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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2004

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period                      to           

Commission file number 1-82

PHELPS DODGE CORPORATION

(Exact name of registrant as specified in its charter)
     
New York
(State or other jurisdiction of
incorporation or organization)
  13-1808503
(I.R.S. Employer
Identification No.)
     
One North Central Avenue, Phoenix, AZ
(Address of principal executive offices)
  85004-4414
(Zip Code)

Registrant’s telephone number, including area code: (602) 366-8100

Securities registered pursuant to Section 12(b) of the Act:

     
Title of each class   Name of each exchange
on which registered
     
Common Shares, $6.25 par value per share
Mandatory Convertible Preferred Shares,
$1.00 par value per share
  New York Stock Exchange

New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o.

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes þ No o.

The aggregate market value of Common Shares of the issuer held by nonaffiliates at June 30, 2004, was approximately $7,267,372,169.

Number of Common Shares outstanding at March 3, 2005: 96,660,599 shares.

Documents Incorporated by Reference:

     
Document   Location in 10-K
     
Proxy Statement for 2004 Annual Meeting   Part III
 
 

 


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PHELPS DODGE CORPORATION
Annual Report on Form 10-K

For the Year Ended December 31, 2004

         
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 EXHIBIT 12.2
 EXHIBIT 21
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 EXHIBIT 24
 EXHIBIT 31
 EXHIBIT 32

 


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PHELPS DODGE CORPORATION
2004 Annual Report on Form 10-K

     
PART I
   
 

Items 1. and 2. Business and Properties

     Phelps Dodge Corporation (the Company, which also may be referred to as Phelps Dodge, PD, we, us or our) is the world’s second largest producer of copper, among the world’s largest carbon black and magnet wire producers, and is the world’s largest producer of continuous-cast copper rod. We also are one of the world’s largest producers/processors of molybdenum and molybdenum products.

     The Company consists of two major divisions: (i) Phelps Dodge Mining Company (PDMC) and (ii) Phelps Dodge Industries (PDI).

     (i) PDMC includes our worldwide, vertically integrated copper operations from mining through rod production, marketing and sales; molybdenum operations from mining through conversion to chemical and metallurgical products, marketing and sales; other mining operations and investments; and worldwide mineral exploration, technology and project development programs. PDMC includes 12 reportable segments — Morenci, Bagdad, Sierrita, Miami/Bisbee, Chino/Cobre and Tyrone (located in the United States), Candelaria/Ojos del Salado, Cerro Verde and El Abra (located in South America), Manufacturing, Sales and Primary Molybdenum — and other mining activities.

     In 2004, PDMC produced 1,260,600 tons of copper on a consolidated basis (1,098,800 tons on a pro rata basis) from worldwide mining operations, and an additional 63,000 tons of copper for our partner’s 15 percent undivided interest in the Morenci mine. Gold, silver, molybdenum, rhenium and sulfuric acid are by-products of our copper and molybdenum operations. Production of copper for our own account from our U.S. operations constituted approximately 51 percent of the copper mined in the United States in 2004. Much of our U.S. copper cathode production, together with additional copper cathode purchased from others, is used to produce continuous-cast copper rod, the basic feed for the electrical wire and cable industry. We are also engaged in exploration efforts for metals and minerals throughout the world.

     In 2004, PDMC produced 57.5 million pounds of molybdenum from mining operations. High-purity, chemical-grade molybdenum concentrate is produced at our Henderson mine in Colorado. Most of the concentrate produced at Henderson is roasted at our Fort Madison, Iowa, facility and is further processed at the facility’s chemical plant into value-added molybdenum chemical products. In addition, some of the concentrate is processed into salable molysulfide for use primarily in the lubricant industry.

     Molybdenum concentrate is also produced as a by-product at three of our U.S. copper operations. This concentrate generally is roasted at one of our three roasting operations to produce technical-grade molybdic oxide for sale into the metallurgical markets (i.e., steel industries).

     We also have research and process technology facilities primarily at our Process Technology Center in Safford, Arizona; and a research and development facility for engineered materials at our Climax Technology Center near Sahuarita, Arizona.

     (ii) PDI is our manufacturing division comprising two reportable segments — Specialty Chemicals and Wire and Cable. PDI produces engineered products principally for the global energy, transportation and specialty chemicals sectors.

     We produce specialty chemicals at operations in North America, Europe, South America and Asia through Columbian Chemicals Company, one of the world’s largest producers of carbon black. Carbon black is a reinforcing agent in natural and synthetic rubber that increases the service lives of tires, hoses, belts and other products for the rubber industry. We also produce specialty carbon black for other industrial applications such as pigments for printing, coatings, plastics and other non-rubber applications.

     Our Wire and Cable segment has operations in the United States, Latin America, Asia and Africa. This segment produces magnet wire, copper and aluminum energy cables, specialty conductors and other products for sale principally to original equipment manufacturers for use in electrical motors, generators, transformers, medical applications and public utilities.

     The Company is exploring strategic alternatives for PDI that may include potential subsidiary sales, selective asset sales, restructurings, joint ventures and mergers, or, alternatively, retention and selective growth.

     Note 22 to our Consolidated Financial Statements contained herein includes financial data for each of the last three years relating to our business segments, including data by geographic area.

     Phelps Dodge was incorporated as a business corporation under the laws of the state of New York in 1885. Our world headquarters is located in Phoenix, Arizona, and is a leased property. We employed approximately 14,000 people worldwide on February 15, 2005.

     Throughout this document, unless otherwise stated, all references to tons are to short tons, and references to ounces are to troy ounces.

Available Information. Phelps Dodge files annual, quarterly and current reports, proxy statements and other information with the U.S. Securities and Exchange Commission (the SEC). You may read and copy any document we file at the SEC’s Public Reference Room at Room 1024, 450 Fifth Street, NW, Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for information on the Public Reference Room. The SEC maintains a Web site that contains annual, quarterly and current reports, proxy statements and other information that issuers (including Phelps Dodge) file electronically with the SEC. The SEC’s Web site is http://www.sec.gov.

     Phelps Dodge’s Web site is http://www.phelpsdodge.com. Phelps Dodge makes available free of charge through its internet site, via a link to the SEC’s Web site at http://www.sec.gov, its annual reports on Form 10-K; quarterly reports on Form 10-Q; current reports on Form 8-K; Forms 3, 4 and 5 filed on behalf of directors and executive officers; and any amendments to those reports filed or furnished pursuant to the Securities Exchange Act of 1934 as soon as reasonably practicable after such material is electronically filed with, or furnished to, the SEC.

     Phelps Dodge makes available free of charge on http://www. phelpsdodge.com its most recent annual report on Form 10-K, its quarterly reports on Form 10-Q for the current fiscal year, its most recent proxy statement and its most recent summary annual report to shareholders, although in some cases these documents are not

 


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available on our site as soon as they are available on the SEC’s site. You will need to have on your computer the Adobe Acrobat® Reader software to view some of these documents, which are in PDF format. If you do not have Adobe Acrobat®, a link to Adobe’s internet site, from which you can download the software, is provided free of charge. The information on Phelps Dodge’s Web site is not incorporated by reference into this report.

PHELPS DODGE MINING COMPANY

     PDMC has six reportable copper production segments in the United States (Morenci, Bagdad, Sierrita, Miami/Bisbee, Chino/Cobre and Tyrone) and three reportable copper production segments in South America (Candelaria/Ojos del Salado, Cerro Verde and El Abra). These segments include open-pit mining, underground mining, sulfide ore concentrating, leaching, solution extraction and electrowinning. In addition, the Candelaria and Chino/Cobre segments produce gold and silver. The Bagdad, Sierrita and Chino mines also produce molybdenum and rhenium as by-products.

     Our Manufacturing segment consists of conversion facilities, including our smelters, refineries and rod mills. The Manufacturing segment processes copper produced at our mining operations and copper purchased from others into copper anode, cathode and rod. In addition, at times it smelts and refines copper and produces copper rod for customers on a toll basis. Toll arrangements require the tolling customer to deliver appropriate copper-bearing material to our facilities, which we then process into a product that is returned to the customer. The customer pays PDMC for processing its material into the specified products.

     Our Sales segment functions as an agent to sell copper from our copper production and manufacturing segments. It also purchases and sells any copper not sold by the South American mines to third parties. Copper is sold to others primarily as rod, cathode or concentrate, and as rod to PDI’s Wire and Cable segment.

     Our Primary Molybdenum segment consists of the Henderson and Climax mines, related conversion facilities and a technology center. This segment is an integrated producer of molybdenum, with mining, roasting and processing facilities producing high-purity, molybdenum-based chemicals, molybdenum metal powder and metallurgical products. In addition, at times it roasts and/or processes material on a toll basis. Toll arrangements require the tolling customer to deliver appropriate molybdenum-bearing material to our facilities, which we then process into a product that is returned to the customer. The customer pays PDMC for processing its material into the specified products.

     The technology center works on new product development and product applications. The principal focus is on molybdenum-based products; however, other metal-based products and application opportunities are also explored. In 2004, a new molybdenum metal powder production facility was commissioned at the technology center in Sahuarita, Arizona, with a capacity of about 1 million pounds per year.

     Our six reportable U.S. Mines segments, the Manufacturing and Sales segments and Other Mining are discussed herein together, where appropriate, as U.S. Mining Operations.

     Our U.S. Mining Operations and our South American Mines are discussed herein together, where appropriate, as our Worldwide Copper Mining Operations.

Properties, Facilities and Production

     Following is a map indicating the approximate location of PDMC’s U.S. copper and molybdenum mines:

     
 

United States Mines

(UNITED STATES MINES PICTURE)

     
 

U.S. Mines

     We produce electrowon copper cathode at leaching and solution extraction/electrowinning (SX/EW) operations near Tyrone and Silver City, New Mexico (Tyrone (partially curtailed) and Chino (partially curtailed) mines), and Morenci, Miami (curtailed since 2002), Bagdad and Green Valley (Sierrita), Arizona mines. We produce copper concentrate from open-pit mines and concentrators located at Bagdad and Green Valley, Arizona (Bagdad and Sierrita mines, respectively) and Silver City, New Mexico (Chino mine).

     We are the world’s leading producer of copper using the SX/EW process. In 2004, we produced a total of 567,100 tons of copper cathode at our SX/EW facilities in the United States, compared with 569,600 tons in 2003 and 578,700 tons in 2002. SX/EW is a cost-effective process for extracting copper from certain types of ores. SX/EW is a major factor in our continuing efforts to maintain internationally competitive costs. The annual design plating capacity of our electrowon copper plants is 410,000 tons at Morenci, 105,000 tons at Miami, 75,000 tons at Chino, 84,000 tons at Tyrone, 25,000 tons at Sierrita and 32,500 tons at Bagdad, which includes 17,500 tons of capacity associated with its concentrate leach facility.

     Morenci

     The Morenci complex in southeastern Arizona comprises an open-pit mine, a concentrator, four solution extraction facilities and three electrowinning tankhouses. We operate Morenci and own an 85 percent undivided interest; the remaining 15 percent interest is owned by Sumitomo Metal Mining Arizona, Inc. (Sumitomo), a jointly owned subsidiary of Sumitomo Metal Mining Co., Ltd., and Sumitomo Corporation. Each partner takes in kind its share of Morenci production. Morenci is the largest copper producing operation in North America.

     In 2001, the Company completed its $220 million mine-for-leach project at Morenci. As a result, the Morenci concentrator was placed on care-and-maintenance status. The crushing facility at the Metcalf

 


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concentrator continues to process approximately 85,000 tons of ore daily for the expanded leach operation. The mine-for-leach facilities increased Morenci’s annual electrowon cathode production capacity to 410,000 tons. Under certain favorable economic circumstances or as necessitated by the mine plan, Morenci may produce concentrates from primary sulfide ores.

     We are at present a party to litigation that could adversely impact the allocation of available water supplies for the Morenci operation and our other properties in Arizona. (Refer to Item 3, Legal Proceedings, for information concerning the status of these proceedings.)

     Bagdad

     Our wholly owned Bagdad operation in northwestern Arizona mines copper sulfide and oxide ore. The operation consists of an open-pit mine, sulfide ore concentrator producing copper and molybdenum concentrates, and a leaching system with an SX/EW operation producing copper cathode. In January 2002, as a result of the then-current economic environment, Bagdad’s mill throughput was curtailed temporarily to approximately one-half capacity. Based upon the rapid increase in copper prices, our view of market fundamentals for copper and molybdenum over the next several years, and our internal concentrate and sulfuric acid balance, Bagdad began increasing production in January 2004 and resumed producing at full capacity in the 2004 second quarter.

     In February 2002, we announced that Bagdad would construct a $40 million copper concentrate leaching demonstration plant designed to recover 35 million pounds of commercial-grade copper cathode from chalcopyrite concentrates annually. The plant was commissioned in the 2003 first quarter and achieved full production in the 2003 second quarter. During nine months of operation (April to December 2003), the plant processed 44,200 tons of concentrate and produced approximately 24.4 million pounds of copper cathode. During 2004, the plant processed 58,000 tons of concentrate and produced 34.9 million pounds of copper cathode. This technology could assist in our long-term cost reduction strategy.

     Sierrita

     We own the Sierrita mine near Green Valley, Arizona. The facility consists of an open-pit mine, sulfide ore concentrator producing copper and molybdenum concentrates, two molybdenum roasters and a rhenium processing facility. Sierrita also uses an oxide and low-grade sulfide ore stockpile leaching system with an SX/EW operation to produce copper cathode. The Sierrita operation leases property adjacent to its mine upon which its electrowinning tankhouse is located. During 2004, the Sierrita operation entered into a new lease for the property upon which its electrowinning tankhouse facility is located. Construction of a new plant capable of producing approximately 40 million pounds of copper sulfate pentahydrate, as an alternative to cathode production, was completed in late 2004.

     Sierrita’s on-site roasters process molybdenum concentrates produced at Sierrita, Bagdad and Chino, as well as purchased concentrates or concentrates tolled for third parties. The resulting metallurgical grade molybdic oxide and related products are either packaged for shipment to customers worldwide or transported to other Phelps Dodge facilities for further processing.

     At year-end 2001, as a result of the then-current economic environment, mill throughput at the Sierrita mine was reduced temporarily to approximately one-half of its capacity. Based upon the rapid increase in copper prices, our view of market fundamentals for copper and molybdenum over the next several years, and our internal concentrate and sulfuric acid balance, Sierrita began increasing production in January 2004 and resumed producing at full capacity in the 2004 fourth quarter.

     Miami/Bisbee

     Our wholly owned operations at Miami, Arizona, consist of an open-pit copper mine, an SX/EW operation producing copper cathode, a smelter, an acid plant, an electrolytic refinery and a copper rod plant. The small Bisbee precipitation operation is located in southern Arizona. In January 2002, as a result of the then-current economic environment, the Miami mine and refinery were closed temporarily. In January 2003, as a result of reduced production at our Bagdad and Sierrita mines along with reduced toll concentrate terms, the Miami smelter was partially curtailed. For 2004, 2003 and 2002, Miami’s production of 9,800 tons, 17,800 tons and 10,500 tons, respectively, only reflected residual leach production. During 2004, the Miami mine and refinery remained temporarily suspended. However, based upon the rapid increase in copper prices, our view of market fundamentals for copper over the next several years, and our internal concentrate and sulfuric acid balance, the Miami smelter resumed operating at full capacity in the 2004 second quarter.

     Chino/Cobre

     We operate an open-pit copper mine, concentrator, leaching and SX/EW facility near Silver City, New Mexico, and a smelter in Hurley, New Mexico, that are owned by Chino Mines Company (Chino), a general partnership in which we held a two-thirds interest through December 18, 2003. Heisei Minerals Corporation (Heisei), a subsidiary of Mitsubishi Materials Corporation and Mitsubishi Corporation, owned the remaining one-third interest in Chino. On December 19, 2003, we purchased Heisei’s interest in Chino. Prior to December 19, 2003, each partner purchased its proportionate share of Chino’s copper production each month. Beginning in late 1998 and extending through the first half of 1999, production was curtailed resulting in a reduction of approximately 35,000 tons of annual copper production. In March 2001, the concentrator was temporarily shut down. In January 2002, the Chino mine and smelter were closed temporarily. As planned, Chino’s SX/EW operations continued producing copper through leaching of existing stockpiles. The production from these stockpiles declined steadily during 2002 and 2003. Limited mining for leach material was renewed in April 2003. In September 2003, Chino resumed a full mine-for-leach operation. Based upon the rapid increase in copper prices, our view of market fundamentals for copper over the next several years, and our internal concentrate and sulfuric acid balance, Chino’s milling operations increased to approximately 80 percent of capacity in the 2004 third quarter. A small amount of molybdenum concentrate also is produced at Chino.

     On December 19, 2003, a wholly owned subsidiary of the Company acquired Heisei’s one-third general partnership interest in Chino. In connection with this transaction, Heisei paid on behalf of Chino approximately $64 million in cash to a trust to provide a portion of the financial assurance for mine closure/close out obligations. That amount represents a one-third share of the then-current estimate by the state of New Mexico of the amount of financial assurance Chino must provide in connection with its current permits. In addition, Heisei

 


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paid $50 million to the Company’s subsidiary to cover other Heisei obligations. Due to our business expectations and plans, which resulted in significant differences in the assumed operating life of Chino compared with that assumed by Heisei, we recognized an extraordinary gain of $68.3 million upon completing the transaction.

     Cobre Mining Company Inc. (Cobre) is located in southwestern New Mexico adjacent to our Chino operations. The primary assets of Cobre include an open-pit copper mine, a concentrator, and the surrounding 12,000 acres of land, including mineral rights. In 1999, production was suspended, reducing copper production by approximately 35,000 tons per year. In 2004, Cobre resumed limited mining activities, including rehabilitation of haul roads, drilling and blasting to establish new access to mining areas, and cleaning of pit benches. In December 2002, the Company recognized an impairment charge to write down Cobre’s assets by $115.5 million (before and after taxes). We took this action after revising mine plans and assessing recoverability.

     Tyrone

     Phelps Dodge operates its wholly owned Tyrone open-pit mine and SX/EW plant near Tyrone, New Mexico. Tyrone has been a mine-for-leach operation since 1992. We partially curtailed production at Tyrone in September 2003.

     The recommencement of our curtailed mines, and the one-third share of Chino acquired in December 2003, net of other reductions, increased our 2004 copper production by approximately 64 million pounds (on a consolidated basis) compared with 2003 production. We expect to increase our copper production by approximately 164 million pounds (on a consolidated basis) in 2005 compared with 2004 production. This would bring our pro rata share of copper production in 2005 to approximately 2.3 billion pounds (2.7 billion pounds on a consolidated basis).

     As a result of increased production at Sierrita, Bagdad and Chino, our 2005 molybdenum by-product production is expected to increase by approximately 3 million pounds compared with 2004 production to a total of 33 million pounds.

     Even though we remain optimistic about the copper upturn, we will remain disciplined about our production profile. We will continue to configure our operations so that we can quickly respond to both positive and negative market demand and price swings.

     Following is a map indicating the approximate location of PDMC’s South American mines:

     
   

South American Mines

(SOUTH AMERICAN MINES PICTURE)

     
 

South American Mines

     We produce electrowon copper cathode at leaching and SX/EW operations near Arequipa, Peru, and near Calama, Chile. We produce copper concentrate from an open-pit and two underground mines and concentrators located near Copiapó, Chile.

     In 2004, we produced a total of 337,900 tons of copper cathode at our SX/EW facilities in South America, compared with 346,100 tons in 2003 and 343,500 tons in 2002. Our total annual design capacity of electrowon copper cathode production is 248,000 tons at El Abra and 96,000 tons at Cerro Verde.

     Candelaria/Ojos del Salado

     We operate the Candelaria mine located near Copiapó in the Atacama Desert of northern Chile. The operation consists of an open-pit and underground copper mine, a concentrator, port and associated facilities. We own an 80 percent partnership interest in Candelaria, a Chilean contractual mining company, through Phelps Dodge Candelaria, Inc., a wholly owned subsidiary. Sumitomo Metal Mining Co., Ltd. and Sumitomo Corporation own the remaining 20 percent interest. In addition, we own two underground mines, a concentrator and associated infrastructure as part of our Ojos del Salado operation. These facilities are owned through our Chilean subsidiary, Compania Contractual Minera Ojos del Salado. In 2004, due to the rapid increase in copper prices, we resumed operation in the concentrator and one of the underground mines. The facilities had been curtailed since 1998. Sumitomo has agreed in principle, subject to the conditions described below, to acquire an equity position in Ojos del Salado of 20 percent.

     El Abra

     Phelps Dodge owns a 51 percent partnership interest in Sociedad Contractual Minera El Abra (El Abra), a Chilean contractual mining company. El Abra holds mining concessions over more than 33,000 acres of land near Calama in the copper-rich Second Region of northern Chile. The remaining 49 percent is owned by the state-owned copper enterprise Corporación Nacional del Cobre de Chile (CODELCO). The El Abra operation consists of a mine-for-leach, open-pit mining operation that uses three stages of crushing prior to leaching, an on/off heap leach pad, and an SX/EW operation to produce copper cathode. In 2001, El Abra completed a project to leach uncrushed, run-of-mine (ROM) material. The ROM project allows El Abra to better utilize its electrowon facilities. ROM production began in January 2002 with full production from the project achieved in the second half of 2002.

     Cerro Verde

     We own approximately 82.5 percent of the common stock of Sociedad Minera Cerro Verde S.A.A. (Cerro Verde). Compañia de Minas Buenaventura S.A. (Buenaventura), a publicly traded Peruvian mining concern, owns approximately 9.2 percent of the outstanding shares, and the remainder is publicly traded on the Lima Stock Exchange. The Cerro Verde operation, located approximately 30 kilometers southwest of Arequipa, Peru, consists of two open pits, Cerro Verde and Santa Rosa, a heap-leach operation and an SX/EW operation to produce copper cathode. The ore is processed through three stages of crushing and placed on a leach pad after agglomeration.

 


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     On October 11, 2004, the Phelps Dodge board of directors announced conditional approval for an $850 million expansion of the Cerro Verde mine. Final approval was contingent upon receiving all required permits from the Peruvian government and placing necessary financing. The required permits and approvals were obtained in the 2004 fourth quarter. In early February 2005, the board approved moving forward on financing and project development. We expect to finalize financing during 2005.

     Buenaventura has agreed in principle to increase its ownership in Cerro Verde up to a maximum of 20 percent. In addition, Sumitomo Metal Mining Co. Ltd. and Sumitomo Corporation have agreed in principle to acquire jointly an equity position in Cerro Verde of 21 to 25 percent. The Buenaventura and Sumitomo transactions are subject to a variety of conditions, including the approval of their respective boards of directors, the approval of Cerro Verde’s shareholders, and the negotiation and execution of definitive agreements. Phelps Dodge will retain a majority interest in the operation.

     The expansion permits the mining of a primary sulfide ore body beneath the leachable ore body currently in production. Through the expansion, approximately 1.4 billion tons of sulfide ore reserves averaging 0.49 percent copper and 0.02 percent molybdenum will be processed through a new concentrator. Processing of the sulfide ore body is expected to begin in late 2006. The current copper production at Cerro Verde is approximately 100,000 tons per year. After the expansion, copper production initially will approximate 300,000 tons per year.

Manufacturing Segment

     We own and operate copper smelters in Miami, Arizona, and, through Chino Mines Company (in which we held a two-thirds partnership interest through December 18, 2003, and a 100 percent interest effective December 19, 2003), the Chino smelter in Hurley, New Mexico. In January 2002, the Chino smelter was temporarily closed. We smelt virtually all of our share of our U.S. copper concentrate production and, depending on market circumstances and internal production requirements, concentrate production from our South American operations. In addition, we may purchase concentrate to keep our smelters operating at efficient levels.

     In September 1999, we suspended operations at our Hidalgo smelter in Hidalgo County, New Mexico, due to a general lack of concentrate availability in the United States and depressed copper market fundamentals. This suspension was coincident with the closure of Morenci’s Metcalf concentrator as previously discussed. As a result of the successful acquisition of Cyprus Amax (in which we acquired the Miami smelter) and the decision to convert Morenci to a mine-for-leach operation, we concluded that Hidalgo would probably not be operated in its historic configuration in the foreseeable future. Accordingly, a $201.5 million pre-tax write-down of the Hidalgo assets was taken in 1999. However, it was anticipated at the time that Hidalgo may have a future as a producer of sulfuric acid for the Company’s leaching operations. As a result of the Company’s ability to use acid more efficiently and an updated assessment of PDMC’s long-term acid production and consumption balance, the Company determined (i) that Hidalgo probably would not be reconfigured to produce acid as originally anticipated and (ii) the net book value of Hidalgo assets probably would not be recovered. In December 2002, the Company recognized an additional $12.9 million (before and after taxes) impairment charge to write down Hidalgo’s assets to their estimated fair value. At the time of the impairment, it was determined that the power facilities would continue to generate electricity when needed, and the facility would continue to be a backup source of acid if conditions warranted. The Company also recognized a $7.0 million (before and after taxes) charge for the estimated remaining cost of its closure obligation at Hidalgo. As a result of a sale of a portion of the facility in the 2004 third quarter, the Company wrote down the remaining Hidalgo assets by $1.1 million to current fair value. The smelter and ancillary buildings currently are expected to be demolished in 2005-2006.

     We refine our share of anode copper production from our smelters at our refineries in El Paso, Texas, and Miami, Arizona. From 2000 to 2004, the El Paso refinery operated significantly below capacity due to the late-1999 closing of the Hidalgo smelter, the conversion of the Morenci operation to a mine-for-leach operation in 2001 and the curtailment of certain production facilities in early 2002. The closure of the Hidalgo smelter resulted not only in a curtailment of operations at our El Paso refinery, but also a reduction of approximately 200 refinery jobs. As a result of production curtailments announced in the 2001 fourth quarter, the Miami refinery was temporarily closed.

     Our Miami refinery has an annual production capacity of about 200,000 tons of copper cathode. The El Paso refinery has an annual production capacity of about 450,000 tons of copper cathode. The total combined capacity of about 650,000 tons of electrolytic copper per year is sufficient to refine all the anode copper we produce for our account at our operating smelters, as well as anodes from other customers that we refine on a toll basis.

