operators, meaning that each owner or operator
of the property is fully responsible for the clean up, although in many
cases, some or all other historical owners or operators no longer exist, do
not have the financial ability to respond or cannot be found. As a result,
because of our acquisition of Phelps Dodge, many of the subsidiary
companies we now own are responsible for a wide variety of environmental
remediation projects throughout the U.S., and we expect to spend
substantial sums annually for many years to address those remediation
issues. Various of our subsidiaries previously have been advised by the
U.S. Environmental Protection Agency, the Department of the Interior, the
Department of Agriculture and several state agencies that, under CERCLA
or similar state laws and regulations, they may be liable for costs of
responding to environmental conditions at a number of sites that have
been or are being investigated to determine whether releases of
hazardous substances have occurred and, if so, to develop and implement
remedial actions to address environmental concerns.
At the acquisition date, Phelps Dodge’s historical environmental
obligations of $385 million were based on accounting guidance provided
by SFAS No. 5, “Accounting for Contingencies,” and American Institute
of Certified Public Accountants Statement of Position (SOP) 96-1,
“Environmental Remediation Liabilities,” which require that an estimated
loss be recorded for a loss contingency if, prior to the issuance of the
financial statements, it is probable that a liability had been incurred and
the amount of loss can be reasonably estimated. Amounts recorded
under this guidance are generally not considered fair value. FCX has an
environmental and legal group dedicated to the ongoing review and
monitoring of environmental remediation sites. At the acquisition date, the
largest environmental remediation sites assumed were undergoing
studies to evaluate the extent of the environmental damage and the
available remedies. Advancement of these studies and consideration of
alternative remedies and cost sharing arrangements resulted in our
calculation of the estimated fair values being approximately $900 million
greater than the historical Phelps Dodge estimates. In accordance with
the purchase method of accounting, we have recorded the assumed
environmental obligations at their estimated fair values of approximately
$1.3 billion. Significant work is expected to be completed in the next
several years to remediate these sites. After the allocation of the purchase
price associated with the Phelps Dodge acquisition is finalized in
first-quarter 2008, future estimates of environmental obligations will be
recorded in accordance with SFAS No. 5 and SOP 96-1. Significant
adjustments to these reserves could occur in the future.