     Our El Paso refinery also produces copper sulfate, nickel sulfate (converted to nickel carbonate production in 2004), copper telluride, and autoclaved slimes material containing gold, silver, platinum and palladium.

     We are the world’s largest producer of continuous-cast copper rod, the basic feed for the electrical wire and cable industry. Most of our refined copper and additional purchased copper cathode are converted into rod at our continuous-cast copper rod facilities in El Paso, Texas; Norwich, Connecticut; Miami, Arizona; and Chicago, Illinois. Our four plants have a collective annual capacity to convert more than 1.1 million tons of refined copper into rod and other refined copper products.

Primary Molybdenum Segment

     See the United States Mines map on page 2 for the location of our molybdenum mines.

     Phelps Dodge owns the underground Henderson molybdenum mine near Empire, Colorado. The operation consists of an underground block-cave mine where molybdenite ore is mined and transported to a conventional sulfide concentrator. The concentrator is capable of operating at a rate of 32,000 tons of ore per day, producing molybdenum disulfide concentrate containing up to 58 percent molybdenum. Most of the concentrate is shipped to our Fort Madison, Iowa, roasting and chemical processing facility where high-purity products are made for final sale to customers. A portion of Henderson’s production is further refined and sold to customers as molysulfide.

 


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     In May 2000, as a result of an oversupply of molybdenum and continued low prices in the world market, Phelps Dodge announced a plan to curtail molybdenum production by approximately 20 percent and reduce its Henderson workforce by approximately 130 workers. In 2001, 2002 and 2003, the previously announced production curtailment essentially remained in place. In 2004, based on rapidly increasing molybdenum prices and our view of market fundamentals for molybdenum, we increased annual production at Henderson to approximately 28 million pounds. Henderson is currently developing the new 7210 foot production level. This level is expected to be capable of producing up to 40 million pounds annually by mid-2006, concurrent with the depletion of ore at the 7700 foot production level of the mine that has been the principal ore production level since 1991.

     Phelps Dodge also owns the Climax molybdenum mine near Leadville, Colorado. The operation consists of both an underground and open-pit mine, and a 16,000-ton-per-day concentrator. The Climax molybdenum mine was placed on care-and-maintenance in 1995 by the predecessor owner. At year-end 2004, as well as at the time of acquisition, we expected to bring Climax into production concurrent with the exhaustion of the Henderson molybdenum mine ore reserves for continued long-term primary molybdenum supply for the chemicals business. Nonetheless, we continue to evaluate short- and mid-term production opportunities for the Climax mine based on market conditions and projections as well as manage the facility in a manner that allows its production to commence in a timely and efficient manner. The property comprises more than 14,000 acres.

     Phelps Dodge processes molybdenum concentrates at its conversion plants in the United States and Europe into such products as technical-grade molybdic oxide, ferromolybdenum, pure molybdic oxide, ammonium molybdates, molybdenum metal powders and molysulfide. The Company operates molybdenum roasters at Green Valley, Arizona; Fort Madison, Iowa; and Rotterdam, the Netherlands.

     The Fort Madison, Iowa, facility consists of two molybdenum roasters, a sulfuric acid plant, a metallurgical (technical oxide) packaging facility, and a chemical conversion plant, which includes a wet chemicals plant and sublimation equipment. In the chemical plant, molybdic oxide is further refined into various high-purity molybdenum chemicals for a wide range of uses by chemical and catalyst manufacturers. In addition to metallurgical oxide products, the Fort Madison facility produces ammonium dimolybdate, pure molybdic oxide, ammonium heptamolybdate, ammonium octamolybdate, sodium molybdate, sublimed pure molybdic oxide and molysulfide.

     The Rotterdam conversion plant consists of a molybdenum roaster, sulfuric acid plant, a metallurgical packaging facility and a chemical conversion plant. The plant produces metallurgical products primarily for third parties. Ammonium dimolybdate and pure molybdic oxide are produced in a wet chemical plant.

     We also produce ferromolybdenum and molysulfide for worldwide customers at our conversion plant located in Stowmarket, United Kingdom. The plant is operated both as an internal and external customer tolling facility.

     Climax has a technology center located in Sahuarita, Arizona, that is focused on new product development and product applications. In 2004, operation of a new molybdenum metal powder production facility, with a capacity of about one million pounds annually, was commissioned to produce value-added products. In addition, work at the technology center is focused on non-molybdenum-based, value-added engineered products and applications.

Worldwide Copper Production, by Source, Other Metal Production and Sales Data, and Manufacturing and Sales Production

     The following tables show our worldwide copper production by source for the years 2000 through 2004; aggregate production and sales data for copper, gold, silver, molybdenum and sulfuric acid from these sources for the same years; annual average copper and molybdenum prices; and production from our smelters and refineries. Major changes in operations during the five-year period included:

•   restart of Ojos del Salado underground mining and milling operations in the 2004 second quarter;
 
•   curtailment of Chino operations beginning in the 1998 fourth quarter, followed by temporary shut-down of the concentrator in March 2001 and temporary closure of the mine and smelter in January 2002, a partial restart of mining for leach material in April 2003 with a full restart of mining for leach materials in September 2003, and an increase in milling operations to 80 percent of capacity in the 2004 third quarter;
 
•   partial curtailment at Tyrone beginning in September 2003;
 
•   completion of the run-of-mine leach project at El Abra with production commencing January 2002;
 
•   temporary closure of the Miami mine and refinery in January 2002;
 
•   partial curtailment of Miami’s smelter throughput in January 2003, followed by restart at full capacity in the 2004 second quarter;
 
•   curtailment of mill throughput at Bagdad to approximately one-half capacity in January 2002, followed by an increase in mill throughput to approximately 80 percent in January 2003, and an increase in production in January 2004, reaching capacity in the 2004 second quarter;
 
•   curtailment of mill throughput at Sierrita to approximately one-half capacity in January 2002, followed by an increase in production in January 2004, reaching capacity in the 2004 fourth quarter;
 
•   conversion of Morenci operations to mine-for-leach during 1999 and 2000, with completion in the 2001 first quarter;
 
•   partial curtailment of Henderson operations beginning in the 2000 second quarter, followed by an increase in production to approximately 28 million pounds by the end of 2004, and;
 
•   temporary closure of the Hidalgo smelter facilities in September 1999 with a decision in the 2002 fourth quarter that Hidalgo would be a back-up alternative to supply acid, write down of remaining Hidalgo assets to fair value in the 2004 third quarter with the smelter and ancillary buildings currently expected to be demolished in 2005-2006.

 


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7
   
Phelps Dodge Copper Production Data, by Source    
   
(thousand tons)    
                                         
    2004     2003     2002     2001     2000  
Material mined (a)
                                       
Morenci
    234,491       237,338       248,505       281,474       274,871  
Bagdad
    61,194       48,935       42,912       63,680       69,101  
Sierrita
    53,231       35,525       23,066       60,869       75,319  
Miami
                      32,702       46,446  
Chino
    43,443       12,299       220       59,277       61,519  
Tyrone
    1,647       16,319       45,515       73,990       113,937  
Candelaria
    106,585       108,442       109,211       126,509       128,464  
Ojos del Salado
    836                          
Cerro Verde
    75,727       72,965       75,982       68,685       61,400  
El Abra
    83,705       87,682       76,831       82,737       67,786  
     
Total material mined
    660,859       619,505       622,242       849,923       898,843  
Less 15% undivided interest at Morenci
    35,174       35,601       37,276       42,220       41,231  
     
Material mined on a consolidated basis
    625,685       583,904       584,966       807,703       857,612  
Less minority participants’ shares previously accounted for on a pro rata basis:
                                       
Chino (b)
          3,785       73       19,758       20,506  
Candelaria (c)
    21,317       21,688       21,842       25,302       25,693  
El Abra (d)
    41,015       42,964       37,647       40,541       33,215  
     
Material mined on a pro rata basis
    563,353       515,467       525,404       722,102       778,198  
     
 
                                       
Mill ore processed
                                       
Morenci
                      4,301       26,698  
Bagdad
    27,157       26,103       19,783       31,667       29,846  
Sierrita
    34,885       26,654       21,439       38,133       38,319  
Chino
    4,895                   3,109       13,889  
Candelaria (e)
    27,318       26,407       28,507       27,365       26,165  
Ojos del Salado
    742                          
     
Total mill ore processed
    94,997       79,164       69,729       104,575       134,917  
Less 15% undivided interest at Morenci
                      645       4,004  
     
Mill ore processed on a consolidated basis
    94,997       79,164       69,729       103,930       130,913  
Less minority participants’ shares previously accounted for on a pro rata basis:
                                       
Chino (b)
                      1,036       4,630  
Candelaria (c)
    5,464       5,281       5,701       5,473       5,233  
     
Mill ore processed on a pro rata basis
    89,533       73,883       64,028       97,421       121,050  
     
 
                                       
Leach ore placed in stockpiles
                                       
Morenci
    224,918       228,940       241,955       258,202       236,696  
Bagdad (f)
    23,627             328       696        
Sierrita
    1,330       375       170       14,347       18,386  
Miami
                      10,208       11,032  
Chino (f)
    30,799       11,066       198       31,009       12,875  
Tyrone (f)
    18,185       10,722       34,835       27,513       51,446  
Cerro Verde
    22,628       21,014       24,096       23,436       17,833  
El Abra
    71,361       80,604       71,224       75,875       62,042  
     
Total leach ore placed in stockpiles
    392,848       352,721       372,806       441,286       410,310  
Less 15% undivided interest at Morenci
    33,738       34,341       36,293       38,729       35,503  
     
Leach ore placed in stockpiles on a consolidated basis
    359,110       318,380       336,513       402,557       374,807  
Less minority participants’ shares previously accounted for on a pro rata basis:
                                       
Chino (b)
          3,376       66       10,336       4,292  
El Abra (d)
    34,967       39,496       34,900       37,179       30,401  
     
Leach ore placed in stockpiles on a pro rata basis
    324,143       275,508       301,547       355,042       340,114  
     
 
                                       
     
 
See footnote explanations on page 10.
   

 


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8
 
Phelps Dodge Copper Production Data, by Source    
   
(thousand tons)    
                                         
    2004     2003     2002     2001     2000  
Grade of ore mined — percent copper
                                       
Morenci — mill
                      0.78       0.71  
Morenci — leach
    0.29       0.28       0.28       0.30       0.26  
Bagdad — mill
    0.41       0.43       0.43       0.43       0.43  
Bagdad — leach
    0.09             0.29       0.28        
Sierrita — mill
    0.25       0.29       0.32       0.29       0.29  
Sierrita — leach
    0.23       0.26       0.21       0.22       0.20  
Miami — leach
                      0.41       0.71  
Chino — mill
    0.81                   0.79       0.83  
Chino — leach
    0.35       0.80       0.29       0.48       0.22  
Tyrone — leach
    0.17       0.34       0.35       0.29       0.26  
Candelaria — mill
    0.89       0.97       0.84       0.96       0.93  
Ojos del Salado — mill
    1.57                          
Cerro Verde — leach
    0.66       0.60       0.55       0.53       0.59  
El Abra — leach
    0.47       0.49       0.50       0.60       0.56  
Average copper grade — mill
    0.52       0.56       0.56       0.54       0.59  
Average copper grade — leach
    0.33       0.37       0.35       0.38       0.33  
 
                                       
Copper production
                                       
Morenci:
                                       
Concentrate
                      23.5       132.3  
Electrowon
    420.3       421.2       412.7       368.1       284.7  
Bagdad:
                                       
Concentrate
    82.1       82.5       68.4       118.1       111.5  
Electrowon
    28.0       24.5       15.6       10.5       11.8  
Sierrita:
                                       
Concentrate
    73.5       66.3       60.0       94.6       95.9  
Electrowon
    4.0       9.3       16.2       26.3       26.5  
Miami:
                                       
Electrowon
    9.8       17.8       10.5       44.1       59.3  
Bisbee:
                                       
Precipitate
                0.1       0.2       0.1  
Chino:
                                       
Concentrate
    29.8                   18.3       87.0  
Electrowon
    61.9       39.9       53.8       59.9       48.6  
Tyrone:
                                       
Electrowon
    43.1       56.9       69.9       76.4       79.3  
Candelaria:
                                       
Concentrate
    220.5       234.5       219.5       243.2       224.7  
Ojos del Salado:
                                       
Concentrate
    10.4                          
Cerro Verde:
                                       
Electrowon
    97.6       96.3       95.3       84.9       78.7  
El Abra:
                                       
Electrowon
    240.3       249.8       248.2       239.8       217.4  
Manufacturing (g)
    2.3       6.6       5.4       3.0       1.2  
     
Total copper production
    1,323.6       1,305.6       1,275.6       1,410.9       1,459.0  
Less 15% undivided interest at Morenci
    63.0       63.3       61.9       58.8       62.5  
     
Copper production on a consolidated basis
    1,260.6       1,242.3       1,213.7       1,352.1       1,396.5  
Less minority participants’ shares previously accounted for on a pro rata basis:
                                       
Chino (b)
          12.5       17.9       26.1       45.2  
Candelaria (c)
    44.1       46.9       43.9       48.6       45.0  
El Abra (d)
    117.7       122.4       121.7       117.5       106.5  
Manufacturing (g)
          1.2       1.4       (0.2 )     (0.5 )
     
Copper production on a pro rata basis
    1,098.8       1,059.3       1,028.8       1,160.1       1,200.3  
     
 
                                       
     
 
See footnote explanations on page 10.
   

 


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9
   
Phelps Dodge Copper Sales Data, by Source    
   
(thousand tons)    
                                         
    2004     2003     2002     2001     2000  
Copper sales:
                                       
From own mines (h):
                                       
Morenci
    420.3       421.2       412.7       391.8       416.9  
Bagdad
    111.9       111.0       92.3       132.9       123.3  
Sierrita
    79.2       79.3       83.8       125.1       122.4  
Miami
    10.9       20.0       15.2       46.6       59.2  
Bisbee
                0.1       0.3       0.1  
Chino
    91.7       40.7       53.7       78.2       135.6  
Tyrone
    43.1       56.9       69.9       76.4       79.2  
Candelaria
    223.2       234.3       218.3       237.6       226.9  
Ojos del Salado
    10.3                          
Cerro Verde
    98.2       95.6       94.9       84.7       78.8  
El Abra
    240.8       251.8       254.1       248.4       214.7  
Manufacturing (g)
    2.3       6.6       5.9       4.2       2.6  
     
Total copper sales from own mines
    1,331.9       1,317.4       1,300.9       1,426.2       1,459.7  
Less 15% undivided interest at Morenci
    63.0       63.3       61.9       58.8       62.5  
     
Copper sales from own mines on a consolidated basis
    1,268.9       1,254.1       1,239.0       1,367.4       1,397.2  
Less minority participants’ shares previously accounted for on a pro rata basis:
                                       
Chino (b)
          13.3       17.9       26.1       45.2  
Candelaria (c)
    44.6       46.9       43.7       47.5       45.4  
El Abra (d)
    118.0       123.4       124.5       121.7       105.2  
Manufacturing (g)
          1.2       1.8       1.3       0.8  
     
Copper sales from own mines on a pro rata basis
    1,106.3       1,069.3       1,051.1       1,170.8       1,200.6  
Purchased copper:
                                       
Candelaria (c)
    37.1       22.1       35.8       37.0       5.0  
El Abra (d)
          7.3       56.5       5.8        
Manufacturing (g)
    394.0       274.6       267.7       342.6       435.0  
Sales
    1.9       70.5       83.0       75.8       55.0  
     
Total purchased copper
    433.0       374.5       443.0       461.2       495.0  
     
Total copper sales on a consolidated basis (i)
    1,701.9       N/A       N/A       N/A       N/A  
     
Total copper sales on a pro rata basis (i)
    N/A       1,443.8       1,494.1       1,632.0       1,695.6  
     
 
                                       
     
Phelps Dodge Other Metal Production and Sales
   
 
                                         
    2004     2003     2002     2001     2000  
Gold (thousand ounces)
                                       
Total production
    134       129       132       140       151  
Less minority participants’ shares previously accounted for on a pro rata basis:
    23       26       24       31       33  
     
Net Phelps Dodge share
    111       103       108       109       118  
     
Sales (h)
    112       108       136       77       120  
     
 
                                       
Silver (thousand ounces)
                                       
Total production
    3,018       2,754       2,582       3,773       4,985  
Less minority participants’ shares previously accounted for on a pro rata basis:
    284       265       225       490       657  
     
Net Phelps Dodge share
    2,734       2,489       2,357       3,283       4,328  
     
Sales (h)
    3,249       2,292       3,317       2,504       4,813  
     
 
                                       
Molybdenum (thousand pounds)
                                       
Primary Molybdenum:
                                       
Henderson
    27,520       22,247       20,517       18,603       19,727  
By-product
    29,969       29,747       24,448       36,912       31,751  
     
Total production
    57,489       51,994       44,965       55,515       51,478  
Less minority participants’ shares previously accounted for on a pro rata basis:
                                       
Chino (b)
                      50       419  
     
Net Phelps Dodge share
    57,489       51,994       44,965       55,465       51,059  
     
Sales — Net Phelps Dodge share from own mines (h)
    63,108       54,158       46,665       55,105       57,988  
Purchased molybdenum
    12,844       8,199       7,393       1,609        
     
Total sales
    75,952       62,357       54,058       56,714       57,988  
     
 
                                       
Sulfuric acid (thousand tons)
                                       
Total production from copper smelters (j)
    722.0       647.6       748.6       1,236.7       1,231.8  
Less minority participants’ shares previously accounted for on a pro rata basis:
                1.6       190.2       186.3  
     
Net Phelps Dodge share
    722.0       647.6       747.0       1,046.5       1,045.5  
     
Sales from copper smelters (j)
    99.0       45.5       14.5       15.9       35.0  
     
 
                                       
 
See footnote explanations on page 10.    

 


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Prices    
   
(per pound)    
                                         
    2004     2003     2002     2001     2000  
COMEX — copper price (k)
  $ 1.29       0.81       0.72       0.73       0.84  
LME — copper price (l)
  $ 1.30       0.81       0.71       0.72       0.82  
Metals Week - molybdenum Dealer Oxide mean price (m)
  $ 16.41       5.32       3.77       2.36       2.56  
 
                                       
 
 
                                       
Phelps Dodge Manufacturing and Sales Production    
   
                                         
    2004     2003     2002     2001     2000  
Smelters (n)
                                       
Total copper (thousand tons)
    214.4       200.8       243.8       463.5       439.8  
Less minority participants’ shares previously accounted for on a pro rata basis:
                0.5       36.7       49.5  
     
Net Phelps Dodge share
    214.4       200.8       243.3       426.8       390.3  
     
 
                                       
Refineries (o)
                                       
Copper (thousand tons)
    308.4       284.6       319.6       502.6       471.2  
Gold (thousand ounces) (p)
                79.0       86.6       52.6  
Silver (thousand ounces) (p)
                1,786.0       3,719.1       3,838.9  
 
                                       
Rod (q)
                                       
Total copper (thousand tons)
    1,014.6       825.8       850.6       879.8       1,153.9  
 
                                       
 

Footnotes to tables on pages 7 through 10:

(a)   Included material mined for leaching operations, excluded material mined from stockpiles.
 
(b)   Reflected a one-third partnership interest in Chino Mines Company from January 1, 2003 to December 18, 2003 (mining interest acquired by Phelps Dodge Mining Company on December 19, 2003).
 
(c)   Reflected a 20 percent partnership interest in Candelaria.
 
(d)   Reflected a 49 percent partnership interest in El Abra.
 
(e)   Included mill ore from stockpiles.
 
(f)   Leach ore placed in the stockpiles included previously considered waste material that is now being leached.
 
(g)   Included smelter production from custom receipts and fluxes as well as tolling gains or losses.
 
(h)   Excluded sales of purchased copper, molybdenum, silver and gold.
 
(i)   2004 reflected full consolidation of El Abra and Candelaria, 2003 and prior reflected El Abra and Candelaria on a pro rata basis (51 percent and 80 percent, respectively).
 
(j)   Sulfuric acid production resulted from smelter air quality control operations; sales do not include internal usage.
 
(k)   New York Commodity Exchange annual average spot price per pound — cathodes.
 
(l)   London Metal Exchange annual average spot price per pound — cathodes.
 
(m)   Annual Metals Week molybdenum Dealer Oxide mean price per pound — as quoted in Platts Metals Week.
 
(n)   Included production from purchased concentrates and copper smelted for others on a toll basis.
 
(o)   Included production from purchased material and copper refined for others on a toll basis.
 
(p)   El Paso closed its precious metals processing facility in the fourth quarter of 2002.
 
(q)   Included rod, wire, oxygen-free billets/cakes, scrap and other shapes.

 


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Other Mining

     Other mining comprises our worldwide mineral exploration and development programs, a process technology center that directs its activities at improving existing processes and developing new cost-competitive technologies, other ancillary operations and mining investments.

     Exploration

     Our exploration group’s primary objectives are to increase PDMC’s ore reserve base through discoveries and joint ventures and, where appropriate, to diversify into other metals, minerals and geographic areas. Exploration is focused on finding large-scale copper and copper/gold deposits in the four principal copper-producing regions of the world: southwest U.S./Mexico, South American Cordillera, Central Africa and Australasia, as well as in other highly prospective areas. This group operates in more than 12 countries and maintains offices in Australia, Brazil, Bulgaria, Canada, Chile, Mexico, Peru, the Philippines and the United States.

     In 2004, Phelps Dodge expended $35.6 million on worldwide exploration, compared with $25.8 million in 2003 and $20.0 million in 2002. Approximately 40 percent of the 2004 expenditures occurred in the United States, with 31 percent being spent at our U.S. mine sites and the remainder for support of U.S. and international exploration activities. This compares with 32 percent in 2003 (25 percent at U.S. mine sites) and 33 percent in 2002 (24 percent at U.S. mine sites). The balance of our exploration expenditures was spent principally in Chile, Central Africa, Australasia, Europe, Peru, Mexico, Brazil and Canada, including 16 percent at our South American mine sites.

     During 2004, exploration efforts continued at our existing copper operations. The underground decline at Candelaria, designed to provide exploration drilling access to a high-grade, underground zone of mineralization at depth adjacent to the Candelaria open pit, was completed and significant progress was made on a definition drilling program. In 2004, Cerro Verde, Morenci and Candelaria mines added reserves.

     In 2004, an updated feasibility study was completed on our Safford project in eastern Arizona. The Bureau of Land Management issued a Record of Decision in July 2004, another step toward environmental permitting that will enable development of the Dos Pobres and San Juan deposits. The two deposits contain an estimated total of 538 million tons of leachable reserves with an ore grade of 0.37 percent copper.

     In December 2004, Phelps Dodge Mining (Zambia) Ltd., a subsidiary of Phelps Dodge Corporation, sold the remaining portion (49 percent) of the Lumwana exploration property to Equinox Minerals Ltd. for $5.0 million in cash and a 1 percent future production royalty. Lumwana is a copper deposit in the Zambian copper belt located in northwestern Zambia.

     In October 2003, Phelps Dodge Australasia, Inc., a subsidiary of Phelps Dodge Corporation, sold its Australian exploration property portfolio to Red Metal Limited, a newly formed junior mining exploration company that listed on the Australian Stock Exchange. As consideration, Phelps Dodge Australasia acquired a 15 percent shareholding in Red Metal Limited and rights to acquire interests in properties explored.

     During 2003, the Company entered into a joint venture agreement with Dynatec Corporation relating to the Ambatovy nickel/cobalt deposit in central Madagascar. As of mid-year 2004, Dynatec completed its portion of the agreement and Phelps Dodge transferred a 53 percent interest in the project to Dynatec. In February 2005, the Company sold its remaining 47 percent interest in the project to Dynatec in exchange for 20.9 million common shares, subject to certain holding restrictions, resulting in a 9.9 percent interest in Dynatec Corporation. We also received 100 preferred shares of Dynatec Corporation (BVI) Inc., a wholly owned subsidiary of Dynatec Corporation. The preferred shares are subject to a put/call arrangement that upon certain triggering events, including the commencement of commercial production, would entitle the Company to receive in the form of cash and stock the difference between $70 million and the then-current value of the 20.9 million Dynatec shares.

     In August 2002, Phelps Dodge announced it had replaced BHP Billiton as option holder under an existing agreement among BHP Billiton, Tenke Mining Corp. and others to acquire a controlling interest and operatorship in the Tenke Fungurume Mining (TFM) copper/cobalt project in the Democratic Republic of the Congo. On January 16, 2004, Phelps Dodge Exploration Corporation entered into a joint venture agreement with Tenke Holdings Limited with respect to the exploration, development and, if warranted, commercial production associated with the TFM copper/cobalt mineral deposit. Phelps Dodge has an option to acquire a 70 percent interest in the joint venture, which currently has a 55 percent ownership in TFM.

     In October 2001, Phelps Dodge sold its 50 percent interest in Mineração Serra do Sossego to Companhia Vale do Rio Doce (CVRD) for $42.5 million in cash. Sossego is a copper-gold mine in the Carajas region of Brazil.

     Process Technology

     The objective of PDMC’s process technology center (PTC) in Safford, Arizona, is to enhance and strengthen Phelps Dodge’s competitive position in the world copper market. The PTC provides metallurgical process development capabilities, process optimization services, metallurgical testing and advanced material characterization services to meet the needs of PDMC and its operations. The PTC is ISO-9001-2000 certified. The activities at PTC are directed at the development of new cost-competitive, “step change” technologies and the continuous improvement of existing processes (“optimization”). A strong focus is maintained on the effective implementation, transfer and sharing of technology within PDMC operations and projects. The PTC employs approximately 96 engineers, scientists and technical support staff. The facilities include:

•   a large-diameter, column-leach facility for testing run-of-mine material, which is capable of processing up to approximately 600 tons of ore annually;
 
•   a continuous SX/EW test facility capable of producing 1.5 tons of copper cathode per day;
 
•   a small-diameter, column-leach facility with a capacity of about 250 individual tests per year for crushed material;
 
•   a metallurgical laboratory for the development of biological leaching processes and enhancements and other biological applications; and

 


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•   a state-of-the-art material characterization laboratory with advanced mineralogy, analytical chemistry and metallography capabilities.

     The principal areas of activity include hydrometallurgy, mineral processing (comminution and flotation), material characterization and technical information services. Some of the most important projects and milestones in 2004 were as follows:

•   Successful operation of the high-temperature concentrate pressure leaching plant at the Bagdad mine continued throughout the year. The facility is the first of its kind in the world to use high-temperature pressure leaching to process chalcopyrite concentrates. The technology is proprietary and is covered under a Technology Development Agreement between Phelps Dodge and Placer Dome, Inc. The plant was designed to produce 35 million pounds of copper cathode annually. The plant was commissioned in the first quarter of 2003 to operate in the high-temperature mode, and achieved full production in the second quarter of 2003. During 2004, the plant processed 58,000 tons of concentrate and produced approximately 34.9 million pounds of copper cathode. Average extraction of copper from concentrate was 98.9 percent, slightly more than design recovery. Plant availability averaged 83 percent during 2004.
 
•   In March 2004, a decision was made to convert the Bagdad concentrate leaching facility to the medium-temperature mode of operation to prove up this alternative technology that generates significantly less sulfuric acid and requires less oxygen than the high-temperature process. The facility was shut down in December to allow tie-ins for the conversion to a medium-temperature operation. New proprietary direct electrowinning technology is being incorporated into the design and is an important feature of this process. The conversion to the medium temperature operating mode is anticipated to be completed in the first quarter of 2005. Start up of the facility is scheduled for the second quarter of 2005. The facility is planned to operate for a period of approximately eight months. This process has potential application for operations and projects where by-product sulfuric acid cannot be beneficially used in stockpile or heap leaching operations.
 
•   Construction of a Central Analytical Service Center (CASC) to provide routine analytical services for PDMC’s operations in Arizona and New Mexico was commenced. The facility, located in Safford, Arizona, is expected to be completed by the end of 2005. The CASC will replace existing analytical facilities at most of the existing mine sites and will ensure that high-quality, timely and cost-effective analytical capability is provided to PDMC’s operations on a consistent basis.
 
•   The advancement of proprietary technology for heap and stockpile leaching of low-grade chalcopyrite ores including the continued operation of a large-scale demonstration plant at Bagdad continued.
 
•   Alternative technologies to reduce the cost of copper electrowinning were investigated.
 
•   Alternative sulfuric acid production techniques were also investigated.
 
•   Alternative copper products and production techniques were developed.

     Total expenditures for PTC in 2004 were approximately $26 million, compared with $18 million in 2003 and $13 million in 2002. PDMC intends to advance all of these research and development projects aggressively in 2005; however, there is no assurance that any of these technologies will be commercialized.

     Other Ancillary Operations

     Our Tohono copper operation in south central Arizona includes an SX/EW facility capable of producing copper cathode. It is located on land leased from the Tohono O’odham Nation. Ore mining at Tohono ceased in July 1997, but copper cathode production continued from existing leach stockpiles until early 1999 at which time the site was placed on care-and-maintenance status. As a result of higher copper prices, the facility restarted operations to recover copper from existing leach stockpiles in the 2004 fourth quarter, which allowed initial cathode production in January 2005.

     Mining Investments

     We own a 14.0 percent interest in Southern Peru Copper Corporation (SPCC), which operates two open-pit copper mines, two concentrators, an SX/EW operation, a smelter and a refinery in Peru. SPCC’s other principal shareholders are a subsidiary of Grupo Mexico, S.A. de C.V. (Grupo Mexico), with a 54.2 percent interest, and Cerro Trading Company, Inc., with a 14.2 percent interest. A total of 17.6 percent interest is publicly held.

     On October 21, 2004, SPCC announced it had executed a merger agreement with Americas Mining Corporation (AMC), a subsidiary of Grupo Mexico, the largest shareholder of SPCC. Pursuant to the merger agreement, AMC will sell its 99.15 percent shareholding in its subsidiary, Minera Mexico, S.A. de C.V., to SPCC in return for 67.2 million shares of SPCC. Based upon the information provided in SPCC’s Form 8-K filed on October 22, 2004, if this transaction is completed, we estimate Phelps Dodge’s interest in SPCC would be diluted to approximately 7.6 percent.

     On December 22, 2004, the Company entered into a letter agreement with Grupo Mexico whereby Grupo Mexico agreed to use reasonable best efforts to cause SPCC to sign a registration rights agreement that will lead to the registration of PD’s shares in SPCC. Under the proposed registration rights agreement, the Company would have the flexibility to sell its shares as part of an underwritten public offering for a period of time or, at a later time, sell its shares in the market, subject to certain restrictions to be provided in the agreement.

     SPCC’s results are not included in our earnings because we account for our investment in SPCC on a cost basis. During 2004, we received dividend payments of $26.7 million from SPCC, compared with $6.3 million and $4.0 million in 2003 and 2002, respectively.

Ore Reserves

     Ore reserves are those estimated quantities of proven and probable material that may be economically mined and processed for extraction of their constituent values. Estimates of our ore reserves are based upon engineering evaluations of assay values derived from samplings of drill holes and other openings. In our opinion, the sites for such samplings are spaced sufficiently closely and the geologic characteristics of the deposits are sufficiently well defined to render the estimates reliable. The ore reserve estimates include

 


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assessments of the resource, mining and metallurgy as well as consideration of economic, marketing, legal, environmental, social and governmental factors.

     Phelps Dodge uses several additional factors to determine mine design limits that it believes maximize the value of future cash flows including time-valued concepts to recognize, for example, any elapsed time between mining of overburden and the mining of ore. Our mine designs recognize capital and other expenditures required to extract the ore reserves over the life of the mine. Cutoff grade strategies are implemented to maximize time-valued cash flows. Phelps Dodge believes its ore reserve estimation methodology is prudent and consistent with appropriate industry standards.

     Proven and probable ore reserves at December 31, 2004, and 2003, for each of our operating, curtailed and development properties are summarized on the following page.

 


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14
   
                                                                 
    Total Ore Reserves Estimated at December 31, 2004 (1)  
                            Leachable Reserves     Phelps  
    Millable Reserves     Crushed Leach     Run-of-Mine (ROM)     Dodge  
    Million     %     %     Million     %     Million     %     Interest  
    Tons     Copper     Moly     Tons     Copper     Tons     Copper     (%)  
Operating and Curtailed Operations
                                                               
Morenci (2)
    224.0       0.46             585.7       0.55       2,434.1       0.19       85.0  
Bagdad (3)
    676.3       0.34       0.02                   14.4       0.29       100.0  
Sierrita (3)
    1,075.1       0.26       0.03                   27.1       0.18       100.0  
Miami (4)
                                  126.4       0.37       100.0  
Chino (3)
    111.4       0.71       0.02                   282.6       0.39       100.0  
Cobre (4) & (8)
    57.6       0.55                         77.8       0.26       100.0  
Tyrone
                                  274.7       0.31       100.0  
Candelaria (5) & (6)
    422.0       0.72                                     80.0  
Ojos del Salado (5)
    17.9       1.31                                     100.0  
Cerro Verde (7)
    1,428.1       0.49       0.02       228.0       0.57       159.2       0.27       82.5  
El Abra
                      243.4       0.49       239.5       0.29       51.0  
Primary Molybdenum:
                                                               
Climax (4)
    156.4             0.19                               100.0  
Henderson
    158.7             0.21                               100.0  
 
                                                               
Undeveloped Copper Ore Reserves - require substantial capital investments to bring into production
                                                               
Safford (8)
                      455.3       0.40       82.7       0.21       100.0  
 
                                                               
 
 
                                                               
                                                                 
    Total Ore Reserves Estimated at December 31, 2003 (1)  
                            Leachable Reserves     Phelps  
    Millable Reserves     Crushed Leach     Run-of-Mine (ROM)     Dodge  
    Million     %     %     Million     %     Million     %     Interest  
    Tons     Copper     Moly     Tons     Copper     Tons     Copper     (%)  
Operating and Curtailed Operations
                                                               
Morenci
    178.7       0.46             575.3       0.54       2,044.6       0.18       85.0  
Bagdad
    797.9       0.36       0.02                   14.8       0.28       100.0  
Sierrita
    1,199.9       0.26       0.03                   35.8       0.18       100.0  
Miami
                                  126.3       0.37       100.0  
Chino
    182.1       0.61       0.02                   239.0       0.42       100.0  
Cobre
    57.6       0.55                         77.8       0.26       100.0  
Tyrone
                                  252.2       0.31       100.0  
Candelaria
    332.2       0.76                                     80.0  
Ojos del Salado
    18.7       1.32                                     100.0  
Cerro Verde
                      156.8       0.69       104.0       0.32       82.5  
El Abra
                      267.8       0.53       269.5       0.29       51.0  
Primary Molybdenum:
                                                               
Climax
    156.4             0.19                               100.0  
Henderson
    165.8             0.21                               100.0  
 
                                                               
Undeveloped Copper Ore Reserves - require substantial capital investments to bring into production
                                                               
Cerro Verde
    464.0       0.61       0.02                               82.5  
Safford
                      447.2       0.40       86.1       0.20       100.0  
 
 
                                                               

(1)   Total ore reserves estimated (i) are presented on a 100% basis (i.e., included 100 percent of Morenci, Candelaria, Cerro Verde and El Abra), (ii) included only in-situ tonnages, and (iii) excluded stockpiled ores.
 
(2)   Morenci ore reserves increased with the inclusion of additional ore reserves in the Shannon, American Mountain and Garfield areas.
 
(3)   Bagdad, Sierrita, and Chino ore reserves reflected new pit designs based on updated slope and economic parameters.
 
(4)   Miami and Climax properties have been on care-and-maintenance status with no mining taking place; Cobre had limited activity in 2004 to improve and establish access to mining areas.
 
(5)   The Candelaria and Ojos del Salado deposits also contained 0.004 ounces and 0.008 ounces of gold per ton, respectively.
 
(6)   The Candelaria ore reserves included 486,000 tons of underground ore reserves from the Candelaria Norte area.
 
(7)   Cerro Verde millable ore reserves reflected the approved development of the mill project.
 
(8)   The Safford and Hanover (Cobre) leach deposits were at various stages of the permitting process.

 


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15
   

Average Drill-Hole Spacing at Ore Reserve Properties

     The following table sets forth the average drill-hole spacing for proven and probable ore reserves by process types:

     
 
                                 
    As of December 31, 2004  
    Proven     Probable  
    (average spacing-feet)     (average spacing-feet)  
Property   Mill     Leach     Mill     Leach  
Morenci
    283       283       400       400  
Bagdad
    190       81       441       323  
Sierrita
    221       144       337       244  
Miami
    N/A       200       N/A       300  
Chino
    141       200       200       283  
Cobre
    150       200       200       300  
Tyrone
    N/A       283       N/A       283  
Candelaria
    115       N/A       230       N/A  
Ojos del Salado
    82       N/A       164       N/A  
Cerro Verde
    196       121       444       303  
El Abra
    N/A       197       N/A       328  
Climax
    200       N/A       200       N/A  
Henderson
    65       N/A       290       N/A  
Safford
    N/A       200       N/A       400  
 
 
                               

Metallurgical Recovery

     The following table sets forth the average expected metallurgical recovery by process type:

     

 
                         
    As of December 31, 2004  
    Copper     Molybdenum  
Property   Mill % (a)     Leach % (b)     Mill % (c)  
Morenci
    80.5       58.4       N/A  
Bagdad
    85.9       47.7       71.1  
Sierrita
    81.7       52.7       78.5  
Miami
    N/A       64.9       N/A  
Chino
    79.6       66.8       35.9  
Cobre
    85.5       69.9       N/A  
Tyrone
    N/A       64.0       N/A  
Candelaria
    91.3       N/A       N/A  
Ojos del Salado
    90.2       N/A       N/A  
Cerro Verde
    85.3       71.2       54.8  
El Abra
    N/A       61.5       N/A  
Climax
    N/A       N/A       85.1  
Henderson
    N/A       N/A       86.3  
Safford
    N/A       70.2       N/A  
 
 
                       

(a)   Mill recoveries include expected mill and smelter recoveries and an allowance
 
    for concentrate transportation losses.
 
(b)   Leach recoveries are the expected total recoveries over multiple leach cycles.
 
(c)   Molybdenum recoveries include mill recoveries and roaster deductions.
     
 
 
   

Mill and Leach Stockpiles

     Stockpiled copper-bearing material that has been removed from the mine, and for which we have reasonable certainty of processing, is summarized below. We begin capitalization of costs for mill and leach stockpiles when we have reasonable certainty that the material will be processed. The capitalized costs are evaluated periodically to ensure carrying amounts are stated at the lower of cost or market. (Refer to Notes 1 and 7 to the Consolidated Financial Statements for additional financial information regarding mill and leach stockpiles.) Effective January 1, 2004, for accounting purposes, El Abra (51 percent) and Candelaria (80 percent) are fully consolidated. Prior to 2004, these entities were accounted for on a pro rata basis. The Phelps Dodge pro rata basis in the tables below reflects our ownership interests in El Abra, Candelaria and Morenci (85 percent). Cerro Verde is included at 100 percent for all categories presented.

     
 
(in million tons)
   
                                 
    2004  
            Contained              
    Stockpile     Copper     Recovery     Recoverable  
    Material     (%)*     (%)     Copper  
Mill stockpiles:
                               
100% basis
    96       0.48       83.1       0.4  
Consolidated basis
                            0.4  
Phelps Dodge pro rata basis
                            0.3  
 
                               
Leach stockpiles:
                               
100% basis
    8,331       0.27       6.4       1.4  
Consolidated basis
                            1.4  
Phelps Dodge pro rata basis
                            1.3  
 
* Copper grade when placed.
     
 
(in million tons)
   
                                 
    2003  
            Contained              
    Stockpile     Copper     Recovery     Recoverable  
    Material     (%)*     (%)     Copper  
Mill stockpiles:
                               
100% basis
    63       0.45       83.6       0.2  
Phelps Dodge pro rata basis
                            0.2  
 
                               
Leach stockpiles:
                               
100% basis
    7,974       0.27       7.3       1.6  
Phelps Dodge pro rata basis
                            1.4  
 
* Copper grade when placed.
 
   

     We employ reasonable estimation methods to determine copper contained in mill and leach stockpiles.

     Mill Stockpiles

     Mill stockpiles contain low-grade ore that has been extracted from the mine and is available for processing to recover the contained copper by milling, concentrating, smelting and refining. The quantity of material delivered to the stockpiles is based on surveyed volumes of mined material and daily production records. Sampling and assaying of blast-hole cuttings determine the estimated copper grades of the material delivered to the mill stockpiles.

     Expected copper recovery rates are determined by metallurgical testing. The recoverable copper in mill stockpiles can be extracted into copper concentrate almost immediately upon processing. Estimates of copper contained in mill stockpiles are adjusted as material is added or removed.

 


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     Leach Stockpiles

     Leach stockpiles contain low-grade ore that has been extracted from the mine and is available for processing to recover the contained copper through a leaching process. Leach stockpiles are exposed to acidic solutions that dissolve contained copper and deliver the copper in solution to the extraction processing facilities. The quantity of material is based on surveyed volumes of mined material and daily production records. Sampling and assaying of blast-hole cuttings determine the estimated copper grade of the material delivered to the leach stockpiles.

     Expected copper recovery rates are determined using small-scale laboratory tests, medium-and large-scale column testing (which simulates the production-scale process), historical trends and other factors, including mineralogy of the ore and rock type.

     Ultimate recovery of copper contained in leach stockpiles can vary from a very low percentage to more than 90 percent depending on several variables, including type of processing, mineralogy and particle size of the rock. Although as much as 70 percent of the copper ultimately recoverable may be extracted during the first year of processing, recovery of the remaining copper may take many years.

     The estimated recoverable copper contained in stockpiles at each mine was as follows.

     
 
(in million tons)
   
                 
    December 31,  
    2004     2003  
Mill stockpiles:
               
Candelaria
    0.3       0.2  
Cerro Verde
    0.1        
     
 
    0.4       0.2  
     
 
               
Leach stockpiles:
               
Morenci
    0.3       0.4  
Bagdad
    0.1       0.1  
Sierrita
    0.1       0.1  
Miami
    0.1       0.1  
Chino
    0.5       0.6  
Tyrone
    0.1       0.1  
Cerro Verde
    0.1       0.1  
El Abra
    0.1       0.1  
     
 
    1.4       1.6  
     
Total (100% basis)
    1.8       1.8  
 
               
Consolidated basis
    1.8       N/A  
Phelps Dodge pro rata basis
    1.6       1.6  
 

     Note: The Candelaria mill stockpiles are expected to be processed late in the mine’s life as milling capacity is available. Some of the Cerro Verde mill stockpiles will be processed during initial mill start-up operations in 2007. The leach stockpiles are expected to be processed over the lives of the respective mines.

     The estimated aggregate copper and molybdenum ore reserves as of December 31 were as follows.

     
 
                                         
    2004     2003     2002     2001     2000  
Milling reserves on a pro rata basis (billion tons) (a)
    4.2       3.5       3.4       3.6       4.3  
Leaching reserves on a pro rata basis (billion tons) (a)
    4.5       4.0       4.3       5.2       3.8  
 
Commercially recoverable copper
                                       
(million tons):
                                       
Ore reserves (b)
    23.2       19.5       19.6       22.1       23.1  
Stockpiles and in-process inventories
    1.6       1.6       1.4       0.9       1.0  
     
Total Phelps Dodge pro rata basis
    24.8       21.1       21.0       23.0       24.1  
Total consolidated basis
    26.1       N/A       N/A       N/A       N/A  
 
(billions of pounds)
                                       
Commercially recoverable molybdenum -
Phelps Dodge pro rata basis
    2.1       2.0       2.1       2.1       2.2  
Commercially recoverable molybdenum - consolidated basis
    2.1       2.0       2.1       2.1       2.2  
 

(a)   Milling and leaching reserves on a 100% basis would have been 4.3 and 5.2 billion tons, respectively, as of December 31, 2004, if El Abra, Candelaria and Morenci were reflected on a 100% basis.
 
(b)   Ore reserves on a 100% basis would have been 25.1 million tons as of December 31, 2004, if El Abra, Candelaria and Morenci were reflected on a 100% basis.
     
 

     We hold a 14.0 percent interest in SPCC as of December 31, 2004. Grupo Mexico is the major shareholder and operator.

Copper and Molybdenum Prices

     The volatility of copper and molybdenum prices is reflected in the following table, which gives the high, low and average COMEX price of high-grade copper and the Platts Metals Week mean price of molybdenum oxide for each of the last 15 years:

                                                 
 
    Cents per pound     Dollars per pound  
    of Copper     of Molybdenum Dealer Oxide  
    COMEX     Platts Metals Week  
Year   High     Low     Average     High     Low     Mean  
1990
    138       96       119       3.30       2.52       2.85  
1991
    120       96       105       2.78       2.08       2.38  
1992
    116       93       103       2.44       1.82       2.21  
1993
    107       72       85       2.80       1.82       2.32  
1994
    140       78       107       17.00       2.68       4.51  
1995
    146       121       135       17.50       3.90       8.08  
1996
    131       86       106       5.50       2.90       3.79  
1997
    123       76       104       4.90       3.52       4.31  
1998
    86       64       75       4.60       2.00       3.41  
1999
    85       61       72       2.90       2.48       2.65  
2000
    93       74       84       2.98       2.15       2.56  
2001
    87       60       73       2.65       2.15       2.36  
2002
    78       65       72       8.30       2.40       3.77  
2003
    104       71       81       7.80       3.15       5.32  
2004
    154       106       129       33.25       7.20       16.41  
 

     Phelps Dodge’s reported ore reserves are economic at the most-recent three-year historical average COMEX copper price of 94 cents per pound and the most-recent three-year historical average molybdenum price of $8.50 per pound (Metals Week Dealer Oxide mean price).

     Phelps Dodge develops its business plans using a time horizon that is reflective of the historical moving average for the full price cycle. We currently use a long-term average COMEX price of 90 cents per pound of copper and an average molybdenum price of $3.90 per pound (Metals Week Dealer Oxide mean price), along with near-term price forecasts reflective of the current price environment to develop mine plans and production schedules.

 


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     The per pound COMEX copper price during the past 10 years, 15 years and 20 years averaged 93 cents, 97 cents and 94 cents, respectively. The per pound Metals Week Dealer Oxide molybdenum mean price over the same periods averaged $5.27, $4.46 and $4.15, respectively.

Mineralized Material

     We hold various properties containing mineralized material that we believe could be brought into production should market conditions warrant. Permitting, additional development work and significant capital expenditures would likely be required before operations could commence at these properties. The deposits are estimated to contain the following mineralized material as of December 31, 2004:

                                                     
 
        Milling Material     Leaching Material              
                         
Property/Deposit   Location   Millions of Tons     % Copper     Millions of Tons     % Copper     % Molybdenum     Phelps Dodge Interest (%)  
 
Ajo
  Arizona     205       0.50                         100.0  
Candelaria Norte & Sur (1)
  Chile     14       2.07                         80.0  
Climax (2)
  Colorado     87                         0.25       100.0  
Cochise/Bisbee
  Arizona                 276       0.47             100.0  
El Abra
  Chile     806       0.54       198       0.31             51.0  
Lone Star (Safford)
  Arizona                 1,600       0.38             100.0  
Niagara (Tyrone)
  New Mexico                 500       0.29             100.0  
Safford
  Arizona     330       0.65                         100.0  
Sanchez (Safford)
  Arizona                 230       0.29             100.0  
Tohono
  Arizona     276       0.70       404       0.63             100.0  
 
                        Leaching Material              
Property/Deposit   Location                   Millions of Tons     % Copper     % Nickel     Phelps Dodge Interest (%)  
 
Ambatovy (3)
  Madagascar                 210             1.10       47.0  
 

(1)   Candelaria Norte and Sur are potential underground mines that would utilize the existing process facilities and infrastructure. The stated tonnage also contains 0.015 ounces of gold per ton. During 2004, 486,000 tons of underground ore were transferred to reserve status and development of these ores commenced in late 2004.

(2)   Climax underground material previously characterized as ore reserves was reclassified to mineralized material in 2003 pending future detailed planning.

(3)   Ambatovy, Madagascar, deposit contains 210 million tons of nickel leaching material at a grade of 1.10%. It also contains 0.10 percent cobalt. During 2003, the Company entered into a joint venture agreement with Dynatec Corporation whereby, as of mid-year 2004, Phelps Dodge transferred a 53 percent interest in the project to Dynatec. In February 2005, the Company sold its remaining 47 percent interest in the project to Dynatec.

Note: Mineralized material has been delineated by appropriately spaced drilling and/or underground sampling to support the reported tonnage and average grade of metal(s). Such a deposit does not qualify as an ore reserve until legal and economic feasibility is concluded based upon a comprehensive evaluation of costs, grade, recoveries and other material factors.

During 2004, Phelps Dodge sold its remaining 49 percent interest in the Lumwana, Zambia, property to Equinox in exchange for cash ($5 million) and a 1 percent future production royalty.


 


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Sales and Competition

U.S. Mining Operations

     The majority of our copper produced or purchased at our U.S. Mining Operations is cast into rod. Rod sales to outside wire and cable manufacturers constituted approximately 70 percent of PDMC’s U.S. sales in 2004, 65 percent in 2003 and 70 percent in 2002. The remainder of our U.S. copper sales is primarily in the form of copper cathode or copper concentrate. Sales of rod and cathode are made directly to wire and cable fabricators and brass mills under contracts principally of a one-year duration. Cathode contract prices are generally based on the prevailing COMEX copper monthly average spot price for shipments in that period. Our rod also is used by our Wire and Cable segment. We generally sell our copper rod and cathode produced at our U.S. Mining Operations at a premium over COMEX prices.

South American Mines

     The production from our South American mines is sold as copper concentrate or as copper cathode. Our Candelaria mine sells its production in the form of copper concentrate primarily to copper smelters located in Japan and elsewhere in Asia under long-term contracts. Production not committed under long term contracts is either shipped to North America for smelting at our Miami smelter (under certain circumstances) or sold on a spot basis to other smelters or merchants. The majority of our Ojos del Salado concentrate production is sold to local Chilean smelters. Copper concentrate sold by our South American operations primarily is based on LME prices.

     Most of Candelaria’s concentrate contracts allow for an annual pricing election that must be declared prior to the beginning of the contract year. The options allowed under this pricing election are the monthly average price of either (i) the month of shipment or (ii) the third calendar month following the month of arrival of concentrates at destination. During 2004, over 90 percent of Candelaria’s concentrate sales were priced on the basis of the third calendar month following arrival. During 2002 and 2003, over 95 percent of its sales were priced on the basis of the month of shipment.

     El Abra produces copper cathodes that are sold primarily under annual or multi-year contracts to Asian or European rod or brass mill customers or to merchants. Cerro Verde produces copper cathode; the majority of which is shipped to our U.S. rod mills for processing. The remainder of Cerro Verde’s production is sold under annual contracts to South American customers or to merchants on a spot basis. Cathode contract prices are generally based on the prevailing LME copper monthly average spot price in the month of arrival. The copper cathode sold by our international operations generally is sold at a premium over LME prices.

Worldwide Copper Mining Operations

     Most of the refined copper we sell is incorporated into electrical wire and cable products worldwide for use in the construction, electric utility, communications and transportation industries. It also is used in industrial machinery and equipment, consumer products and a variety of other electrical and electronic applications.

     When we sell copper as rod, cathode and concentrate, we compete, directly or indirectly, with many other sellers, including at least two other U.S. primary producers, as well as numerous foreign producers, metal merchants, custom refiners and scrap dealers. Some major producers outside the United States have cost advantages resulting from richer ore grades, lower labor costs, and, in some cases, a lack of strict regulatory requirements. We believe our ongoing programs to contain costs, improve productivity and employ new technologies will significantly narrow these cost advantages and place us in a more competitive position with respect to a number of our international competitors.

     Other materials that compete with copper include aluminum, plastics, stainless steel and fiber optics. Our principal methods of competing include pricing, product properties, product quality, customer service and dependability of supply.

     From time to time, we engage in hedging programs designed to enable us to realize current average prices for metal delivered or committed to be delivered. We also have entered into price protection arrangements from time to time, depending on market circumstances, to ensure a minimum price for a portion of expected future sales.

Primary Molybdenum Segment

     Molybdic oxide is used primarily in the steel industry for corrosion resistance, strengthening and heat resistance. Molybdenum chemicals are used in a number of diverse applications such as lubricants, additives for water treatment, feedstock for the production of pure molybdenum metal and catalysts used for petroleum refining. Pure molybdenum metal powder products are used in a number of diverse applications, such as lighting, electronics and specialty steel alloys. A substantial portion of Phelps Dodge’s expected 2005 molybdenum production is committed for sale throughout the world pursuant to annual or quarterly agreements based primarily on prevailing market prices one month prior to the time of sale.

     The metallurgical market for molybdenum is characterized by cyclical and volatile prices, little product differentiation and strong competition. The chemical market is more diverse and contains more specialty products and segments. In both markets, prices are influenced by production costs of domestic and foreign competitors, worldwide economic conditions, world supply/demand balances, inventory levels, the U.S. dollar exchange rate and other factors. Molybdenum prices also are affected by the demand for end-use products in, for example, the construction, transportation and durable goods markets. A substantial portion of world molybdenum is produced as a by-product of copper mining, which is relatively insensitive to molybdenum price levels. By-product production is estimated to account for approximately 60 percent of global molybdenum production.

Prices, Supply and Consumption

Worldwide Copper Mining Operations

     Copper is an internationally traded commodity, and its prices are effectively determined by the three major metals exchanges — COMEX, LME and Shanghai Futures Exchange (SHFE). The prices on these exchanges generally reflect the worldwide balance of copper supply and demand, but are also influenced significantly from time to time by speculative actions and by currency exchange rates.

     Copper is a critical component of the world’s infrastructure. The demand for copper ultimately reflects the rate of underlying world

 


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economic growth, particularly the growth in industrial production, construction and durable goods. Copper’s end-use markets reflect its fundamental role in the world economy. Estimated percentages of copper consumption by end-use markets comprise (i) construction — 37 percent, (ii) electrical applications — 26 percent, (iii) industrial machinery — 15 percent, (iv) transportation — 11 percent, and (v) consumer products — 11 percent. Since 1990, refined copper consumption grew by an estimated annual compound rate of 3.2 percent to 16.7 million tons according to published data by the World Bureau of Metals Statistics (WBMS) and Phelps Dodge’s estimate for 2004. This rate of increase was slightly higher than the growth of world industrial production, which grew at an estimated compound annual rate of 2.6 percent over the same period. Asian copper consumption, led by China, was particularly strong, increasing by almost 6.6 percent per year from 1990 through 2004. Asia now represents approximately 47 percent of world refined copper consumption, compared with 23 percent for Western Europe and 22 percent for the Americas. The strong demand for copper in Asia has been driven by the increasing standard of living in this region as well as production of value-added products for export to the developed world.

     From 1990 through 2004, refined copper production has grown at an average annual rate of 2.8 percent according to WBMS (based on published data through 2003) and Phelps Dodge’s estimates for 2004. This growth was influenced by a number of factors. First, limited investment in new mine production in the latter half of the 1980s coupled with growing demand for copper during that period resulted in market deficits and declining copper inventories that in turn encouraged new investment. Second, an improved investment climate in Latin America, particularly Chile, encouraged investment in this region. In 2004, Latin America represented 48 percent of world mine production, a significant increase from 25 percent in 1990. Third, SX/EW technology made some previously uneconomic resources viable investments.

     Copper demand and price tend to follow economic cycles and, therefore, copper price has historically experienced significant fluctuations. Considering the period from 1990 through 2004, the LME price of copper averaged 96 cents per pound and ranged from a high annual average price of $1.33 per pound in 1995 to a low annual average price of 71 cents per pound in 2002. The COMEX price of copper averaged 97 cents per pound from 1990 through 2004, but has ranged from a high annual average price of $1.35 per pound in 1995 to a low annual average price of 72 cents per pound in 2002.

     In 2004, the average COMEX price of $1.29 per pound was almost 50 cents above the previous year average. The large increase in price was led by year-on-year consumption growth of approximately 7.5 percent. This was only partially offset by a more modest growth in refined production of 5.1 percent. Consumption was driven by Asia which we estimate grew approximately 9.7 percent year-on-year led by China, which experienced an estimated 15 percent growth year-on-year. Demand also benefited from a recovery in the U.S. manufacturing sector. We estimate that U.S. copper consumption grew by approximately 9.0 percent year-on-year in 2004. Production increases were drawn from re-started idled capacity and brownfield expansions. Only one significant greenfield project began production in 2004. The imbalance between supply and demand drove exchange inventories down over 80 percent, or 675,000 metric tons.

     In 2003, the average COMEX price of 81 cents per pound was almost 9 cents higher than the 2002 average price. The higher price levels were driven by moderate consumption rates combined with flat production growth and a depreciating U.S. dollar. U.S. economic recovery in the second half of the year combined with continued strong growth rates in Asia led by China boosted consumption levels in 2003.

     Global demand for copper in 2003 grew by 3.5 percent led by Asia and specifically China, which grew at 18 percent. China’s double digit consumption rate continues to be based on domestic economic growth and a burgeoning export market. Speculative activity, in anticipation of a U.S. recovery, reached record amounts in October 2003, and led to a large price increase in the 2003 fourth quarter.

     On the production side, a number of disruptions due to accidents and strikes offset restarts from some major producers. Global refined production is estimated to have declined slightly (0.3 percent) in 2003. The rise in consumption combined with production disruptions led to an approximate 495,000 metric ton reduction in global exchange inventories, which were just over 800,000 metric tons at year-end 2003. This also led to an estimated deficit for the global copper market of approximately 360,000 metric tons for the year.

     In 2002, the average COMEX copper price of 72 cents per pound was 1 cent less than the 2001 average price. Continued low prices resulted from weak global economic conditions and a resulting modest production surplus. More than 175,000 metric tons of excess metal in the market were delivered into LME and COMEX warehouses, bringing the combined inventories to historically high levels of more than 1.2 million metric tons. Demand for copper remained sluggish in 2002, increasing a modest 1.8 percent from 2001 levels as copper consumption in many regions, particularly the United States, Europe and Japan, remained weak as the result of depressed global economic conditions. Expectations of improvement in global manufacturing diminished as the technology and electronics sectors stagnated. However, Chinese copper demand continued to outpace the rest of the world as government infrastructure projects, an expanding industrial complex and increasing domestic prosperity led to the third year of double-digit growth in copper consumption.

Primary Molybdenum Segment

     Molybdenum demand is heavily dependent on the worldwide steel industry, which uses the metal as a hardening and corrosion inhibiting agent. More than 80 percent of molybdenum is used for this application. The balance is used in specialty chemical applications such as refinery catalysts, water treatment and lubricants.

     Molybdenum continued to experience price improvement during 2004 for the third straight year, with molybdenum prices in 2004 reaching near historical highs. Production increases were primarily experienced in by-product copper production, although primary production also experienced an increase resulting principally from an increase in production from the Henderson mine as metal prices improved throughout the year. Production in China remains difficult to estimate; however, based on published reports, production was negatively impacted in several molybdenum producing regions due to safety concerns and operational issues. Tight supply of western, high-quality materials continued throughout the year. The overall market remained in slight deficit during 2004 due to demand outpacing supply.

 


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     Annual Metals Week Dealer Oxide mean prices averaged $16.41 per pound in 2004, compared with $5.32 per pound in 2003 and $3.77 per pound in 2002. Continued strong demand, which has outpaced supply over the past several years (deficit market conditions), has reduced inventory levels throughout the industry. The majority of our molybdenum sales are based on published pricing (i.e., Platts Metals Week, Ryan’s Notes or Metal Bulletin), plus a premium. The remaining sales are priced on a fixed basis (capped), or on a variable basis within certain ranges, for periods of varying duration. Given this mix of pricing, Phelps Dodge received an average realized price of $12.65 per pound in 2004, compared with $5.79 per pound in 2003 and $4.57 per pound in 2002, reflecting a broad mix of upgraded molybdenum products as well as technical grade molybdic oxide.

Costs

Worldwide Copper Mining Operations

     Energy, including electricity, diesel fuel and natural gas, represents a significant portion of the production costs for our operations. The principal sources of energy for our mining operations are electricity, purchased petroleum products and natural gas. The principal sources of energy in our wire and cable and specialty chemicals operations are purchased electricity and natural gas. In addition, the price of residual oil feedstock is a significant factor in the cost of our specialty chemicals products because the carbon black we produce is made primarily from heavy residual oil.

     In response to volatile energy markets in 2000 and 2001, we implemented a power cost stabilization plan that moderated electricity-related costs at our U.S. mining operations. Under the plan, we use a combination of multi-year energy contracts that we put in place at favorable points in the price cycle as well as self-generation and natural gas hedging. Additionally, we enter into price protection programs for our diesel fuel and natural gas purchases to protect us against significant short-term upward movements in energy prices while maintaining the flexibility to participate in any favorable price movements. However, because energy is a significant portion of our production costs, we could be negatively impacted by future energy availability issues or increases in energy prices. For example, as our diesel fuel and natural gas price protection programs were extended at gradually increasing price levels, our energy cost per pound of copper increased in 2004. In 2005 we may continue to experience higher energy costs if the current energy commodity prices remain at the levels experienced in 2004.

     We continue to explore alternatives to moderate or offset the impact to increasing energy costs. To address volatility associated with a shortfall of power generation capacity experienced in the 2000 energy crisis in the western United States, in late 2004 we purchased a one-third interest in a partially constructed power plant in New Mexico owned by Duke Energy Luna, LLC. The plant is expected to be operating by the 2006 second quarter. One third of its electricity (approximately 190 megawatts) is expected to be consumed by PDMC operations in New Mexico and Arizona. This investment in an efficient, low-cost plant is expected to continue to stabilize our southwest U.S. operations’ energy costs, and increase the reliability of our energy supply.

     To mitigate the Company’s exposure to increases in diesel fuel and natural gas prices, we utilize several price protection programs designed to protect the Company against a significant short-term upward movement in prices. The Company’s diesel fuel price protection program consists of a combination of purchased, out-of-the-money (OTM) diesel fuel call options and fixed-price diesel fuel swaps for our North and South American operations. The OTM call options give the holder the right, but not the obligation, to purchase a specific commodity at a pre-determined dollar cost, or “strike price.” OTM call options are options with a strike price above the prevailing market price for that commodity when purchased.

     OTM diesel fuel call options mitigate a portion of our exposure to volatile markets by capping the cost of the commodity if prices rise above the strike price. If the price of diesel fuel is lower than the strike price, the Company has the flexibility to purchase diesel fuel at prices less than the strike price and the options expire with no value. The swaps allow us to establish a fixed price for a specific commodity product for delivery during a specific future period.

     Our natural gas price protection program consists of purchasing OTM call options or OTM collars for our North American operations. OTM call options cap the commodity purchase cost at the strike price while allowing the Company the ability to purchase natural gas at a lower cost when market prices are lower than the strike price. The purchase of collars (the simultaneous purchase of an OTM call option and the sale of an OTM put option) allows us to establish both a price ceiling and a price floor for natural gas costs.

     As a result of the above-mentioned plans and programs, in 2004, 2003 and 2002, Phelps Dodge was able to reduce and partially mitigate the impacts of volatile electricity markets and rising diesel fuel and natural gas prices.

     In addition, we realized cost increases in 2004 that were the result of the overall improved business climate. Some of these cost increases were anticipated. For example, we realized additional compensation costs resulting from certain employee bonus and variable compensation programs that are contingent on copper price and/or company performance. Other costs that have increased due to business conditions include taxes, freight and transportation, smelting and refining rates, and materials and supplies that are manufactured from metal or fossil fuels. We would anticipate that at least a portion of these cost increases would reverse in periods of lower metal and commodity prices.

Environmental and Other Regulatory Matters

U.S. Mining Operations

Significant Federal Environmental Programs

     Our operations in the United States are subject to stringent federal, state and local laws and regulations relating to improving or maintaining environmental quality. Our global operations also are subject to many environmental protection laws in the jurisdictions where we operate. We pursue environmental performance at all of our operations with the same diligence that we pursue financial, health and safety performance. We are committed to pollution prevention and responsible environmental stewardship worldwide.

     Environmental regulatory programs create potential liability for our domestic operations, which may result in requirements to perform

 


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environmental investigations or corrective actions under federal and state laws and to federal and state Superfund requirements (refer to the discussion of Superfund requirements in OTHER ENVIRONMENTAL MATTERS). Major environmental programs and developments of particular interest are summarized in the paragraphs that follow.

     Most air emissions from our domestic operations are subject to regulation under the federal Clean Air Act (CAA) and related state laws. These laws impose permitting, performance standards, emission limits, and monitoring and reporting requirements on sources of regulated air pollutants.

     Several of our domestic operations have obtained major source operating permits under Title V of the CAA and related state laws. Facilities with smelters, rod mills, molybdenum roasters and power plants are the primary examples of our operations that are subject to this program. These permits typically do not impose new substantive requirements, but rather incorporate in one permit all existing requirements. However, they can increase compliance costs by imposing new monitoring requirements, such as more frequent emission testing, to demonstrate compliance with existing requirements. The process of developing and renewing these comprehensive permits also can bring to light new or previously unknown agency interpretations of existing regulations, which also may increase compliance costs.

     At least one of our smelters will be subject to one or more Maximum Achievable Control Technology (MACT) standards under the CAA. These standards do not have immediate compliance dates; instead they allow two or three years after promulgation to provide the opportunity to come into compliance or to reduce emissions to avoid regulation before the compliance date. For example, the copper smelter MACT standard was issued in 2002, and the compliance date for that standard is June 2005. We continue to monitor the development and implementation of other MACT standards.

     Most discarded materials from our domestic operations are subject to regulation as solid waste under the federal Resource Conservation and Recovery Act (RCRA) and related state laws. These laws impose design, operating, closure and post-closure care requirements on facilities used to store, treat or dispose of solid waste.

     Mineral extraction (mining) and beneficiation (the concentration of economic minerals) occur at our mining operations. The solid wastes uniquely associated with these activities are exempt from hazardous waste regulation. Mineral processing (the segregation of minerals or the alteration of a mineral from one mineralogic state to another) occurs at our smelter, refinery and molybdenum roasting operations. Except for a list of 20 exempt processing wastes (three of which include wastes from copper mineral processing operations), all mineral processing wastes generated at our U.S. Mining Operations are subject to hazardous waste regulation if they exhibit a hazardous waste characteristic or if the U.S. Environmental Protection Agency (EPA) specifically designates them as a listed hazardous waste. In 1998, EPA finalized its supplemental Land Disposal Restriction Phase IV (LDR) rules that imposed regulation on certain hazardous mineral processing wastes. This final LDR rule also subjects certain mineral processing wastes that exhibit a hazardous waste characteristic to stringent treatment standards if the materials are disposed on land. A portion of the LDR rule was judicially vacated on appeal in 2000. While EPA’s final LDR rule likely will require us to continue to make expenditures to manage hazardous mineral processing wastes, it is not possible to determine the full impact on us of the new LDR requirements until the requirements are fully adopted and implemented.

     The federal Emergency Planning and Community Right-to-Know Act (EPCRA) was expanded in 1997 to cover mining operations. This law requires companies to report to EPA the amount of certain materials managed in or released from their operations each year. Annually, we report a significant volume of naturally occurring minerals and other substances that we managed during the previous year. While these materials are very high in volume, how they are safely managed is governed by existing regulations and permit requirements outside of EPCRA.

     The federal National Pollutant Discharge Elimination System (NPDES) program requires a permit for the point source discharge of pollutants to surface waters that qualify as waters of the United States. Although most states, including Arizona and Colorado, have received authorization to implement this program in lieu of EPA, New Mexico has not received such authorization and therefore the NPDES permit program in New Mexico continues to be implemented primarily by EPA. The NPDES permit program also regulates the discharge of stormwater runoff from active and inactive mines and construction activities. EPA and authorized states have issued general permits that cover discharges from active and inactive mines. We likely will continue to have to make expenditures to comply with the NPDES permit program, especially as the program continues to expand as applied to stormwater discharges.

     The Clean Water Act requires states to periodically evaluate surface waters to determine whether they meet levels of water quality adequate to support the designated uses of the waters as determined by the state. Surface waters that do not meet water quality standards may be identified as impaired waters. Waters listed as impaired must be further evaluated by the state. Unless further study shows that the water is not impaired, the state must establish a “total maximum daily load” (TMDL) for the water. A TMDL must establish the allowable pollutant load and allocate the allowable load among the sources of the pollutant. Following the establishment of a TMDL, sources of the pollutant may be required to take measures to reduce the pollutant load to acceptable levels. Some of the Company’s operations are located in the vicinity of waters that are listed as impaired and for which TMDLs have been or may be established. Operations in the vicinity of such waters may be required to take measures to reduce pollutant loading to the listed waters.

Significant Arizona Environmental and Reclamation Programs

     The Arizona Department of Environmental Quality (ADEQ) has adopted regulations for its aquifer protection permit (APP) program that replaced the previous Arizona groundwater quality protection permit regulations. Several of our properties continue to operate pursuant to the transition provisions for existing facilities under the APP regulations. The APP regulations require permits for certain facilities, activities and structures for mining, concentrating and smelting. The APP requires compliance with aquifer water quality standards at an applicable point of compliance well or location. The APP also may require mitigation and discharge reduction or elimina-

 


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tion of some discharges. Existing facilities operating under the APP transition provisions are not required to modify operations until requested by the state of Arizona, or unless a major modification at the facility alters the existing discharge characteristics. We have received an APP for our Morenci operations, for portions of our Bagdad and Miami mines, for the sewage treatment facility at Ajo, and for a closed tailing impoundment in Clarkdale, Arizona. We have conducted groundwater studies and submitted APP applications for several of our other properties and facilities, including the Bagdad, Sierrita and Miami mines, our Safford development property and Copper Queen and United Verde branches. Permits for most of these other properties and facilities will likely be issued by ADEQ during 2005. We will continue to submit all required APP applications for our remaining properties and facilities, as well as for any new properties or facilities. We do not know what the APP requirements are going to be for all existing and new facilities, and therefore, it is not possible for us to estimate costs associated with those requirements. We are likely to continue to have to make expenditures to comply with the APP program.

     An application for an APP requires a description of a closure strategy to meet applicable groundwater protection requirements following cessation of operations and a cost estimate to implement the closure strategy. An APP may specify closure requirements, which may include post-closure monitoring and maintenance requirements. A more detailed closure plan must be submitted within 90 days after a permittee notifies ADEQ of its intent to cease operations. A permit applicant must demonstrate its financial capability to meet the closure costs required under the APP. ADEQ has proposed modifications to the financial assurance requirements under the APP regulations.

     Portions of the Company’s Arizona mining operations that operated after January 1, 1986, also are subject to the Arizona Mined Land Reclamation Act (AMLRA). AMLRA requires reclamation to achieve stability and safety consistent with post-mining land use objectives specified in a reclamation plan. Reclamation plans require approval by the State Mine Inspector and must include a cost estimate to perform the reclamation measures specified in the plan. Financial assurance must be provided under AMLRA covering the estimated cost of performing the reclamation plan.

     Both under APP regulations and AMLRA, a publicly traded company may satisfy the financial assurance requirements by showing that its unsecured debt rating is investment grade and that it meets certain requirements regarding assets in relation to estimated closure and post-closure cost and reclamation cost estimates. Phelps Dodge’s senior unsecured debt currently carries an investment-grade rating. Additionally, the Company currently meets another financial strength test under Arizona law that is not ratings dependent.

     At December 31, 2004 and 2003, we had accrued closure costs of approximately $48 million and $43 million, respectively, for our Arizona operations. The amount of financial assurance currently demonstrated for closure and reclamation activities is approximately $105 million. If the Company’s bond ratings fall below investment grade, and if it could not meet the alternative financial strength test that is independent of debt ratings, the Arizona mining operations would be required to supply financial assurance in another form.

     Cyprus Tohono Corporation (Cyprus Tohono), a wholly owned subsidiary of Cyprus Amax, leases lands on the Tohono O’odham Nation (the Nation). The leased lands include the site of a mining operation comprising an open pit, underground mine workings, leach and non-leach rock stockpiles, tailing and evaporation ponds, SX/EW operations and ancillary facilities. Ore mining at Tohono ceased in July 1997, but copper cathode production continued from existing leach stockpiles until early 1999 at which time the site was placed on care-and-maintenance status. As a result of higher copper prices, the facility restarted operations to recover copper from existing leach stockpiles in the 2004 fourth quarter, which allowed initial cathode production in January 2005. Many of these facilities are covered by Mine Plans of Operations (MPOs) that were issued by the federal Bureau of Land Management (BLM). The leases and MPOs impose certain environmental compliance, closure and reclamation requirements upon Cyprus Tohono. The closure and reclamation requirements under the leases require action to be taken upon termination of the leases, which currently expire between 2012 and 2017, unless terminated earlier in accordance with the terms of the leases. Preliminary studies indicate that closure and reclamation requirements, excluding any potential Superfund environmental response costs, are estimated to cost $5.0 million.

     The Nation, along with several federal agencies, has notified Cyprus Tohono of groundwater quality concerns and concerns with other environmental impacts of historical mining operations. In 2003, Cyprus Tohono expanded its groundwater-monitoring well network, and samples from a few of the new wells show contaminant values above primary and secondary drinking water standards. Tests of a neighboring Native American village’s water supply well indicate elevated concentrations of sulfate. Cyprus Tohono has installed new water wells and provided an alternative water supply to the village.

     EPA has completed a Preliminary Assessment and Site Investigation (PA/SI) of the Tohono mine under the federal Superfund program and concluded that the site is eligible for listing on the National Priorities List. Cyprus Tohono initiated an Engineering Evaluation/Cost Analysis (EE/CA) study of potential remedial alternatives to address the former tailing impoundment and evaporation pond areas; this study is being conducted through the EPA Superfund program’s Removal Branch. Based on information in the draft November 2004 EE/CA that was submitted to EPA, the Company increased its reserve for this Superfund matter from $10.9 million to $15.0 million. Cyprus Tohono is conducting treatability testing for the various remedial technologies under consideration in the draft EE/CA, and the Company will re-evaluate its reserve based on the results of those studies. Cyprus Tohono is subject to financial assurance for mine reclamation. It has provided interim financial assurance in the amount of $5.1 million, of which $5.0 million is in the form of a Company performance guarantee.

     The Company’s historic United Verde mine has obtained an APP for closure of a tailing impoundment located near Clarkdale, Arizona, and is awaiting approval of an APP for existing mine water discharge containment facilities at the mine near Jerome, Arizona. The tailing impoundment has not received tailing discharges since the early 1950s, but has received discharges of municipal sewage effluent from the town of Clarkdale since the late 1970s. Closure work under the APP for the tailing impoundment has been partially completed, and the Company intends to submit an amendment to alter the cap design for final closure.

 


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Construction of improvements under the proposed APP for the mine are expected to begin following issuance of the APP. Implementation of the plan under the proposed APP is required under the terms of a Consent Decree settling alleged Clean Water Act violations and entered by the U.S. District Court for the District of Arizona on November 23, 2003. A voluntary remediation project also has commenced under supervision of ADEQ at the nearby historic Iron King mine to manage potential discharges of acidic water from an adit. Additional work may be required at historical mine workings in the district that are owned by the Company to satisfy requirements under stormwater discharge permits. At the United Verde mine, APP and remedial costs are estimated to be approximately $15 million; at the Clarkdale tailing, APP costs are estimated to be approximately $12 million; and at the Iron King mine, voluntary remediation costs are estimated to be approximately $2 million. These amounts, totaling approximately $29 million, are included in environmental reserves at December 31, 2004.

Significant New Mexico Environmental and Reclamation Programs

     Background

     The Company’s New Mexico operations, Chino Mines Company (Chino), Phelps Dodge Tyrone, Inc. (Tyrone), Cobre Mining Company (Cobre) and Phelps Dodge Hidalgo, Inc. (Hidalgo), each are subject to regulation under the New Mexico Water Quality Act and the Water Quality Control Commission (WQCC) regulations adopted under that Act. The New Mexico Environment Department (NMED) has required Chino, Tyrone, Cobre and Hidalgo to submit closure plans for NMED’s approval. The closure plans must describe the measures to be taken to prevent groundwater quality standards from being exceeded following closure of the discharging facilities and to abate any groundwater or surface water contamination.

     Chino, Tyrone and Cobre also are subject to regulation under the New Mexico Mining Act (the Mining Act), which was enacted in 1993, and the Mining Act Rules, which are administered by the Mining and Minerals Division (MMD) of the Energy, Minerals and Natural Resources Department. Under the Mining Act, Chino, Tyrone and Cobre are required to submit and obtain approval of closeout plans describing the reclamation to be performed following closure of the mines or portions of the mines.

     Financial assurance is required to ensure that funding will be available to perform both the closure plans and the closeout plans if the operator is not able to perform the work required by the plans. The amount of the financial assurance is based upon the estimated cost for a third party to complete the work specified in the plans, including any long-term operation and maintenance, such as operation of water treatment systems. NMED and MMD calculate the required amount of financial assurance using a “net present value” (NPV) method, based upon approved discount and escalation rates, when the closure plan and/or closeout plan require performance over a long period of time.

     The Company’s cost estimates to perform the work itself (internal cost basis) generally are substantially lower than the cost estimates used for financial assurance due to the Company’s historical cost advantages, savings from the use of the Company’s own personnel and equipment as opposed to third-party contractor costs and opportunities to prepare the site for more efficient reclamation.

     Chino Mines Company

     NMED issued Chino’s closure permit on February 24, 2003. The closure permit was appealed by a third party. WQCC dismissed the appeal, and that dismissal was appealed to the New Mexico Court of Appeals. If the dismissal is not upheld, WQCC could hold a public hearing on Chino’s closure permit.

     MMD issued a permit revision approving Chino’s closeout plan, subject to conditions, on December 18, 2003. MMD’s permit revision was not appealed. The third-party cost estimate is approximately $395 million (undiscounted and unescalated) over the 100-year period of the closure and closeout plans. Chino has provided financial assurance to NMED and MMD for approximately $192 million (NPV basis), including a trust fund containing approximately $64 million and a third-party performance guarantee for approximately $128 million provided by Phelps Dodge. The guarantee is subject to a financial test that, in part, requires Phelps Dodge to maintain an investment-grade rating on its senior unsecured debt. Phelps Dodge’s senior unsecured debt currently carries an investment-grade rating. If Phelps Dodge’s senior unsecured debt ratings are downgraded below investment grade, Chino could be required to replace some or all of the guarantee with another form of financial assurance.

     The terms of the NMED and MMD permits require Chino to conduct supplemental studies concerning closure and closeout, including a feasibility study. The terms of the NMED permit also require Chino to prepare and submit an abatement plan. Chino is complying with those requirements. The studies and abatement plan are due to be submitted to NMED before an application for renewal of the closure permit is due in August 2007. Changes to the closure permit, which could increase or decrease the estimated cost of closure and closeout, will be considered when the permit is renewed. The permits also contain requirements and a schedule for Chino to commence closure and reclamation of inactive portions of the operations, subject to Chino’s ability to seek “standby status” for portions of the operations anticipated to resume operation in the future.

     The Company estimates its cost, on an internal cost basis, to perform the requirements of the approved Chino closure and closeout permits to be approximately $293 million (undiscounted and unescalated) over the 100-year period of the closure and closeout plans. That estimate is lower than the estimated cost used as the basis for the financial assurance amount due to the factors discussed above, and reflects our internal cost estimate. Our cost estimate, on a third-party cost basis, used to determine the fair value of our closure and closeout accrual for Statement of Financial Accounting Standards (SFAS) No. 143 was approximately $393 million (undiscounted and unescalated). This cost estimate excludes approximately $2 million of net environmental costs from the financial assurance cost estimate that are primarily not within the scope of SFAS No. 143. At December 31, 2004 and 2003, we had accrued approximately $52 million and $39 million, respectively, for closure and closeout at Chino.

     In December 1994, Chino entered into an Administrative Order on Consent (AOC) with NMED. The AOC requires Chino to perform a Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) quality investigation of environmental impacts and potential risks to human health and the environment associated with portions of the Chino property affected by historical mining operations. The remedial investigations began in 1995 and are still under

 


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way, although substantial portions of the remedial investigations are near completion. The Company expects that some remediation will be required, although no feasibility studies have yet been completed. NMED has not yet issued a record of decision regarding any remediation that may be required under the AOC. The Company’s estimated cost for all aspects of the AOC, as of December 31, 2004, is $23.0 million. In addition to work under the AOC, Chino is continuing ongoing projects to control blowing dust at an estimated cost of $4.8 million. Chino initiated work on excavating and removing copper-bearing material from an area known as “Lake One” for copper recovery in existing leach stockpiles at the mine. The Company’s estimated cost, as of December 31, 2004, for the remaining work at Lake One is $1.5 million. The Company’s aggregate environmental reserve for liability under the Chino AOC, the interim work on the tailing impoundments and Lake One, as described above, is $29.3 million.

     Phelps Dodge Tyrone, Inc.

     NMED issued Tyrone’s closure permit on April 8, 2003. Tyrone appealed to the WQCC, which upheld NMED’s permit conditions. Tyrone has appealed the WQCC’s decision to the New Mexico Court of Appeals.

     MMD issued a permit revision approving Tyrone’s closeout plan, subject to conditions, on April 12, 2004. MMD’s permit revision was not appealed. The third-party cost estimate is approximately $439 million (undiscounted and unescalated) over the 100-year period of the closure and closeout plans. Tyrone has provided financial assurance to NMED and MMD for approximately $271 million (NPV basis). The financial assurance includes a trust fund initially funded in the amount of approximately $17 million, to increase to approximately $27 million over five years, a letter of credit for approximately $6 million, a surety bond for approximately $58 million, and a third-party performance guarantee for approximately $190 million provided by Phelps Dodge. Tyrone expects to replace both the letter of credit and the surety bond with other collateral approved by MMD and NMED over the next few months. The guarantee is subject to a financial test that, in part, requires Phelps Dodge to maintain an investment-grade rating on its senior unsecured debt. Phelps Dodge’s senior unsecured debt currently carries an investment-grade rating. If Phelps Dodge’s senior unsecured debt ratings are downgraded below investment grade, Tyrone could be required to replace some or all of the guarantee with another form of financial assurance.

     The terms of the NMED and MMD permits require Tyrone to conduct supplemental studies concerning closure and closeout plans, including a feasibility study. The terms of the NMED permit also require Tyrone to prepare and submit an abatement plan. Tyrone is complying with those requirements. The studies and abatement plan are due to be submitted to NMED before an application for renewal of the closure permit is due in October 2007. Changes to the closure permit, which could increase or decrease the estimated cost of closure and closeout, will be considered when the permit is renewed. The permits also contain requirements and a schedule for Tyrone to commence closure and reclamation of inactive portions of the operations, subject to Tyrone’s ability to seek “standby status” for portions of the operations anticipated to resume operation in the future.

     During 2004, Tyrone commenced certain closure activities with the mining of the 1C Stockpile and placement of re-mined material on existing leach stockpiles for recovery of residual copper. Approximately $18 million was spent in 2004 on the 1C Stockpile removal action. Once removal activities are completed in 2005, the remaining material will be graded and capped to meet stipulated closure requirements. Tyrone also initiated planning for accelerated reclamation of tailing impoundments located within the Mangas Valley, with initial earthwork commencing in November 2004. The project is expected to be completed in 2008. During 2004, Tyrone also substantially completed the reclamation of the Burro Mountain tailing area at an approximate cost of $0.8 million. Upon NMED acceptance of completion for these various projects, Tyrone will request that NMED reduce its financial assurance obligations consistent with the value of the work completed.

     The Company estimates its costs, on an internal cost basis, to perform the requirements of Tyrone’s closure and closeout permits to be approximately $247 million (undiscounted and unescalated) over the 100-year period of the closure and closeout plans. That estimate does not yet reflect the deduction of costs for work performed in 2004, and is lower than the estimated cost used as the basis for the financial assurance amount due to the factors discussed above. Our cost estimate, on a third-party cost basis, used to determine the fair value of our closure and closeout accrual for SFAS No. 143 was approximately $442 million (undiscounted and unescalated). This cost estimate includes approximately $2 million of net costs in addition to the financial assurance cost estimate that primarily relate to an increased scope of work for the tailings and stockpiles, and updated estimates for actual closure expenditures. At December 31, 2004 and 2003, we had accrued approximately $99 million and $81 million, respectively, for closure and closeout at Tyrone.

     Cobre Mining Company

     NMED issued Cobre’s closure permit on December 10, 2004. MMD conducted a public hearing on February 3, 2005, on the proposed issuance of a permit revision approving Cobre’s closeout plan, subject to conditions. The third-party cost estimate is approximately $45 million (undiscounted and unescalated) over the 100-year period of the closure and closeout plans. Cobre has provided financial assurance to NMED and MMD for approximately $29 million (NPV basis). The financial assurance includes a trust fund initially funded in the amount of at least $1 million, to increase to $3 million over five years, real estate collateral for approximately $8 million, and a third-party performance guarantee for approximately $20 million to be provided by Phelps Dodge.

     The terms of the NMED and MMD permits require Cobre to conduct supplemental studies concerning closure and closeout, including a feasibility study. The terms of the NMED permit also require Cobre to prepare and submit an abatement plan. The studies and abatement plan are due to be submitted to NMED before an application to renew the closure permit is due in 2009. Changes to the closure permit, which could increase or decrease the estimated cost of closure and closeout, will be considered when the permit is renewed. The permits also contain requirements and a schedule for Cobre to commence closure and reclamation of inactive portions of the operations, subject to Cobre’s ability to seek “standby status” for portions of the operations anticipated to resume operation in the future.

     Our cost estimate, on a third-party cost basis, used to determine the fair value of our closure and closeout accrual for SFAS No. 143 was approximately $41 million (undiscounted and unescalated). This

 


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estimate will be updated when MMD approves the final closeout plan and establishes the financial assurance amount. At both December 31, 2004 and 2003, we had accrued approximately $7 million for closure and closeout at Cobre.

     Phelps Dodge Hidalgo, Inc.

     Hidalgo obtained approval of a closure plan under a discharge permit issued by NMED in 2000. In accordance with the permit, Hidalgo provided financial assurance to NMED in the form of surety bonds for approximately $11 million. Since obtaining approval of the closure plan, Hidalgo has completed the closure of a former wastewater evaporation pond by construction of a soil cap approved by NMED. The discharge permit under which the closure plan was approved also requires corrective action for contaminated groundwater near the smelter’s closed former wastewater evaporation pond. Impacted groundwater is pumped from a series of wells, treated in a neutralization facility, and discharged to a series of lined impoundments or to an irrigation system. The discharge permit requires a comprehensive groundwater study to characterize groundwater at the site. The discharge permit requires updates of the closure plan, and NMED could require future enhancement of the system based upon the results of the ongoing study when the permit expires in 2005. Hidalgo is not subject to the Mining Act and, consequently, does not require a closeout plan. Our cost estimate, on a third-party cost basis, used to determine the fair value of our closure accrual was approximately $7 million (undiscounted and unescalated). At both December 31, 2004 and 2003, we had accrued approximately $4 million for closure at Hidalgo.

Significant Colorado Reclamation Program

     Our Climax and Henderson mines in Colorado are subject to permitting requirements under the Colorado Mined Land Reclamation Act, which requires approval of reclamation plans and provisions for financial assurance. These mines have had approved mined-land reclamation plans for several years and have provided the required financial assurance to the state of Colorado in the amount of $52.4 million and $10.1 million, respectively, for Climax and Henderson. As a result of adjustments to the approved cost estimates for various reasons, the amount of financial assurance requirements can increase or decrease over time. Discussions are in progress with the Colorado Division of Minerals and Geology regarding the Henderson reclamation plan and related financial assurance. At December 31, 2004 and 2003, we had accrued closure costs of approximately $20 million and $18 million, respectively, for our Colorado operations.

Avian Mortalities and Natural Resources Damage Claims

     Since the fall of 2000, we have been sharing information and discussing various approaches with the U.S. Fish and Wildlife Service (FWS) in conjunction with the FWS investigations of avian mortalities at some of the Company’s mining operations, including Cyprus Tohono, Tyrone, Chino and Morenci. As a result of the FWS investigations, federal authorities have raised issues related to the avian mortalities under two federal laws, the Migratory Bird Treaty Act (MBTA) and the natural resource damages provision of CERCLA. As part of the discussions regarding the MBTA, the FWS has requested that the mining operations undertake various measures to reduce the potential for future avian mortalities, including measures to eliminate or reduce avian access to ponds that contain acidic water. The FWS interprets the MBTA as strictly prohibiting the unauthorized taking of any migratory bird, and there are no licensing or permitting provisions under the MBTA that would authorize the taking of migratory birds as a result of industrial operations such as mining. The Tyrone mine has entered into a settlement agreement with NMED to complete reclamation of its inactive tailing impoundments, which should address many of the avian concerns related to Tyrone. Cyprus Tohono and the Morenci mine also have developed plans for additional measures to address the FWS’s concerns.

     On August 9, 2004, a plea agreement was entered in the U.S. District Court for the District of Arizona to resolve MBTA charges at Morenci, under which Morenci pled guilty to one misdemeanor count. The plea agreement requires Morenci to implement a corrective action plan to address the avian concerns at that mine during a five-year probation period. The plea agreement also required payment of a $15,000 fine and expenditures totaling $90,000 toward identifying options to conduct mitigation projects and bird rehabilitation. Tyrone also is in discussions with the Department of Justice regarding an asserted violation of the MBTA and is using the Morenci plea agreement as a model to resolve this issue. Similar to Morenci, Tyrone expects to be required to implement a corrective action plan to mitigate future avian mortalities.

     The Company received a letter, dated August 21, 2003, from the U.S. Department of Interior as trustee for certain natural resources, and on behalf of trustees from the states of New Mexico and Arizona, asserting claims for natural resource damages relating to the avian mortalities and other matters. The notice cited CERCLA and the Clean Water Act and identified alleged releases of hazardous substances at the Chino, Tyrone and Continental (Cobre Mining Company) mines in New Mexico and the Morenci mine in Arizona. In addition to allegations of natural resource damages relating to avian mortalities, the letter alleges injuries to other natural resources, including other wildlife, surface water and ground water. The letter was accompanied by a Preassessment Screen report. On July 13, 2004, the Company entered into a Memorandum of Agreement (MOA) to conduct a cooperative assessment of the alleged injury. The Company has entered into tolling agreements with the trustees to toll the statute of limitations while the Company and the trustees engage in the cooperative assessment process.

     The Bureau of Indian Affairs (BIA) and the Nation have notified Cyprus Tohono of potential claims for natural resource damages resulting from groundwater contamination and avian mortalities. The Company has expressed a willingness to engage in a cooperative assessment process.

     On February 6, 2004, the Company received a Notice of Intent to Initiate Litigation for Natural Resource Damages from the New Jersey Department of Environmental Protection for the Company’s Port Carteret facility. The Company offered to settle New Jersey’s claim through restoration work. The state has not responded to the Company’s settlement offer.

Other Mining Regulatory Matters

     Some portions of our mining operations located on public lands are subject to mine plans of operation approved by the federal BLM. BLM’s regulations include financial assurance requirements for reclamation plans required as part of the approved plans of operation. As a result of recent changes to BLM’s regulations, including more

 


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stringent financial assurance requirements, increases in existing financial assurance amounts held by BLM could be required. Currently, financial assurance for the Company’s operations held by BLM totals $3.4 million.

     The Company is investigating available options to provide additional financial assurance and, in some instances, to replace existing financial assurance. The cost of surety bonds, the traditional source of financial assurance, has increased significantly during the past few years, and many surety companies are now requiring an increased level of collateral supporting the bonds such that they no longer are economically prudent. Some surety companies that issued surety bonds to the Company are seeking to exit the market for reclamation bonds. The terms and conditions presently available from one of our principal surety bond providers for reclamation and other types of long-lived surety bonds have made this type of financial assurance economically impractical in certain instances. We are working with the impacted state and federal agencies to put in place acceptable alternative forms of financial assurance in a timely fashion.

     Portions of Title 30, Chapter 2, of the United States Code govern access to federal lands for exploration and mining purposes (the General Mining Law). In 2003, legislation was introduced in the U.S. House of Representatives to amend the General Mining Law. Similar legislation was introduced in Congress during the 1990s. None of these bills has been enacted into law. Concepts in the legislation over the years have included the payment of royalties on minerals extracted from federal lands, payment of fair market value for patenting federal lands and reversion of patented lands used for non-mining purposes to the federal government. Several of these same concepts and others likely will continue to be pursued legislatively in the future.

     The federal Endangered Species Act protects species listed by the FWS as endangered or threatened, as well as designated critical habitat for those species. Some listed species and critical habitat may be found in the vicinity of our mining operations. When a federal permit is required for a mining operation, the agency issuing the permit must determine whether the activity to be permitted may affect a listed species or critical habitat. If the agency concludes that the activity may affect a listed species or critical habitat, the agency is required to consult with the FWS concerning the permit. The consultation process can result in delays in the permit process and the imposition of requirements with respect to the permitted activities as are deemed necessary to protect the listed species or critical habitat. The mine operators also may be required to take or avoid certain actions when necessary to avoid affecting a listed species.

     We also are subject to federal and state laws and regulations pertaining to plant and mine safety and health conditions. These laws include the Occupational Safety and Health Act of 1970 and the Mine Safety and Health Act of 1977. Present and proposed regulations govern worker exposure to a number of substances and conditions present in work environments. These include dust, mist, fumes, heat and noise. We are making and will continue to make expenditures to comply with health and safety laws and regulations.

     We estimate that our share of capital expenditures for programs to comply with applicable environmental laws and regulations that affect our mining operations will total approximately $37 million in 2005 and approximately $37 million in 2006; approximately $38 million was spent on such programs in 2004. We also anticipate making significant capital and other expenditures beyond 2006 for continued compliance with such laws and regulations. In light of the frequent changes in the laws and regulations and the uncertainty inherent in this area, we are unable to reasonably estimate the total amount of such expenditures over the longer term, but it may be material. (Refer to the discussion of OTHER ENVIRONMENTAL MATTERS.)

     We do not expect that additional capital and operating costs associated with achieving compliance with the many environmental, health and safety laws and regulations will have a material adverse affect on our competitive position relative to other U.S. copper producers. These domestic copper producers are subject to comparable requirements. However, because copper is an internationally traded commodity, these costs could significantly affect us in our efforts to compete globally with those foreign producers not subject to such stringent requirements.

     On February 7, 2004, the Chilean Ministry of Mining published and passed a modification to its mining safety regulations. The current published regulation requires a company to submit a reclamation plan within five years of the published regulation. Additionally, the Peruvian government approved a new reclamation law for which, as of December 31, 2004, the final regulations had not been defined or published. These potential law changes may impact our asset retirement obligation (ARO) estimates and financial assurance obligations. As of December 31, 2004, our ARO estimates for our Chilean and Peruvian mines were based on the requirements set forth in our environmental permits. We are in the process of determining the requirements and obtaining updated ARO estimates to comply with these new laws. Any potential impact of these new laws on Phelps Dodge cannot be reasonably estimated at this time.

Ownership of Property

U.S. Mining Operations

     In the United States, most of the land occupied by our copper and molybdenum mines, concentrators, SX/EW facilities, smelters, refineries, rod mills, and molybdenum roasters, processing facilities and the Climax technology center generally is owned by, or is located on unpatented mining claims owned by, the Company. Certain portions of our Henderson, Miami, Bagdad, Sierrita, Tyrone, Chino and Cobre operations, and our Process Technology Center, are located on government-owned land and are operated under a Mine Plan of Operations, or other use permit. The Sierrita operation leases property adjacent to its mine upon which its electrowinning tankhouse is located. Cyprus Tohono Corporation holds leases for land, water and business purposes on land owned by the Tohono O’odham Nation. Various federal and state permits or leases on government land are held for purposes incidental to mine operations.

South American Mining

     At the Candelaria, Ojos del Salado, El Abra and Cerro Verde operations in South America, mine properties and facilities are controlled through mining concessions under the general mining laws of the relevant country. The concessions are owned or controlled by the operating companies in which the Company or its subsidiaries have an ownership interest.

 


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Primary Molybdenum Operations

     Climax’s Rotterdam processing operation is located on leased property. The company has leased the land through a series of three 25-year lease periods that commenced on December 1, 1964. The lease agreement will expire on November 30, 2039, unless the company chooses not to use its renewal option for the third extension of 25 years, in which case the lease will end on November 30, 2014.

PHELPS DODGE INDUSTRIES

     PDI is our manufacturing division comprising two business segments that produce engineered products principally for the global energy, transportation and specialty chemicals sectors. Its operations are characterized by products with significant market share, internationally competitive cost and quality, and specialized engineering capabilities. The two segments are Specialty Chemicals and Wire and Cable. The Company is exploring strategic alternatives for PDI that may include potential subsidiary sales, selective asset sales, restructurings, joint ventures and mergers, or, alternatively, retention and selective growth.

Specialty Chemicals Segment

     Columbian Chemicals Company and its subsidiaries (Columbian Chemicals or Columbian), our Specialty Chemicals segment headquartered in Marietta, Georgia, is an international producer and marketer of carbon black. At Columbian Chemicals, we produce a full range of rubber and industrial carbon black in 12 plants worldwide, with approximately 36 percent of our production in North America and the remaining 64 percent at facilities in Europe, Asia and South America. Our El Dorado, Arkansas, plant is idled.

     Our rubber carbon black improves the tread wear and durability of tires, and extends the service lives of many rubber products, such as belts and hoses. Our industrial carbon black is used in such diverse applications as pigmentation of coatings, inks and plastics; ultraviolet stabilization of plastics; and as conductive insulation for wire and cable. We also maintain sales offices worldwide and use a network of distributors where appropriate.

     Extensive research and development is performed at our technology centers located at Marietta, Georgia, and Avonmouth, United Kingdom. These technology centers are responsible for studies specific to both industrial and rubber applications of carbon black. Carbon black product and process development at these technology centers is supported by development work at Columbian’s plants worldwide.

     Beginning in December 2001, Columbian curtailed 54,000 metric tons of annual North American carbon black production at its El Dorado, Arkansas, plant due to significant over-capacity in the U.S. market caused by economic recession. As a part of its annual planning process, Columbian reviewed the probability of reopening its El Dorado plant and determined it unlikely. Columbian recognized a full impairment of the plant’s fixed assets in the amount of $5.9 million during the fourth quarter of 2004. The company will continue to maintain the plant in an idled status, to allow for a restart of operations, until such time as it is determined there is no possibility of bringing the facility back on line.

     In the second quarter of 2000, we acquired the remaining 40 percent share in the carbon black manufacturing business of Columbian Tiszai Carbon Ltd. in Hungary for $19.0 million, bringing our total interest to 100 percent.

     In the first quarter of 2000, we acquired an additional 18 percent ownership in Columbian Carbon Japan, a sales and distribution company serving the Japanese market, bringing our total ownership interest to 68 percent.

Competition and Markets

     The principal competitive factors in the various markets in which our Specialty Chemicals segment competes are product quality, customer service, price, dependability of supply, delivery lead time, breadth of product line, and technical service and innovation.

     Columbian is among the world’s largest producers of carbon black. Approximately 90 percent of the carbon black it produces is used in rubber applications, a substantial portion of which is used in the tire industry. Major tire manufacturers worldwide account for a significant portion of our carbon black sales. In addition, we have maintained a strong competitive position in both the mechanical rubber goods market and the industrial carbon black market based on our commitment to quality, service and technical innovation. Despite ongoing attempts to substitute carbon black with silica, reclaimed rubber or other materials, none has been able to match the cost and performance of carbon black in its principal applications. The closest successful substitute is a silane-treated silica that has made some in-roads in the tire market due to its increased wet traction characteristics for specific applications.

     Including Columbian, there are a total of five major carbon black producers in the United States, three in Canada, three in Western Europe and three in South America. There also are many producers in Asia and Eastern Europe (Russia and the Ukraine). The carbon black industry is highly competitive, particularly in the rubber black market.

Raw Materials and Energy Supplies

     Carbon black is produced primarily from heavy residual oil, a by-product of the crude oil refining process. At Columbian, we purchase substantially all of our feedstock at market prices that fluctuate with world oil prices. Our residual oil feedstock and other raw materials for our specialty chemicals business are purchased from various suppliers. The cost of this feedstock is a significant factor in the cost of carbon black. To achieve satisfactory financial results during periods of high and/or increasing oil prices, we must be able to pass through these high and/or increasing costs to our customers. Hence, we have put in place a number of “formula-based contracts” that allow our selling prices to increase/decrease with feedstock costs. We do not believe that the loss of any one supplier would have a material adverse effect on our financial condition or on the results of our operations.

     Our specialty chemical operations generally use purchased or internally generated electricity and natural gas as their principal sources of energy.

Ownership of Property

     Columbian owns all property other than the leased land at its U.K., German and Korean facilities. This leased land is not material to our overall operations.

 


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Wire and Cable Segment

     The Wire and Cable segment, headquartered in Phoenix, Arizona, consists of three worldwide product line businesses comprising magnet wire, energy cables and specialty conductors.

     Magnet wire, the insulated conductor used in most electrical motors, is manufactured in the United States at our plant in Fort Wayne, Indiana. We also manufacture magnet wire at our wholly owned subsidiary at Monterrey, Mexico. In 2003, we began construction of a new magnet wire production facility in China. The facility, which is in Suzhou, began production during 2004, and will serve the fast-growing demand for magnet wire in China. In 2004, we permanently closed our magnet wire manufacturing facilities at El Paso, Texas, and Mureck, Austria.

     In the 2003 fourth quarter, based upon the continuing reduced market conditions in North America for magnet wire, we determined that our Laurinburg, North Carolina, plant would not re-open and its value was written down by $0.5 million to reflect appraised value. At the end of 2002, this facility was temporarily closed with production being shifted to the El Paso, Texas, and Fort Wayne, Indiana, facilities, and its value was written down by $15.3 million. In 2000, our Hopkinsville, Kentucky, plant was closed; its value was written down by $3.3 million in the second quarter of 2001. The productive assets of our Hopkinsville, Kentucky, plant were moved to other facilities in the United States and Mexico. Its value was written down further by $0.4 million in the 2003 fourth quarter, and then again by $0.6 million in the 2004 second quarter to reflect its appraised value. In the 2004 fourth quarter, Phelps Dodge Magnet Wire completed the sale of the Hopkinsville facility. In 2000, a special, pre-tax charge of $5.8 million was recognized for our wire and cable operations in Austria as a result of the long-term impact of continuing extremely competitive pricing conditions in Europe. In 2004, another special pre-tax charge of $3.3 million was recognized as a result of the closure of this manufacturing facility. In 2004, we also recognized $7.2 million as special, pre-tax items related to closure of our magnet wire facility at El Paso, Texas, and the resulting realignment of our manufacturing facilities in North America.

     In the 2003 fourth quarter, we performed an annual impairment test on goodwill at our magnet wire and high performance conductor facilities through a comparison of carrying values to respective fair values (using an estimate of discounted cash flows) and determined that a $0.9 million charge was required to write-off Magnet Wire’s remaining goodwill balance.

     Phelps Dodge International Corporation manufactures energy cables for international markets in factories located in 10 countries. We provide management, marketing assistance, technical support, and engineering and purchasing services to these companies. Three of our international wire and cable companies have continuous-cast copper rod facilities, and three of our international wire and cable companies have continuous-cast aluminum rod facilities. We have majority interests in companies with production facilities in seven countries – Brazil, Chile, Costa Rica, Honduras, Thailand, Venezuela and Zambia. We also have minority interests in companies located in Hong Kong and Thailand, accounted for on the equity basis, and in a company located in India, accounted for on the cost basis. We operate distribution centers in eight countries in addition to the United States – Guatemala, El Salvador, Honduras, Panama, Puerto Rico, Colombia, Ecuador and South Africa.

     In December 1997, we acquired a 60 percent interest in the Brazilian copper and aluminum wire and cable manufacturing business of Alcoa Aluminio, S.A. (Aluminio) for $72 million. In 2001, Aluminio exercised an optional exit mechanism whereby the Company acquired Aluminio’s remaining 40 percent interest for $44.8 million.

     During the second quarter of 2000, we ceased production at two wire and cable plants in Venezuela due to low forecast plant utilization as a result of significantly reduced infrastructure spending in the Latin America region. These plant closures resulted in a special, pre-tax loss of $26.1 million. We also ceased production at our majority-owned telephone cable operation in El Salvador in the fourth quarter of 2000 due to low plant utilization as a result of heightened global competition for telecommunication cable. The plant closure resulted in a special, pre-tax loss of $5.5 million. A charge of $7.2 million to miscellaneous income and expense was recognized to reflect the impairment of our 40 percent equity interest in a wire and cable operation in the Philippines. The impairment was based upon an analysis of future cash flows of the operation, continuing economic uncertainty in the Philippines and the erosion of our strategic and operating influence.

     We manufacture and market highly engineered conductors of copper and copper alloy wire electroplated with silver, tin or nickel for sophisticated, specialty product niches in the aerospace, automotive, biomedical, computer and consumer electronics markets. Those products are manufactured in plants located in Inman, South Carolina; Trenton, Georgia; and Elizabeth, New Jersey. As part of the manufacturing rationalization program initiated in 1999, leased plants in Fairfield and Montville, New Jersey, were closed in 2000, and the West Caldwell, New Jersey, plant was temporarily closed in 2002 and its value was written down by $1.6 million. In the 2003 fourth quarter, based upon the continuing reduced market conditions in North America for high performance conductors, we determined that our West Caldwell plant would not re-open and its value was written down by $0.8 million to reflect appraised value. Their productive capacities were transferred to the remaining facilities.

     In the 2002 third quarter, actions were taken to improve efficiencies and consolidate certain wire and cable operations. In addition to the above-mentioned closures of our Laurinburg and West Caldwell facilities, we streamlined operational and production support at other high performance conductor facilities in order to reduce costs and increase operating efficiencies, and restructured and consolidated certain administrative functions. The restructuring plan included the reduction of approximately 300 positions and charges associated with employee severance and relocation ($3.9 million) and pension and other postretirement obligations ($2.8 million).

 


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Competition and Markets

     Phelps Dodge is one of the world’s largest manufacturers of magnet wire. Our plants draw, roll and insulate copper and aluminum wire that is sold as magnet wire and bare conductors to original equipment manufacturers for use in electric motors, generators, transformers, televisions, automobiles and a variety of small electrical appliances. Magnet wire also is sold to electrical equipment repair shops and smaller original equipment manufacturers through a network of distributors. We principally compete with two international and two U.S. magnet wire producers.

     Our international energy cable companies primarily sell products to contractors, distributors, and public and private utilities. Our products are used in lighting, power distribution, and other electrical applications. Our competitors range from worldwide wire and cable manufacturers to small local producers.

     Our specialty conductors are sold primarily to intermediaries (insulators, assemblers, subcontractors and distributors). Approximately 40 percent of these products ultimately are sold to commercial and military aerospace companies for use in airframes, avionics, space electronics, radar systems and ground control electronics. Specialty conductors also are used in appliances, instrumentation, computers, telecommunications, military electronics, medical equipment and other products. We have two primary U.S. competitors and compete with three importers in the specialty conductor market; however, in those few markets where we compete for high volume products, we face competition from several U.S. fabricators.

Raw Materials and Energy Supplies

     The principal raw materials used by our magnet wire manufacturing operations are copper, aluminum and various chemicals and resins used in the manufacture of electrical insulating materials. Most of the copper purchased for our magnet wire operations is from our PDMC division.

     The principal raw materials used by our international energy cable companies are copper, copper alloy, aluminum, aluminum alloy, copper-clad steel and various electrical insulating materials.

     The specialty conductor product line usually is plated with silver, nickel or tin. With the exception of copper needed in specialty conductors, the majority of the materials used by these companies are purchased from others. We do not believe that the loss of any one supplier would have a material adverse effect on our financial condition or on the results of our operations.

     Most of our wire and cable operations generally use purchased electricity and natural gas as their principal sources of energy. Our magnet wire company’s principal manufacturing equipment uses natural gas; however, it is also equipped to burn alternative fuels.

Ownership of Property

     We own most of the plants and land on which our wire and cable operations are located. The exceptions are the leased land and buildings of our closed magnet wire facilities in Austria and closed specialty conductor facility in Montville, New Jersey. This land is not material to our overall operations.

Environmental Matters

     Federal and state environmental laws and regulations affect many aspects of our domestic industrial operations. We estimate that capital expenditures for programs to comply with applicable environmental laws and regulations within our PDI division will total approximately $10 million in 2005 and approximately $5 million in 2006; approximately $7 million was spent on such programs in 2004. We anticipate making significant capital and other expenditures beyond 2006 for continued compliance with environmental laws and regulations.

     Our domestic carbon black operations have obtained or are in the process of obtaining major source operating permits under Title V of the CAA and related state laws. These permits typically do not impose new substantive requirements, but rather incorporate in one permit all existing requirements. However, they can increase compliance costs by imposing new monitoring requirements, such as more frequent emission testing, to demonstrate compliance with existing requirements. The process of developing and renewing these comprehensive permits also can bring to light new or previously unknown agency interpretations of existing regulations, which also may increase compliance costs.

     Domestic carbon black plants are subject to the carbon black MACT standard issued in 2002. Capital has been included to meet the compliance deadline of July 2005, which, in the case of the Marshall, West Virginia, plant has been extended until April 2006. Our Fort Wayne magnet wire plant is subject to the Miscellaneous Metal Parts and Products (MMPP) MACT standard under the federal CAA. The MMPP MACT standard for magnet wire plants was issued in 2003 with a compliance date of 2007. We continue to monitor the development and implementation of other MACT standards.

     The European Union (EU) has commenced work on the development of Best Available Technology (BAT) for the carbon black industry. The current BAT Reference Document (BREF Note) proposes to control sulfur dioxide emissions by limiting the annual sulfur content in feedstocks to between 0.5 percent to 1.5 percent, depending upon local ambient conditions. The lower part of this range, if adopted, could negatively impact the carbon black industry, including Columbian. Columbian, through the carbon black industry trade association, is actively involved in reviewing with the EU the proposed limits. The final BREF Note is expected to be ready by the end of 2005, so that BAT can be reflected in EU environmental operating (IPPC) permits that must be issued by the end of October 2007.

     The EU and certain other countries are beginning to implement greenhouse gas (GHG) reduction plans for various industry segments to meet targets under the Kyoto Treaty. Carbon black production is not currently listed as an activity subject to the European Directive, but will likely be included by certain member states or specifically included in later lists. The initial step is to be identified as a potential GHG generating facility so that a GHG inventory can be developed, with GHG reduction targets ultimately being established by industry sector. Columbian continues to monitor this process.

     Because of the frequent changes in environmental laws and regulations and the uncertainty these changes create for us, we are unable to estimate reasonably the total amount of such expenditures over the longer term, but it may be material to our results of opera-

 


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tions. (Refer to the discussion of OTHER ENVIRONMENTAL MATTERS.)

LABOR MATTERS

     Employees at PDMC’s Arizona operations, El Paso refinery and rod mill, Tyrone, the Norwich and Chicago rod mills, the Henderson mine in Colorado, the Fort Madison, Iowa, molybdenum processing facility, and over half of the employees at Chino are not represented by any unions.

     Our El Abra mine in Chile has two labor agreements covering approximately 418 and 66 employees that expire in November 2008. Candelaria has two labor agreements covering approximately 508 and 105 employees that expire in April 2006. Our Ojos del Salado mine does not have any employees covered by labor agreements. Cerro Verde has one labor agreement covering approximately 429 employees that expires in December 2008. Our Chino mine in Hurley, New Mexico, had two agreements covering approximately 447 employees that expired in November 2002. The employees represented by one of the two unions decertified their union during 2004. Chino now has one union representing 243 employees and negotiations are ongoing in regard to this agreement. Our molybdenum operation in Rotterdam had an agreement covering approximately 45 employees that expired in December 2004. Negotiations are expected to begin in the 2005 second quarter in regard to this agreement. Our molybdenum operation in Stowmarket has an agreement covering approximately 44 employees that expires in May 2005. Our Braithwaite plant near New Orleans, Louisiana, is a discontinued operation on care-and-maintenance status. An agreement covering four employees expired in January 2004. The represented employees decertified their union during 2004.

     In addition, we currently have labor agreements covering most of our U.S. and international manufacturing division plants. Our specialty chemicals plant in Trecate, Italy, had one internal agreement covering 85 employees that expired in December 2004; negotiations are expected to begin in the first quarter of 2005 in regard to that agreement. Trecate also has an agreement covering nine managers that expires in December 2008, and one with the National Chemicals Industries that expires in December 2005. Our specialty chemicals plant in Hamilton, Ontario, Canada, has an agreement covering 60 employees that expires in November 2006. Our specialty chemicals facilities in Cubatao and Sao Paulo, Brazil, have agreements covering 216 and 26 employees, respectively, that expire in October 2005. Our specialty chemicals plant in Bristol, United Kingdom, has an agreement covering 68 employees that expires in May 2005. There are three trade unions involved in the labor agreement. Our specialty chemicals plant in Hannover, Germany, has an agreement covering 50 employees that expires in August 2005. Our specialty chemicals plant in Yosu, South Korea, has a wage agreement covering 40 employees that expired in February 2005; negotiations are expected to begin in mid-2005. The agreement for contract language for Columbian Chemicals Korea expires in July 2005. Our specialty chemicals plant in Santander, Spain, has an agreement covering 44 employees that expires in December 2005. Our specialty chemicals plant in Marshall, West Virginia, has two agreements covering 59 employees that expire in June 2005. Our specialty chemicals North Bend plant in Franklin, Louisiana, has an agreement covering 109 employees that expires in February 2006.

     Employees at PDWC’s operations in Bentonville, Arkansas, El Paso, Texas, Inman, South Carolina, Trenton, Georgia, China, Costa Rica, Honduras and Thailand are not represented by any unions.

     Our wire plant in Elizabeth, New Jersey, has an agreement covering approximately 45 employees that expires in April 2007. Our plant in Zambia has an agreement covering approximately 90 employees that expires in July 2005. Our magnet wire plant in Monterrey, Mexico, has an agreement covering approximately 230 employees that expires in March 2005. Our magnet wire plant in Fort Wayne, Indiana, has an agreement covering approximately 190 employees that expires in May 2005. Our wire and cable facilities in Brazil have agreements covering approximately 350 and 25 employees that expire in September and November 2005, respectively. Our wire and cable facilities in Venezuela have agreements covering approximately 140 and 100 employees that expire in October 2006 and December 2006, respectively. Our wire and cable plant in Chile has an agreement covering approximately 140 employees that expires in May 2007.

RESEARCH AND DEVELOPMENT

     We conduct research and development programs relating to technology for exploration for minerals, mining and recovery of metals from ores, concentrates and solutions, smelting and refining of copper, metal processing and product and engineered materials development. We also conduct research and development programs related to our carbon products through Columbian Chemicals, and our wire insulating processes and materials and conductor materials and processes through our Wire and Cable segment. Expenditures for all of these research and development programs, together with contributions to industry and government-supported programs, totaled $32.5 million in 2004, compared with $30.2 million in 2003 and $26.0 million in 2002.

OTHER ENVIRONMENTAL MATTERS

     Phelps Dodge is subject to various 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. The Company also is 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 cleanup of hazardous substances released from the facility into the environment, including injuries to natural resources. In addition, the Company is subject to potential liabilities under the Resource Conservation and Recovery Act (RCRA) and analogous state laws that require responsible parties to remediate releases of hazardous or solid waste constituents into the environment associated with past or present activities.

     Phelps Dodge or its subsidiaries have been advised by EPA, the U.S. Forest Service and several state agencies that they may be liable under CERCLA or similar state laws and regulations for costs of responding to environmental conditions at a number of sites that have been or are being investigated by EPA, the U.S. Forest Service or states to determine whether releases of hazardous substances have occurred and, if so, to develop and implement remedial actions

 


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to address environmental concerns. Phelps Dodge also has been advised by trustees for natural resources that the Company may be liable under CERCLA or similar state laws for injuries to natural resources caused by releases of hazardous substances.

     Phelps Dodge has established reserves for potential environmental obligations that management considers probable and for which reasonable estimates can be made. For closed facilities and closed portions of operating facilities with closure obligations, an environmental liability is considered probable and is accrued when a closure determination is made and approved by management. Environmental liabilities attributed to CERCLA or analogous state programs are considered probable when a claim is asserted, or is probable of assertion, and we have been associated with the site. Other environmental remediation liabilities are considered probable based upon specific facts and circumstances. Liability estimates are based on an evaluation of, among other factors, currently available facts, existing technology, presently enacted laws and regulations, Phelps Dodge’s experience in remediation, other companies’ remediation experience, Phelps Dodge’s status as a potentially responsible party (PRP), and the ability of other PRPs to pay their allocated portions. Accordingly, total environmental reserves of $303.6 million and $317.2 million were recorded as of December 31, 2004 and 2003, respectively. The long-term portion of these reserves is included in other liabilities and deferred credits on the Consolidated Balance Sheet and amounted to $239.5 million and $271.3 million at December 31, 2004 and 2003, respectively.

     The site currently considered to be the most significant is the Pinal Creek site near Miami, Arizona. Current year adjustments to reserves pertained primarily to the Yonkers site.

Pinal Creek Site

     The Pinal Creek site was listed under the ADEQ Water Quality Assurance Revolving Fund program in 1989 for contamination in the shallow alluvial aquifers within the Pinal Creek drainage near Miami, Arizona. Since that time, environmental remediation has been performed by the members of the Pinal Creek Group (PCG), comprising Phelps Dodge Miami, Inc. (a wholly owned subsidiary of the Company) and two other companies. (For a description of the litigation associated with this site including litigation in respect of other potentially responsible parties, refer to page 34).

     While significant recoveries may be achieved in the contribution litigation, the Company cannot reasonably estimate the amount and, therefore, has not taken potential recoveries into consideration in the recorded reserve.

Yonkers Site

     In 1984, the Company sold a cable manufacturing facility located in Yonkers, New York. Pursuant to the sales agreement, the Company agreed to indemnify the buyer for certain environmental liabilities at the facility. In 2000, the owner of the property entered into a consent order with the New York State Department of Environmental Conservation (NYSDEC) under which the owner committed to complete a remedial investigation and feasibility study. In December 2001, the Company entered into an Interim Agreement with the owner of the property regarding the owner’s claim for both contractual and statutory indemnification from the Company for certain environmental liabilities at the facility. The owner submitted its revised feasibility study to NYSDEC in September 2004. On November 30, 2004, NYSDEC issued a Proposed Remedial Action Plan (PRAP) for the Yonkers site. The PRAP accepted the remedy recommendation of the feasibility study, with certain modifications. On December 31, 2004, the Company and the Yonkers site owner finalized a settlement agreement that relieves the Company of financial responsibility for implementation of the NYSDEC’s remedy at the Yonkers site. Pursuant to this settlement agreement, the Company agreed to pay a portion of the future anticipated remedial costs, as well as portions of the premiums associated with cost cap and pollution legal liability insurance associated with future site remedial actions. In addition, the Company resolved the site owner’s claims of contractual and statutory indemnity for past remedial costs at the site. To address all aspects of the settlement agreement, the reserve was increased from approximately $20 million to $50 million. A partial payment of approximately $43 million was made on December 31, 2004; final payments of approximately $7 million will be made in 2005.

Laurel Hill Site

     Phelps Dodge Refining Corporation, a subsidiary of the Company, owns a portion of the Laurel Hill property in Maspeth, New York, that formerly was used for metal-related smelting, refining and manufacturing. All industrial operations at the Laurel Hill site ceased in 1984. In June 1999, the Company entered into an Order on Consent with NYSDEC that required the Company to perform, among other things, a remedial investigation and feasibility study relating to environmental conditions and remedial options at the Laurel Hill site. NYSDEC issued a final remedial decision in January 2003 in the form of a Record of Decision (ROD) regarding the property. The Company expects to complete the work under the ROD by 2006.

     In July 2002, Phelps Dodge entered into another Order on Consent with NYSDEC requiring the Company to conduct a remedial investigation and feasibility study relating to sediments in Newtown and Maspeth Creeks, which are located contiguous to the Laurel Hill site. The Company commenced the remedial investigation in 2004. The Company is engaged in preliminary discussions with NYSDEC concerning the types of remedial actions that should be considered in the feasibility study.

Other

     In 2004, the Company recognized charges of $58.9 million for environmental remediation. As discussed above, the site with significant charges was the Yonkers site (an increase of $30.4 million). The remainder of environmental remediation charges was primarily at closed sites, none of which increased or decreased individually more than $5 million.

     At December 31, 2004, the cost range for reasonably possible outcomes for all reservable environmental remediation sites other than Pinal Creek and Yonkers was estimated to be from $156 million to $358 million, of which $186 million has been reserved. Significant work is expected to be completed in the next several years on the sites that constitute a majority of the reserve balance, subject to inherent delays involved in the remediation process.

     Phelps Dodge believes certain insurance policies partially cover the foregoing environmental liabilities; however, some of the insurance carriers have denied coverage. We presently are negotiating with the carriers over some of these disputes. Further, Phelps Dodge

 


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believes it has other potential claims for recovery from other third parties, including the United States Government and other PRPs. Neither insurance recoveries nor other claims or offsets are recognized unless such offsets are considered probable of realization. In 2004 and 2003, the Company recognized proceeds from settlements reached with several insurance companies on historic environmental liability claims of $9.3 million and $0.5 million, net of fees and expenses, respectively.

     Phelps Dodge has a number of sites that are not the subject of an environmental reserve because it is not probable that a successful claim will be made against the Company for those sites, but for which there is a reasonably possible likelihood of an environmental remediation liability. At December 31, 2004, the cost range for reasonably possible outcomes for all such sites for which an estimate can be made was estimated to be from $3 million to $17 million. The liabilities arising from potential environmental obligations that have not been reserved at this time may be material to the results of any single quarter or year in the future. Management, however, believes the liability arising from potential environmental obligations is not likely to have a material adverse effect on the Company’s liquidity or financial position as such obligations could be satisfied over a period of years.

     Our operations are subject to many environmental laws and regulations in jurisdictions both in the United States and in other countries in which we do business. For further discussion of these laws and regulations, refer to PDMC - Environmental and Other Regulatory Matters and PDI - Environmental Matters. The estimates given in those discussions of the capital expenditures to comply with environmental laws and regulations in 2005 and 2006, and the expenditures in 2004 are separate from the reserves and estimates described above.

     The Environmental, Health and Safety Committee of the Board of Directors comprises five non-management directors. The Committee met four times in 2004 to review, among other things, the Company’s policies with respect to environmental, health and safety matters, and the adequacy of management’s programs for implementing those policies. The Committee reports on such reviews and makes recommendations with respect to those policies to the board of directors and to management.

Item 3. Legal Proceedings

I. We are a member of several trade associations that, from time to time, initiate legal proceedings challenging administrative regulations or court decisions that the membership considers to be improper and potentially adverse to their business interests. These legal proceedings are conducted in the name of the trade associations, and the members of the trade association are not parties, named or otherwise.

II. Arizona water regulations, water rights adjudications and other related water cases.

     A. General Background

          Arizona surface water law is based on the doctrine of prior appropriation (first in time, first in right). Surface water rights in Arizona are usufructuary rights, and as such the water right holder is granted only the right to use public waters for a statutorily defined beneficial use, at a designated location. Groundwater in Arizona is governed by the doctrine of reasonable use. Arizona has initiated two water rights adjudications in order to quantify and prioritize all of the surface water rights and water right claims to two of the state’s river systems and sources. Groundwater is not subject to the adjudication; however, wells may be adjudicated to the extent that they are found to produce or impact appropriable surface water. The two adjudication cases that could potentially impact Phelps Dodge’s surface water rights and claims (including some wells) are entitled In Re The General Adjudication of All Rights to Use Water in the Little Colorado Water System and Source, Arizona Superior Court, Apache County, Cause No. 6417 filed on or about February 17, 1978 and In Re The General Adjudication of All Rights to Use Water in the Gila River System and Source, Arizona Superior Court, Maricopa County, Cause Nos. W-1 (Salt), W-2 (Verde), W-3 (Upper Gila), W-4 (San Pedro), (consolidated) filed on February 17, 1978. The major parties in addition to Phelps Dodge in the Gila River adjudication are: Gila Valley Irrigation District, the San Carlos Irrigation and Drainage District, the state of Arizona, the San Carlos Apache Tribe, the Gila River Indian Community, and the United States on behalf of those Tribes, on its own behalf, and on the behalf of the White Mountain Apache Tribe, Ft. McDowell Mohave-Apache Indian Community, Salt River Pima-Maricopa Indian Community and the Payson Community of Yavapai Apache Indians. The major parties in addition to Phelps Dodge in the Little Colorado adjudication are: the state of Arizona, the Salt River Project, Arizona Public Service Company, the Navajo Nation, the Hopi Indian Tribe, the San Juan Southern Paiute Tribe and the United States on behalf of those Indian Tribes, on its own behalf, and on behalf of the White Mountain Apache Tribe.

          Phelps Dodge has four active mining operations in Arizona: Morenci, Miami, Sierrita and Bagdad. Each operation requires water for mining and all related support facilities. With the exception of Bagdad, each operation is located in a watershed within an ongoing surface water adjudication. Each operation has sufficient water claims to cover its operational demands. In many instances, the water supply may come from a variety of possible sources. The potential impact of the surface water adjudications on each active operation is discussed below.

     B. Operations

          Morenci – The Morenci operation is located in eastern Arizona. Morenci water is supplied by a combination of sources, including decreed surface water rights in the San Francisco River, Chase Creek and Eagle Creek drainages, groundwater from the Upper Eagle Creek wellfield, and Central Arizona Project (CAP) water leased from the San Carlos Apache Tribe and delivered to Morenci via exchange through the Black River Pump Station. Phelps Dodge has filed Statements of Claimants in the adjudication for each of its water sources for Morenci except the CAP water.

          Phelps Dodge’s decreed water rights are subject to the Gila River adjudication and potentially could be impacted. Although the purpose of the adjudication is to determine only surface water rights, wells such as those in the Upper Eagle Creek wellfield may be subject to the Gila River adjudication, but only to the extent those wells may be determined to capture or impact appropriable surface water. The CAP water provided via exchange is not subject to any state

 


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adjudication process. The CAP lease became effective as of January 1, 1999, and has a 50-year term.

          Miami – The Miami operation obtains water from a number of sources in the Salt River watershed. Statements of Claimants have been filed in connection with these water sources, each of which is subject to the adjudication and could be potentially impacted. Miami currently holds a CAP subcontract, although CAP water is not currently used at the operation. CAP water is not subject to adjudication; however, an exchange agreement has been executed to allow the delivery of this water to the Miami operation.

          Sierrita – The Sierrita operation is located in the Santa Cruz River watershed. The water for the operation is groundwater. The wells that supply the water may be subject to the Gila River adjudication only to the extent that such wells are determined to be pumping or impacting appropriable surface water. Phelps Dodge has filed Statements of Claimants in the adjudication for these water sources in case any are later determined to produce or impact appropriable surface water. In 1980, the Arizona legislature enacted the Arizona Groundwater Code. The Code established Active Management Areas (AMA’s) in several groundwater basins, including the Santa Cruz Groundwater Basin. The groundwater at this operation is subject to regulation under the Tucson AMA.

          Bagdad – The Bagdad operation is located in the Bill Williams River watershed. The water supply includes claims to both surface water and groundwater. There is not an active adjudication proceeding in this watershed; however, the legal precedent set in the active adjudications regarding the determination of whether water pumped from wells is treated as surface water or groundwater may impact the use of water from some wells.

     C. Other Arizona Mining Properties

          The potential impact of the ongoing adjudication on other mining properties is discussed below.

          Safford – Water for the planned future operation at Safford may come from a combination of sources. Wells that supply groundwater may be used and those wells will be subject to the adjudication only to the extent that such wells are determined to be pumping or impacting appropriable surface water. CAP water may also be considered for use at the operation some time in the future. CAP water is not subject to adjudication; however, an exchange agreement will need to be negotiated in order to deliver the water. The implementation of such an exchange will require approval of the Globe Equity Court as well as environmental reviews and related agency approvals.

          Ajo – The potential water supply for Ajo is groundwater. The wells that supply the water may be subject to the Gila River adjudication to the extent that such wells are determined to be pumping or impacting appropriable surface water. Phelps Dodge has filed a Statement of Claimant in the adjudication for these water sources in case any are later determined to produce or impact appropriable surface water.

          Bisbee – The potential water supply for Bisbee is groundwater. The wells that supply the water may be subject to the Gila River adjudication to the extent that such wells are determined to be pumping or impacting appropriable surface water. Phelps Dodge has filed a Statement of Claimant in the adjudication for these water sources in case any are later determined to produce or impact appropriable surface water.

     D. Water Settlements

          1. Gila River Indian Community Water Settlement

     On May 4, 1998, Phelps Dodge executed a settlement agreement with the Gila River Indian Community (the Community) that resolves the issues between Phelps Dodge and the Community pertinent to the Gila River adjudication. Since that time, comprehensive settlement negotiations with users all along the Gila River have been initiated. Phelps Dodge’s settlement with the Community is now included in the comprehensive settlement. Federal legislation authorizing the settlement was passed in December 2004. The final enforceability date, however, will not occur until certain provisions in the associated agreements are met. The parties have until December 31, 2007, to meet their obligations for the settlement to become enforceable.

          2. San Carlos Apache Tribe

     In 1997, issues of dispute arose between Phelps Dodge and the San Carlos Apache Tribe (the Tribe) regarding Phelps Dodge’s use and occupancy of the Black River Pump Station, which delivers water to the Morenci operation. In May 1997, Phelps Dodge reached an agreement with the Tribe, and subsequently federal legislation (Pub. L. No. 105-18, 5003, 111 stat. 158, 181-87) was adopted. The legislation prescribes arrangements intended to ensure a future supply of water for the Morenci mining complex in exchange for certain payments by Phelps Dodge. The legislation does not address any potential claims by the Tribe relating to Phelps Dodge’s historical occupancy and operation of Phelps Dodge facilities on the Tribe’s Reservation, but does require that any such claims be brought, if at all, exclusively in federal district court. As of this writing, no such claims have been filed.

     The 1997 legislation required that the Company and the Tribe enter a lease for the delivery of CAP water through the Black River Pump Station to Morenci on or before December 31, 1998. In the event a lease was not signed, the legislation expressly provided that the legislation would become the lease. On January 24, 2002, a lease between the San Carlos Apache Tribe, Phelps Dodge and the United States was executed (effective as of January 1, 1999) in accordance with that legislation. On the same date, and in accordance with the legislation, an Exchange Agreement between the San Carlos Apache Tribe, the United States and the Salt River Project Water User’s Association was executed and subsequently approved by Phelps Dodge. Since that date, CAP water has been delivered to Morenci. Phelps Dodge has not reached a settlement with the Tribe on general water issues and Phelps Dodge water claims within the Gila River adjudication are still subject to litigation with the Tribe and other parties.

     E. Other Related Cases

          The following proceedings involving water rights adjudications are pending in the U.S. District Court of Arizona:

          1. On June 29, 1988, the Gila River Indian Community filed a complaint-in-intervention in United States v. Gila Valley Irrigation District, et al., and Globe Equity No. 59 (D. Ariz.). The underlying action was initiated by the United States in 1925 to determine conflicting claims to water rights in certain portions of the Gila River watershed.

 


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Although Phelps Dodge was named and served as a defendant in that action, Phelps Dodge was dismissed without prejudice as a defendant in March 1935. In June 1935, the Court entered a decree setting forth the water rights of numerous parties, but not Phelps Dodge’s. The Court retained, and still has, jurisdiction of the case. The complaint-in-intervention does not name Phelps Dodge as a defendant, however, it does name the Gila Valley Irrigation District as a defendant. Therefore, the complaint-in-intervention could affect the approximately 3,000 acre-feet of water that Phelps Dodge has the right to divert annually from Eagle Creek, Chase Creek or the San Francisco River pursuant to Phelps Dodge’s decreed rights and an agreement between Phelps Dodge and the Gila Valley Irrigation District.

          During 1997 and 1998, Phelps Dodge purchased farmlands with associated water rights that are the subject of this litigation. As a result, Phelps Dodge has been named and served as a party in this case. The lands and associated water rights are not currently used in connection with any Phelps Dodge mining operation.

          Phelps Dodge’s Miami operation (formerly named Cyprus Miami Mining Corporation) was named and served as a defendant in this action in 1989. These proceedings may affect water rights associated with former Cyprus Miami lands in the Gila River watershed.

          2. Prior to January 1, 1983, various Indian tribes filed several suits in the U.S. District Court for the District of Arizona claiming prior and paramount rights to use waters, which at present are being used by many water users, including Phelps Dodge, and claiming damages for prior use in derogation of their allegedly paramount rights. These federal proceedings have been stayed pending state court adjudication.

          3. Cyprus Sierrita Corporation’s predecessor in interest was a defendant in United States, et al. v. City of Tucson, et al., No. CIV 75-39 (D. Ariz.). This is a consolidation of several actions seeking a declaration of the rights of the United States, the Papago Indian Tribe (now known as the Tohono O’odham Nation), and individual allottees of the Tohono O’odham Nation, to surface water and groundwater in the Santa Cruz River watershed; damages from the defendants’ use of surface water and groundwater from the watershed in derogation of those rights; and injunctive relief. Congress in 1982 enacted the Southern Arizona Water Rights Settlement Act, which was intended to resolve the water right claims of the Tohono O’odham Nation and its member allottees relating to the San Xavier Reservation and the Schuk Toak District of the Sells Papago Reservation. The allottees contested the validity of the Act and contended that the Court could not dismiss the litigation without their consent. This prompted additional litigation, and eventually culminated in settlement negotiations. The Court suspended most aspects of the litigation to enable the parties to negotiate a settlement with the allottees. The Court’s recent attention has been devoted to the composition of appropriate classes of allottees and identification of class representatives, so that any settlement that is reached would bind the allottees. It is anticipated that a settlement and authorizing legislation would conclude all litigation on behalf of the Tohono O’odham Nation, its allottee members, and the United States as Trustee for the nation and its allottee members, relating to water rights. Federal legislation has been passed authorizing a settlement. The parties have until December 31, 2007, to finalize the agreements and meet certain obligations for the settlement to become enforceable. The outcome of this dispute could impact water right claims associated with the acquired Cyprus operations at Sierrita, and miscellaneous former Cyprus land holdings in the Santa Cruz River watershed.

III. On October 1, 1997, the U.S. Environmental Protection Agency (EPA) issued a Notice of Violation (NOV) to Cyprus Amax’s (now the Company’s) Sierrita operations in southeastern Arizona. The NOV alleged certain emission standards and permitting violations associated with the molybdenum roasting facility at Sierrita. On September 6, 2000, EPA also issued an NOV to Phelps Dodge Sierrita for alleged violations of Prevention of Significant Deterioration permitting requirements, and New Source Performance Standards under the federal Clean Air Act. The Company and the EPA reached a settlement of the issues raised in the NOVs. The settlement agreement was embodied in a consent decree, which, along with a formal complaint, was lodged with the United States District Court for the District of Arizona on June 21, 2004, United States and State of Arizona v. Phelps Dodge Sierrita, Inc., No. CIV 04-312 TUC FRZ, and entered by the Court on August 12, 2004. The state of Arizona joined in the complaint and consent decree, although it did not join in most of the allegations made by EPA. Without admitting any of the allegations, the Company agreed to pay a civil penalty totaling $1.4 million to be divided between the United States and the state of Arizona. The Company also agreed to undertake certain monitoring and permitting actions, including continuous emissions monitoring at the molybdenum roasting facility.

IV. The Pinal Creek site was listed under the Arizona Department of Environmental Quality’s Water Quality Assurance Revolving Fund program in 1989 for contamination in the shallow alluvial aquifers within the Pinal Creek drainage near Miami, Arizona. Since that time, environmental remediation has been performed by members of the Pinal Creek Group (PCG), comprising Phelps Dodge Miami, Inc. (a wholly owned subsidiary of the Company) and two other companies. In 1998, the District Court approved a Consent Decree between the PCG members and the state of Arizona resolving all matters related to an enforcement action contemplated by the state of Arizona against the PCG members with respect to the groundwater matter. The Consent Decree committed Phelps Dodge Miami, Inc. and the other PCG members to complete the remediation work outlined in the Consent Decree. That work continues at this time pursuant to the Consent Decree and consistent with state law and the National Contingency Plan prepared by EPA under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA).

     Phelps Dodge Miami, Inc. and the other members of the PCG are pursuing contribution litigation against three other parties involved with the site. At least two of the three defendants now have admitted direct liability as responsible parties. The first phase of the case has been assigned a trial date in June 2005. Phelps Dodge Miami, Inc. also asserted claims against certain past insurance carriers. As of November 2002, all of the carriers have settled or had their liability adjudicated. One carrier unsuccessfully appealed the judgment against it and then settled in October 2004.

     In addition, a dispute between one dissenting PCG member and Phelps Dodge Miami, Inc. and the other PCG member was filed in Superior Court in 2002. The settlement of that litigation in September 2004 included an amendment of the PCG agreement.

 


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     Approximately $111 million remained in the Company’s Pinal Creek remediation reserve at December 31, 2004. While significant recoveries may be achieved in the contribution litigation, the Company cannot reasonably estimate the amount and, therefore, has not taken potential recoveries into consideration in the recorded reserve.

V. The Company’s wholly owned subsidiary, Cyprus Amax Minerals Company (Cyprus), was the plaintiff in an action entitled Cyprus Amax Minerals Company v. Asarco Incorporated, No. 99 CIV 11198 (LMM), which was filed on November 9, 1999, in the U.S. District Court for the Southern District of New York. The action arose out of the merger agreement between Cyprus and Asarco dated as of July 15, 1999 (the merger agreement). The complaint alleged, among other things, that Asarco breached the merger agreement and a subsequent agreement by soliciting an alternative takeover proposal for Asarco from another company. Cyprus sought, among other things, compensatory damages of not less than $90 million.

     Asarco moved for summary judgment on all of Cyprus’ claims on November 10, 2003. That motion was granted on October 14, 2004, in favor of Asarco.

VI. On October 18, 2002, the Mining and Minerals Division (MMD) of the New Mexico Energy, Minerals and Natural Resources Department issued NOVs under the New Mexico Mining Act Rules (NMMAR) to Chino Mines Company (Chino), Phelps Dodge Tyrone, Inc. (Tyrone) and Cobre Mining Company (Cobre). The NOVs allege that Chino, Tyrone and Cobre failed to obtain approval of closeout plans as required by NMMAR by October 1, 2002. A closeout plan under NMMAR consists of a plan for reclamation of a mining operation following cessation of operations and financial assurance sufficient for MMD to complete the closeout plan if the operator defaults. The NOVs would have established schedules requiring that the alleged violations be abated by April 20, 2003, for Chino, June 30, 2003, for Cobre and September 30, 2003, for Tyrone. The NOVs did not assess civil penalties, but reserved the right to assess penalties in the future in accordance with the penalty assessment procedures in NMMAR. The NOVs further stated that if the alleged violations were not abated by the dates set in the NOVs, MMD would issue “cessation orders” in accordance with NMMAR requiring that mining operations cease until the alleged violation is abated. On November 1, 2002, Chino, Tyrone and Cobre each filed Petitions for Review of the NOVs with the New Mexico Mining Commission (Commission). The Petitions for Review contended that closeout plan approval was not possible by October 1, 2002, because of delays by the New Mexico Environment Department (NMED) in issuing discharge permits for closure and issuing determinations that the closeout plans for Chino, Tyrone and Cobre are expected to achieve compliance with environmental standards, including compliance with water quality standards. The Petitions requested that the NOVs be vacated or, in the alternative, that different dates be set for abatement of the alleged violations that allow a reasonable period of time after NMED issues its discharge permits to obtain approval of the closeout plans. The Commission held a public hearing on December 13-14, 2002, on the Petitions for Review. The Commission upheld the NOVs but modified the period for abatement for each mine to run from the dates when NMED issues the discharge permits for closure for the mines. Under the modified NOVs, Chino, Cobre and Tyrone will have seven, nine and 12 months, respectively, after NMED issues their closure permits to obtain approval of their closeout plans.

     NMED issued Chino’s closure permit on February 24, 2003. Since the closure permit was issued, Chino has engaged in discussions to resolve the amount and form of financial assurance required by NMED and MMD and the details of the closeout plan approval by MMD. To allow additional time to finalize applicable documentation and to hold a public hearing as required under the Mining Act, MMD issued orders extending the deadline for Chino’s closeout plan approval to December 19, 2003. MMD approved Chino’s closeout plan on December 18, 2003. Chino’s closure permit has been appealed by third parties to the Water Quality Control Commission (WQCC). Chino filed a motion to dismiss the appeal due to the failure to follow required procedures, which was granted by the WQCC. The WQCC’s decision has been appealed to the New Mexico Court of Appeals.

     NMED issued Tyrone’s closure permit on April 8, 2003, and Tyrone’s closeout plan was approved by MMD on April 12, 2004. On July 12, 2004, Tyrone filed an appeal of a decision by the WQCC affirming the conditions of Tyrone’s closure permit to the New Mexico Court of Appeals. Tyrone is complying with the requirements of the closure permit pending the outcome of the appeal.

     NMED issued Cobre’s closure permit on December 10, 2004. MMD held a public hearing on February 3, 2005, and is expected to take action on the plan in the first quarter of 2005.

VII. Since approximately 1990, Phelps Dodge or its subsidiaries have been named as a defendant in a number of product liability or premises lawsuits brought by electricians and other skilled tradesmen or contractors claiming injury from exposure to asbestos found in limited lines of electrical wire products produced or marketed many years ago, or from asbestos at certain Phelps Dodge properties. Phelps Dodge presently believes its liability, if any, in these matters will not have a material adverse effect, either individually or in the aggregate, upon its business, financial condition, liquidity, results of operations or cash flow. There can be no assurance; however, that future developments will not alter this conclusion.

VIII . On September 30, 2002, Columbian Chemicals Company, a subsidiary of the Company, received an administrative complaint from EPA for alleged violations of the Clean Air Act at its El Dorado, Arkansas, carbon black plant. On April 19, 2004, Columbian signed a Consent Agreement and First Order (Consent) resolving this matter. The Consent requires Columbian to pay a civil penalty of $39,300 and fund a Supplement Environmental Project in the amount of $75,700 for a total settlement amount of $115,000.

IX. On November 7, 2002, the United Kingdom Environment Agency (Agency) issued an enforcement notice to Columbian Chemicals Company’s Sevalco plant in the United Kingdom. This notice followed Sevalco’s disclosure to the Agency in October 2002 that Sevalco had discovered irregularities in its effluent discharge reports, and requires the plant to implement procedures to ensure that discharges satisfy permit limits and are properly reported. At a hearing in Magistrates’ Court in Bristol, England, on November 15, 2004, Sevalco pled guilty to six charges concerning the alleged submission of incorrect data to the Agency and operation of a process not in accordance with its operating permit. The magistrates referred the case to Crown’s Court for sentencing. At the hearing in

 


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Crown’s Court on December 8, 2004, the Court imposed a fine of 40,000 pounds per offense plus Agency’s costs of 70,000 pounds for a total fine of 310,000 pounds (approximately U.S. $598,000), which Sevalco has paid.

X. In November 2002, Columbian Chemicals Company was contacted by U.S. and European antitrust authorities regarding a joint investigation they initiated into alleged price fixing in the carbon black industry. European antitrust authorities reviewed documents at three of Columbian Chemicals’ facilities in Europe, and U.S. authorities contacted Columbian Chemicals’ headquarters in Marietta, Georgia, but have not requested documents or other information.

XI. The Company and Columbian Chemicals Company, together with several other companies, were named as defendants in an action entitled Technical Industries, Inc. v. Cabot Corporation, et al., No. CIV 03-10191 WGY, filed on January 30, 2003, in the U.S. District Court in Boston, Massachusetts, and 14 other actions filed in four U.S. district courts, on behalf of a purported class of all individuals or entities who purchased carbon black directly from the defendants since January 1999. The Judicial Panel on Multidistrict Litigation consolidated all of these actions in the U.S. District Court for the District of Massachusetts under the caption In Re Carbon Black Antitrust Litigation. The consolidated amended complaint filed in these actions does not name the Company as a defendant. The consolidated amended complaint, which alleges that the defendants fixed the prices of carbon black and engaged in other unlawful activities in violation of the U.S. antitrust laws, seeks treble damages in an unspecified amount and attorneys’ fees. Columbian Chemicals Company and other defendants filed a motion to dismiss the consolidated amended complaint for failure to state a claim. The plaintiffs have filed a motion for class certification. The court has denied the motion to dismiss and has certified a class that includes all direct purchasers of carbon black in the United States from January 30, 1999 through January 18, 2005. Discovery is ongoing.

     Similar class actions have been filed in state courts in California, North Carolina, Florida, Kansas, New Jersey, South Dakota and Tennessee on behalf of indirect purchasers of carbon black in those and 17 other states and the District of Columbia alleging violations of state antitrust and deceptive trade practices laws. Columbian has also received a demand for relief on behalf of indirect purchasers in Massachusetts, but no lawsuit has been filed in state court. In the class action filed in state court in North Carolina, the court granted the defendants’ motion to dismiss and the plaintiff dropped his appeal of the decision, so that case has been dismissed. The court in the New Jersey action denied a motion to dismiss; the defendants have filed a motion for leave to take an interlocutory appeal.

     The Company believes the claims are without merit and intends to defend the lawsuits vigorously.

XII. In November 2002, EPA issued a unilateral administrative order (UAO) under CERCLA to the Company’s wholly owned subsidiary, Western Nuclear, Inc., and two other companies, Kerr McGee Corporation and Fremont Lumber Company (collectively, the PRPs) requiring the companies to perform certain remedial design (RD) and remedial action (RA) work at the White King/Lucky Lass Uranium Mines site near Lakeview, Oregon. The PRPs do not believe the UAO was lawfully issued because EPA failed to recognize the joint responsibility of the U.S. government under applicable laws and to perform non-discretionary duties to ensure federal government responsibility for remediating the site prior to issuance of the UAO. The PRPs notified the EPA of their intent to sue and obtain, among other things, a judicial determination of the illegality of the UAO.

     The PRPs voluntarily commenced and undertook the RD work (but not RA work) required by the UAO, and advised the EPA of their position and progress. From January 2003 through July 2003, the PRPs and EPA exchanged letters expressing their respective positions concerning the validity of the UAO. On July 31, 2003, the EPA rejected the PRPs’ position, notifying them that penalties are accruing for the alleged violations of the UAO and that the purported penalties through the end of July 2003 total approximately $5.2 million.

     On September 19, 2003, the PRPs served a complaint on the Acting Administrator of the EPA, which seeks to have the federal district court of Oregon declare the UAO unlawful for failure to comply with the requirement under CERCLA to ensure federal government participation in remedying the site. Fremont Lumber Company, et al. v. Horinko, No. 03-CV-1073-AS (D. Ore.). On December 15, 2003, EPA answered the complaint and denied the PRPs’ allegations of non-compliance with CERCLA. On January 12, 2004, EPA filed a complaint against the PRPs seeking to enforce the PRPs’ compliance with the UAO and to recover administrative penalties and response costs incurred at the site. The cases have been consolidated and the litigation has been stayed until March 2005. The PRPs and EPA have commenced discussions in an effort to settle all outstanding issues.

Item 4. Submission of Matters to a Vote of Security Holders

     No matters were submitted during the fourth quarter of 2004 to a vote of security holders through solicitation of proxies or otherwise.

 


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Executive Officers of Phelps Dodge Corporation

     The executive officers of Phelps Dodge Corporation are elected to serve at the pleasure of its board of directors. As of February 28, 2005, the executive officers of Phelps Dodge Corporation were as follows:

                     
 
                Officer of the
    Age at       Corporation
Name   2/28/05   Position   Since
 
J. Steven Whisler
    50     Chairman of the Board and Chief Executive Officer     1987  
 
                   
 
Timothy R. Snider
    54     President and Chief Operating Officer     1997  
 
                   
 
Ramiro G. Peru
    49     Executive Vice President and Chief Financial Officer     1995  
 
                   
 
Arthur R. Miele
    63     Senior Vice President-Marketing; President, Phelps Dodge Sales Company     1987  
 
                   
 
Kalidas V. Madhavpeddi
    49     Senior Vice President-Asia; President, Phelps Dodge Wire and Cable Group     1999  
 
                   
 
S. David Colton
    49     Senior Vice President and General Counsel     1998  
 
                   
 
David L. Pulatie
    63     Senior Vice President-Human Resources     1999  
 
                   
 
David C. Naccarati
    52     President, Phelps Dodge Mining Company        
 
                   
 
James P. Berresse
    44     President and Chief Executive Officer, Columbian Chemicals Company        
 
                   
 

     Mr. Whisler was elected Chairman of the Corporation in May 2000, and has been Chief Executive Officer since January 2000. He was President from December 1997 to October 2003 and was also Chief Operating Officer from December 1997 until January 2000. He was President of Phelps Dodge Mining Company, a division of the Corporation, from 1991 to October 1998.

     Mr. Snider was elected President and Chief Operating Officer in November 2003. Prior to that time, Mr. Snider was Senior Vice President of the Corporation, a position he held since 1998.

     Mr. Peru was elected Executive Vice President in October 2004. He was elected Senior Vice President and Chief Financial Officer in January 1999. Prior to that time, Mr. Peru was Senior Vice President for Organization Development and Information Technology, a position he held since January 1997. Prior to that, Mr. Peru was Vice President and Treasurer of the Corporation, a position he held since 1995.

     Mr. Miele was elected Senior Vice President-Marketing in June 2000. Prior to that time, he served as Vice President-Marketing since 1987. Mr. Miele is also President, Phelps Dodge Sales Company, a position he has held since October 1987.

     Mr. Madhavpeddi was elected Senior Vice President-Asia in October 2004. He was elected President, Phelps Dodge Wire and Cable Group in May 2002 and Senior Vice President, Business Development in November 2000. Prior to that time, Mr. Madhavpeddi was elected Vice President, Business Development in November 1999.

     Mr. Colton was elected Senior Vice President in November 1999. He was elected Vice President and General Counsel in April 1998. Prior to that time, Mr. Colton was Vice President and Counsel for Phelps Dodge Exploration, a position he held since 1995.

     Mr. Pulatie was elected Senior Vice President-Human Resources in March 1999. Mr. Pulatie joined Phelps Dodge in March 1999 after a 34-year career with Motorola, Inc.

     Mr. Naccarati was appointed to the Corporation’s Senior Management Team, as well as elected President, Phelps Dodge Mining Company in October 2004. He was elected Vice President, North American Mining, Phelps Dodge Mining Company, in October 2003. Prior to that time, Mr. Naccarati was President, Phelps Dodge Morenci, Inc., a position he held since 2001. Prior to that time, he was President, PD Candelaria, Inc., a position he held since 1999. Prior to that, he was President, Phelps Dodge Tyrone, Inc., a position he held since 1997.

     Mr. Berresse was appointed to the Corporation’s Senior Management Team in November 2003. He was elected President and Chief Executive Officer of Columbian Chemicals Company in April 2002. He was elected Executive Vice President, Columbian Chemicals Company, in October 2001. Prior to that time, Mr. Berresse was Senior Vice President, Finance and Business Development, and Chief Financial Officer, Columbian Chemicals Company, positions he held since August 1998.

 


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PART II

Item 5. Market for the Registrant’s Common Equity and Related Stockholder Matters

     The information called for in paragraphs (a) and (b) of Item 5 appears on pages 88 through 89 and page 116 of this report.

(c) Issuer Purchases of Equity Securities

The following table sets forth information with respect to shares of common stock of the Company purchased by the Company during the three months ended December 31, 2004:

                                 
                    (c) Total Number of     (d) Maximum Number (or  
                    Shares (or Units)     Approximate Dollar Value)  
    (a) Total Number     (b) Average Price     Purchased as Part of     of Shares (or Units) That May  
    of Shares (or Units)     Paid Per     Publicly Announced     Yet Be Purchased Under  
Period   Purchased*     Share (or Unit)     Plans or Programs     the Plans or Programs  
 
                       
October 1-31, 2004
    958     $ 94.08              
November 1-30, 2004
    14,980       89.50              
December 1-31, 2004
    9,669       95.85              
 
                         
Total
    25,607       92.07              
 
                         
 
                               
 

*   The shares shown have been repurchased under the Company’s applicable restricted stock plans (Plans) and its non-qualified supplemental savings plan (SSP). Through the Plans, certain employees may elect to satisfy their tax obligations on restricted stock awards by having the Company withhold a portion of their shares of restricted stock. Additionally, the Company repurchases shares in the SSP as a result of changes in investment elections by plan participants.

 


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Item 6. Selected Financial Data

     The following financial and operating data should be read in conjunction with the information set forth in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and related notes thereto appearing in this Annual Report.

     
   
($ in millions except per share and per pound amounts)
   
                                         
    Year Ended December 31,*
    2004 (a)     2003 (b)     2002 (c)     2001 (d)     2000 (e)  
     
Statement of Operations Data
                                       
Sales and other operating revenues
  $ 7,089.3       4,142.7       3,722.0       4,002.4       4,525.1  
Operating income (loss)
    1,503.6       197.6       (209.3 )     (28.8 )     268.2  
Income (loss) before extraordinary item and cumulative effect of accounting changes
    1,046.3       18.1       (315.2 )     (329.5 )     56.3  
Net income (loss)
    1,046.3       94.8       (338.1 )     (331.5 )     56.3  
Basic earnings (loss) per common share before extraordinary item and cumulative effect of accounting changes
    11.06       0.06       (3.86 )     (4.19 )     0.72  
Diluted earnings (loss) per common share before extraordinary item and cumulative effect of accounting changes
    10.58       0.06       (3.86 )     (4.19 )     0.72  
Basic earnings (loss) per common share
    11.06       0.92       (4.13 )     (4.22 )     0.72  
Diluted earnings (loss) per common share
    10.58       0.91       (4.13 )     (4.22 )     0.72  
 
                                       
Balance Sheet Data (at period end)
                                       
Current assets
  $ 2,661.7       1,790.0       1,428.2       1,531.2       1,542.7  
Total assets
    8,594.1       7,272.9       7,029.0       7,584.3       7,841.2  
Total debt
    1,096.9       1,959.0       2,110.6       2,871.6       2,687.7  
Long-term debt
    972.2       1,703.9       1,948.4       2,538.3       1,963.0  
Shareholders’ equity
    4,343.1       3,063.8       2,813.6       2,730.1       3,184.4  
Cash dividends declared per common share
    0.50                   0.75       2.00  
 
                                       
Other Data
                                       
Net cash provided by operating activities
  $ 1,726.2       470.5       348.0       302.7       511.2  
Capital expenditures and investments
    317.3       102.4       133.2       311.0       422.3  
Net cash (used in) investing activities
    (291.0 )     (87.7 )     (140.3 )     (266.8 )     (274.2 )
Net cash provided by (used in) financing activities
    (947.2 )     (48.8 )     (244.8 )     101.0       (221.2 )
 
                                       
Division Results
                                       
Phelps Dodge Mining Company operating income (loss)
  $ 1,606.7       265.2       (65.0 )     (83.6 )     276.0  
Phelps Dodge Industries operating income
    47.5       68.5       30.6       74.0       70.3  
Corporate and Other operating loss
    (150.6 )     (136.1 )     (174.9 )     (19.2 )     (78.1 )
     
 
  $ 1,503.6       197.6       (209.3 )     (28.8 )     268.2  
     
 
                                       
Copper
                                       
Copper production – thousand short tons (h)
    1,260.6       1,059.3       1,028.8       1,160.1       1,200.3  
Copper sales from own mines – thousand short tons (h)
    1,268.9       1,069.3       1,051.1       1,170.8       1,200.6  
COMEX copper price (per pound) (f)
  $ 1.29       0.81       0.72       0.73       0.84  
LME copper price (per pound) (g)
  $ 1.30       0.81       0.71       0.72       0.82  
 
                                       
Commercially recoverable copper (million tons)
                                       
Ore reserves (h)
    24.3       19.5       19.6       22.1       23.1  
Stockpiles and in-process inventories (h)
    1.8       1.6       1.4       0.9       1.0  
     
 
    26.1       21.1       21.0       23.0       24.1  
     
     
   

*   2004 reflected full consolidation of El Abra and Candelaria; 2003-2000 reflected El Abra and Candelaria on a pro rata basis (51 percent and 80 percent, respectively).

     
   

 


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     All references to per share earnings or loss are based on diluted earnings (loss) per share.

(a)   Reported amounts included after-tax, net special charges of $44.7 million, or 45 cents per common share, for environmental provisions; $30.9 million (net of minority interest), or 31 cents per common share, for early debt extinguishment costs; $9.9 million, or 10 cents per common share, for the write-down of two cost-basis investments; $9.6 million, or 10 cents per common share, for taxes on anticipated foreign dividends; $9.0 million, or 9 cents per common share, for a deferred tax asset valuation allowance at our Brazilian wire and cable operation; $7.6 million, or 8 cents per common share, for Magnet Wire restructuring activities; $5.9 million, or 6 cents per common share, for asset impairments; and $0.7 million, or 1 cent per common share, for interest on a Texas franchise tax matter; partially offset by special gains of $30.0 million, or 31 cents per common share, for the reversal of a U.S. deferred tax asset valuation allowance; $15.7 million (net of minority interest), or 16 cents per common share, for the reversal of an El Abra deferred tax asset valuation allowance; $10.1 million, or 10 cents per common share, for the gain on the sale of uranium royalty rights; $7.4 million, or 7 cents per common share, for environmental insurance recoveries; and $4.7 million, or 5 cents per common share, for the settlement of historical legal matters.

(b)   Reported amounts included after-tax, net special gains of $2.4 million, or 3 cents per common share, for the termination of a foreign postretirement benefit plan; $0.5 million, or 1 cent per common share, for environmental insurance recoveries; $0.2 million for the reassessment of prior restructuring programs; $6.4 million, or 7 cents per common share, on the sale of a cost-basis investment; $8.4 million, or 9 cents per common share, for cumulative effect of an accounting change; $1.0 million, or 1 cent per common share, for the tax benefit relating to additional 2001 net operating loss carryback; and an extraordinary gain of $68.3 million, or 76 cents per common share, on the acquisition of our partner’s one-third interest in Chino Mines Company; partially offset by charges of $27.0 million, or 30 cents per common share, for environmental provisions; $8.0 million, or 9 cents per common share, for a probable Texas franchise tax matter; $2.9 million, or 3 cents per common share, for the settlement of historical legal matters; and $2.6 million, or 3 cents per common share, for asset and goodwill impairments.

(c)   Reported amounts included after-tax, net special charges of $153.5 million, or $1.82 per common share, for PDMC asset impairment charges and closure provisions; $53.0 million, or 63 cents per common share, for historical lawsuit settlements; $45.0 million, or 54 cents per common share, for a historical arbitration award; $26.6 million, or 32 cents per common share, for early debt extinguishment costs; $23.0 million, or 27 cents per common share, for Phelps Dodge Industries restructuring activities; $22.9 million, or 27 cents per common share, for cumulative effect of an accounting change; $14.0 million, or 17 cents per common share, for environmental provisions; $1.2 million, or 1 cent per common share, for the write-off of two cost-basis investments; and $1.0 million, or 1 cent per common share, for the settlement of legal matters; partially offset by special gains of $29.1 million, or 35 cents per common share, for environmental insurance recoveries; $22.6 million, or 27 cents per common share, for the gain on the sale of a non-core parcel of real estate; $13.0 million, or 15 cents per common share, for the release of deferred taxes previously provided with regard to Plateau Mining Corporation; and $66.6 million, or 79 cents per common share, for the tax benefit relating to the net operating loss carryback prior to 2002 resulting from a change in U.S. tax legislation.

(d)   Reported amounts included after-tax, net special gains of $61.8 million, or 79 cents per common share, for environmental insurance recoveries; $39.9 million, or 51 cents per common share, for the gain on the sale of Sossego; $9.0 million, or 11 cents per common share, for an insurance settlement for potential future legal matters; offset by special charges of $57.9 million, or 74 cents per common share, to provide a deferred tax valuation allowance; $31.1 million, or 40 cents per common share, for environmental provisions; $29.8 million, or 38 cents per common share, for restructuring activities; $12.9 million, or 16 cents per common share, for investment impairments; $2.0 million, or 3 cents per common share, for the cumulative effect of an accounting change; and $3.4 million, or 4 cents per common share, for other items, net.

(e)   Reported amounts included after-tax, net special charges of $56.4 million, or 72 cents per common share, for restructuring activities; partially offset by gains of $10.1 million, or 13 cents per common share, for an income tax refund and related interest; and $3.0 million, or 4 cents per common share, for an insurance settlement refund.

(f)   New York Commodity Exchange annual average spot price per pound — cathodes.
 
(g)   London Metal Exchange annual average spot price per pound — cathodes.
 
(h)   2004 reflected production, sales and commercially recoverable copper on a consolidated basis; 2003-2000 reflected that information on a pro rata basis.
     
   

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The information called for in Item 7 appears on pages 41 through 89 of this report.

     
   

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

The information called for in Item 7A appears on pages 41 through 43 and 78 through 83 of this report.

     
   

Item 8. Financial Statements and Supplementary Data

The information called for in Item 8 appears on pages 92 through 137 of this report.

     
   

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

     
   

Item 9A. Controls and Procedures

     Disclosure Controls and Procedures

     The Company maintains a system of disclosure controls and procedures that is designed to ensure information required to be disclosed by the Company is accumulated and communicated to management, including our chief executive officer and chief financial officer, in a timely manner.

     An evaluation of the effectiveness of this system of disclosure controls and procedures was performed under the supervision and with the participation of the Company’s management, including the Company’s chief executive officer and chief financial officer, as of the end of the period covered by this report. Based upon this evaluation, the Company’s management, including the Company’s chief executive officer and chief financial officer, concluded that the current system of controls and procedures is effective.

     Management’s Annual Report on Internal Control Over Financial Reporting and Report of Independent Registered Public Accounting Firm

     The reports required to be furnished pursuant to this item appear on pages 90 and 91, respectively.

     Changes in Internal Control Over Financial Reporting

     The Company’s management, including the Company’s chief executive officer and chief financial officer, has evaluated the Company’s internal control over financial reporting to determine whether any changes occurred during the fourth fiscal quarter covered by this annual report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. Based on that evaluation, there has been no such change in the Company’s internal control over financial reporting that occurred during the fourth fiscal quarter.

     
   

Item 9B. Other Information

None.

 


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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     
   

     The following provides information that management believes is relevant to an assessment and understanding of the consolidated results of operations and financial condition of Phelps Dodge Corporation (the Company, which also may be referred to as Phelps Dodge, PD, we, us or our). It should be read in conjunction with the Consolidated Financial Statements and accompanying Notes. Our business consists of two major divisions, Phelps Dodge Mining Company (PDMC) and Phelps Dodge Industries (PDI).

     The United States securities laws provide a “safe harbor” for certain forward-looking statements. This annual report contains forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those projected in such forward-looking statements. Statements regarding the expected commencement dates of operations, projected quantities of commercially recoverable copper and molybdenum from ore reserves and stockpiles, projected quantities of future production, capital costs, production rates, cash flow and other operating and financial data are based on expectations that the Company believes are reasonable, but we can give no assurance that such expectations will prove to have been correct.

     Factors that could cause actual results to differ materially include, among others: risks and uncertainties relating to general U.S. and international economic and political conditions; the cyclical and volatile price of copper, molybdenum and other commodities; political and economic risks associated with foreign operations; unanticipated ground and water conditions; geological problems; metallurgical and other processing problems; availability of materials and equipment; delays in the receipt of or failure to receive necessary government permits; appeals of agency decisions or other litigation; volatility in the price or availability of oil (the main feedstock for our carbon black operations), diesel fuel, electricity and natural gas; currency fluctuations; changes in laws or regulations or the interpretation and enforcement thereof (including changes in treaties or laws governing international trade or tariffs); the occurrence of unusual weather or operating conditions; force majeure events; lower than expected ore grades and recovery rates; the failure of equipment or processes to operate in accordance with specifications or expectations; unanticipated difficulties consolidating acquired operations and obtaining expected synergies; labor relations; accidents; delays in anticipated start-up dates; environmental risks; the ability to obtain anticipated cost savings and efficiencies; the ability to obtain satisfactory insurance coverage; the ability to obtain surety bonds or other financial assurance for reclamation obligations; and the results of financing efforts and financial market conditions.

     These and other risk factors are discussed in more detail herein. Many such factors are beyond our ability to control or predict. Readers are cautioned not to put undue reliance on forward-looking statements. We disclaim any intent or obligation to update these forward-looking statements, whether as a result of new information, future events or otherwise.

Overview of Phelps Dodge Corporation’s Businesses and Management’s Assessment of Key Factors and Indicators that Could Impact Our Business, Operating Results and Cash Flows

     Phelps Dodge is the world’s second-largest producer of copper, a world leader in the production of molybdenum, the largest producer of molybdenum-based chemicals and continuous-cast copper rod, and among the leading producers of magnet wire and carbon black. PDMC is our international business division comprising our vertically integrated copper operations from mining through rod production, primary molybdenum operations from mining through conversion to chemical and metallurgical products, marketing and sales; and worldwide mineral exploration, technology and project development programs. Our copper mines include Morenci, Bagdad, Sierrita, Miami, Chino, Cobre and Tyrone in the United States and Candelaria, Cerro Verde, El Abra and Ojos del Salado in South America. The Primary Molybdenum segment includes our Henderson and Climax molybdenum mines.

     PDI is our manufacturing division comprising two business segments that produce engineered products principally for the global energy, transportation and specialty chemicals sectors. Its operations are characterized by products with significant market share, internationally competitive costs and quality, and specialized engineering capabilities. Columbian Chemicals Company, our specialty chemicals segment, is one of the world’s largest producers of engineered carbon black, with facilities in North America, Europe, South America and Asia. Phelps Dodge Wire and Cable, our Wire and Cable segment, consists of three worldwide product-line businesses comprising magnet wire, energy cables and specialty conductors.

     The Company currently is exploring strategic alternatives for PDI that may include potential subsidiary sales, selective asset sales, restructurings, joint ventures and mergers, or, alternatively, retention and selective growth.

     From an overall Phelps Dodge perspective, some of the most significant risks associated with our businesses, or factors that could impact our businesses, operating results and cash flows, are the volatility of copper and molybdenum prices, increased energy costs, our cost structure, environmental and regulatory compliance, and mine closure regulations. Additionally, our ability to replenish our copper and molybdenum ore reserves, which are depleted as we mine, is important to our long-term viability.

Markets. Copper is a fundamental material used in residential and commercial construction, electrical and electronics equipment, transportation, industrial machinery and consumer durable goods. Copper is an internationally traded commodity and is traded on the London Metal Exchange (LME), the New York Commodity Exchange (COMEX) and the Shanghai Futures Exchange (SHFE). The prices on these exchanges generally reflect the worldwide balance of copper demand and supply and various U.S. and international macroeconomic and political conditions. The copper market is volatile and cyclical. During the past 15 years, prices per pound have ranged from a high of $1.54 to a low of 60 cents. Any material change in the price we receive for copper has a significant effect on our results. Based upon expected 2005 annual consolidated production of approximately 2.7 billion pounds of copper, each 1 cent per pound change in our average annual realized copper price (or our average

 


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annual unit cost of production) causes a variation in annual operating income before taxes and adjustments for minority interests of approximately $27 million. Consequently, a sustained and uninterrupted period of unusually high or low copper prices has a dramatic impact on our profits and cash flow.

     After a protracted downturn in demand and correspondingly lower prices that began in the early part of 2000, the market dynamics for copper began improving at the end of 2003 and continued throughout 2004.

     In 2003, China overtook the United States as the largest consumer of refined copper in the world and retained this position during 2004. United States consumption was strong during 2004 as industrial production grew approximately 4.4 percent. Reported world exchange inventories fell from approximately 800 thousand metric tons at the end of 2003 to approximately 125 thousand metric tons at the end of 2004. The ramp-up of production by copper producers, including Phelps Dodge, increased production approximately 5 percent, but did not keep pace with consumption growth of more than 7 percent. This produced a large deficit in 2004 of approximately 800 thousand metric tons, which reduced global inventories to critical levels. These market fundamentals, combined with record speculative positions, a weakening U.S. dollar and low U.S. interest rates, resulted in COMEX copper prices averaging $1.29 per pound in 2004, almost 50 cents above the average for 2003. COMEX copper prices increased to $1.49 per pound at the end of 2004.

     Phelps Dodge expects that continued strong demand for copper, led by China, combined with lagging growth in refined copper supply because of smelter capacity constraints in the first half of 2005, will generally result in a supply deficit that is expected to support copper prices in 2005.

     Molybdenum is characterized by volatile, cyclical prices, even more so than copper. Prices are influenced by worldwide economic conditions, world supply/demand balances, inventory levels, currency exchange rates, production costs of U.S. and foreign competitors, and other factors. Molybdenum demand depends heavily on the global steel industry, which uses the metal as a hardening and corrosion inhibiting agent. More than 80 percent of molybdenum is used in this application. The remainder is used in specialty chemical applications such as catalysts, water treatment agents and lubricants. A substantial portion of world molybdenum production is a by-product of copper mining, which is relatively insensitive to molybdenum prices. During the past 15 years, Metals Week Dealer Oxide mean prices per pound have ranged from a high of $33.25 to a low of $1.82.

     Molybdenum experienced a significant price improvement during 2004, far outpacing those recorded in the previous two years. The Metals Week Dealer Oxide mean price increased more than 200 percent from the 2003 mean price of $5.32 per pound to $16.41 per pound in 2004. Global production increased approximately 15 percent in 2004. We estimate demand increased approximately 11 percent in 2004 to 370 million pounds. For 2005, Phelps Dodge expects supply to increase while demand remains strong. We anticipate that supply increases will occur as producers improve recoveries and increase capacity utilization to meet growing demand. The stainless steel, specialty steel and specialty chemical sectors are expected to continue to grow, led by capital spending increases and growth in China. The overall supply/demand outlook for 2005 is for a generally balanced market.

     Wire and cable products serve a variety of different markets, including energy, construction, consumer and industrial products, aerospace, medical devices, transportation and natural resources. Products include magnet wire, energy cables and specialty conductors. These products advance technology and support infrastructure development in growing regions of the world.

     During 2004, wire and cable sales experienced an increase in sales and profitability resulting from increased metal prices and increased demand in the international markets. For 2005, wire and cable products are expected to continue to experience an increase in sales and profitability as the U.S. and world economies continue to recover.

     Carbon black is a key raw material used in the manufacture of tires, rubber and plastic products, inks, paints and coatings, and a variety of other applications. Carbon black demand is primarily driven by the needs of the tire industry, which consumes nearly 70 percent of world production. In 2004, world demand for carbon black exceeded 7.8 million metric tons.

     During the past decade, global demand for carbon black has grown at slightly more than 3 percent per year, and this growth rate is projected to approach 4 percent per year during the remainder of the decade. Increased worldwide vehicle demand and growth in demand for larger tire sizes and high-performance tires have contributed to this sustained growth rate for carbon black.

     Despite strong growth of carbon black that was fueled by global growth in tire and industrial production in 2004, the rise in raw material and other costs had an adverse effect on the performance of Phelps Dodge’s carbon black subsidiary, Columbian Chemicals Company. Price increases for carbon black in all regions were not sufficient to overcome the fast and significant increase in raw material and other costs. Although the outlook for 2005 is positive, with continued global growth of carbon black consumption of approximately 4 percent, any resulting improvement in prices are expected to be partially mitigated by continued high raw material and other costs and competitive pressures.

Energy Costs. Energy, including electricity, diesel fuel and natural gas, represents a significant portion of the production costs for our operations. The principal sources of energy for our mining operations are electricity, purchased petroleum products and natural gas. The principal sources of energy in our wire and cable and specialty chemicals operations are purchased electricity and natural gas. In addition, the price of residual oil feedstock is a significant factor in the cost of our specialty chemicals products because the carbon black we produce is made primarily from heavy residual oil.

     In response to volatile energy markets in 2000 and 2001, we implemented a power cost stabilization plan that moderated electricity-related costs at our U.S. mining operations. Under the plan, we use a combination of multi-year energy contracts that we put in place at favorable points in the price cycle as well as self-generation and natural gas hedging. Additionally, we enter into price protection programs for our diesel fuel and natural gas purchases to protect us against significant short-term upward movements in energy prices while maintaining the flexibility to participate in any favorable price

 


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movements. However, because energy is a significant portion of our production costs, we could be negatively impacted by future energy availability issues or increases in energy prices. For example, as our diesel fuel and natural gas price protection programs were extended at gradually increasing prices, our energy cost per pound of copper increased in 2004. In 2005, we may continue to experience higher energy costs if the current energy commodity prices remain at the levels experienced in 2004.

     We continue to explore alternatives to moderate or offset the impact of increasing energy costs. To address volatility associated with a shortfall of power generation capacity experienced in the 2000 energy crisis in the western United States, in late 2004, we purchased a one-third interest in a partially constructed power plant in New Mexico owned by Duke Energy Luna, LLC. The plant is expected to be operating by the 2006 second quarter. One-third of its electricity (approximately 190 megawatts) is expected to be consumed by PDMC operations in New Mexico and Arizona. This investment in an efficient, low-cost plant is expected to continue to stabilize our southwest U.S. operations’ energy costs and increase the reliability of our energy supply.

Cost Structure. Our cost structure for copper production is generally higher than that of some major producers, whose principal mines are located outside the United States. This is due to lower ore grades, higher labor costs (including pension and health-care costs) and, in some cases, stricter regulatory requirements. Our competitive cost position receives much attention from senior management. In 2001 we implemented a company-wide, comprehensive lean-production program, called Quest for Zero (QFZ). QFZ is a comprehensive continuous improvement process whereby we strive to achieve zero accidents, zero lost-time injuries, zero defects, zero environmental discharges, improve both product and process quality, apply technology in new and innovative ways, increase yields and increase revenues. The success of the business improvement teams we formed to execute our QFZ program led us in 2003 to reorganize our North American mining operations into what we call North America One Mine. This organizational plan has been designed to enable us to shift QFZ from a project-based approach to a process-focused approach, i.e., emphasis is on driving optimization through common site processes and sharing of best practices. We believe QFZ is an important foundation for our operations to be competitive throughout the business cycle.

Environmental and Mine Closure Regulatory Compliance. Our operations in the United States are subject to stringent federal, state and local laws and regulations relating to improving or maintaining environmental quality. Our global operations also are subject to many environmental protection laws in the jurisdictions where we operate. Environmental laws often require parties to pay for remedial action or to pay damages regardless of fault. Environmental laws also often impose liability with respect to divested or terminated operations, even if the operations were terminated or divested many years ago. The federal Clean Air Act has had a significant impact, particularly on our smelters and power plants. The amended federal Bureau of Land Management (BLM) regulations governing mined-land reclamation for mining on federal lands will likely increase our regulatory obligations and compliance costs over time with respect to mine closure reclamation. We are subject to state laws and regulations that establish requirements for mined-land reclamation and financial assurance. We also have potential liability for certain sites we currently operate or formerly operated and for certain third-party sites under the federal Superfund law and similar state laws. The Company is also subject to claims for natural resource damages where the release of hazardous substances has injured natural resources.

     Our mining operations and exploration activities, both inside and outside the United States, are subject to extensive laws and regulations governing prospecting, development, production, exports, taxes, labor standards, occupational health, waste disposal, protection and remediation of the environment, protection of endangered and protected species, mine safety, toxic substances and other matters. Mining also is subject to risks and liabilities associated with pollution of the environment and disposal of waste products occurring as a result of mineral exploration and production. Compliance with these laws and regulations imposes substantial costs on us and subjects us to significant potential liabilities.

Ore Reserves. We use several strategies to replenish and grow our copper and molybdenum ore reserves. Our first consideration is to invest in mining and exploration properties near our existing operations. These additions allow us to develop adjacent properties with relatively small, incremental investments in operations.

     Technology innovations not only improve productivity, but also may increase ore reserves for us. Developing and applying new technologies, for example our success with solution extraction/electrowinning beginning in the early 1980s, creates the ability to process ore types we previously considered uneconomic.

     Our exploration strategy focuses on identifying new mining opportunities in Latin America, Asia, Australia, Central Africa and other regions. In several cases, we pursue these opportunities with joint-venture partners. By working with others, we maximize the potential benefits of our exploration expenditures and spread costs and risks among several parties.

     Acquisitions also may contribute to increased ore reserves. If acquisition opportunities present themselves, we will consider them, but we will pursue them only if they pass our rigorous screenings for adding economic value to the Company.

Other Considerations. The mining business is subject to many risks and factors that could impact our business, operating results and cash flows. Phelps Dodge actively manages the factors that are controllable, such as implementing a company-wide comprehensive lean production program to improve our cost structure, implementing a power cost stabilization plan at our U.S. mining operations, investing in a projected efficient, low-cost power plant, and establishing price protection programs for our diesel fuel and natural gas purchases, that have protected us against short-term significant upward movements in energy prices while maintaining the flexibility to participate in any favorable price movements. As discussed above, there are various factors outside of our control, such as the volatility of copper and molybdenum prices, increasing market energy costs and availability, and changes to environmental, closure and other regulatory laws, that could significantly impact our business.

 


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Critical Accounting Policies and Estimates

     Phelps Dodge’s discussion and analysis of its financial condition and results of operations are based upon its Consolidated Financial Statements, which have been prepared in accordance with generally accepted accounting principles in the United States (GAAP). The preparation of these financial statements requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the related disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The more significant areas requiring the use of management estimates and assumptions relate to mineral reserves that are the basis for future cash flow estimates and units-of-production depreciation and amortization calculations; environmental and asset retirement obligations; estimates of recoverable copper in mill and leach stockpiles; asset impairments (including estimates of future cash flows); postemployment, postretirement and other employee benefit liabilities; bad debts; restructuring reserves; realization of deferred tax assets; reserves for contingencies and litigation; and fair value of financial instruments. Phelps Dodge bases its estimates on the Company’s historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.

     Phelps Dodge believes the following significant assumptions and estimates affect its more critical practices and accounting policies used in the preparation of its Consolidated Financial Statements.

     In 2003, the Company implemented Financial Accounting Standards Board’s (FASB) Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,” (FIN 46) and the revised Interpretation (FIN 46-R), which provided guidance associated with variable interest entities (VIEs). With respect to entities created prior to February 1, 2003, we determined that our El Abra and Candelaria copper mining operations in Chile met the VIE criteria and that we are the primary beneficiary of these entities. Historically, the Company had accounted for its partnership interests in the 51 percent-owned El Abra and the 80 percent-owned Candelaria copper mines using the proportional consolidation method. In accordance with FIN 46-R, beginning January 1, 2004, we fully consolidated the results of operations for El Abra and Candelaria with the interests held by our minority shareholders reported as minority interests in consolidated subsidiaries in our Consolidated Balance Sheet and Statement of Consolidated Operations. (Refer to Note 1, Summary of Significant Accounting Policies, under New Accounting Pronouncements, for further discussion). Other investments in undivided interests and unincorporated mining joint ventures that are limited to the extraction of minerals are accounted for using the proportional consolidation method. These investments include the Morenci mine, located in Arizona, in which we hold an 85 percent undivided interest and the Chino mine, located in New Mexico, in which we held a two-thirds partnership interest through December 18, 2003, and a 100 percent interest from December 19, 2003 to December 31, 2004.(Refer to Note 2, Acquisitions and Divestures, for further discussion.) Interests in other majority-owned subsidiaries are reported using the full consolidation method; the Consolidated Financial Statements include 100 percent of the assets and liabilities of these subsidiaries and the ownership interests of minority participants are recorded as “Minority interests in consolidated subsidiaries.” All material intercompany balances and transactions are eliminated.

     Phelps Dodge, at least annually, estimates its ore reserves at active properties and properties on care-and-maintenance status. There are a number of uncertainties inherent in estimating quantities of reserves, including many factors beyond the control of the Company. Ore reserve estimates are based upon engineering evaluations of assay values derived from samplings of drill holes and other openings. Additionally, declines in the market price of a particular metal may render certain reserves containing relatively lower grades of mineralization uneconomic to mine. Further, availability of operating and environmental permits, changes in operating and capital costs, and other factors could materially and adversely affect our ore reserve estimates. Phelps Dodge uses its ore reserve estimates in determining the unit basis for units-of-production depreciation and amortization rates, as well as in evaluating mine asset impairments. Changes in ore reserve estimates could significantly affect these items. For example, a 10 percent increase or decrease in ore reserves at each mine would either decrease or increase, respectively, total depreciation expense by approximately $29 million in 2005.

     Phelps Dodge’s reported ore reserves are economic at the most-recent three-year historical average COMEX copper price of 94 cents per pound, and the most-recent three-year historical average molybdenum price of $8.50 per pound (Metals Week Dealer Oxide mean price).

     Phelps Dodge evaluates its long-term assets (to be held and used) for impairment when events or changes in economic circumstances indicate the carrying amount of such assets may not be recoverable. Goodwill, investments and long-term receivables, and our identifiable intangible assets are evaluated at least annually for impairment. PDMC’s evaluations are based on business plans that are developed using a time horizon that is reflective of the historical, moving average for the full price cycle. We currently use a long-term average COMEX price of 90 cents per pound of copper and an average molybdenum price of $3.90 per pound (Metals Week Dealer Oxide mean price), along with near-term price forecasts reflective of the current price environment, to develop mine plans and production schedules. PDI’s business plans are based on the remaining asset life of the asset group and bases its economic projections on market supply and demand forecasts. We use an estimate of the future undiscounted net cash flows of the related asset or asset grouping over the remaining life to measure whether the assets are recoverable and measure any impairment by reference to fair value. Fair value is generally estimated using the Company’s expectation of discounted net cash flows.

     The per pound COMEX copper price during the past 10 years, 15 years and 20 years averaged 93 cents, 97 cents and 94 cents, respectively. The molybdenum per pound Metals Week Dealer Oxide mean price over the same periods averaged $5.27, $4.46 and $4.15, respectively. Should estimates of future copper and molybdenum prices decrease, impairments may result.

     Phelps Dodge capitalizes applicable costs for copper contained in mill and leach stockpiles that are expected to be processed in the future. The mill and leach stockpiles are evaluated periodically to ensure that they are stated at the lower of cost or market. Because

 


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the determination of copper contained in mill and leach stockpiles by physical count is impracticable, we employ reasonable estimation methods.

     The quantity of material delivered to mill stockpiles is based on surveyed volumes of mined material and daily production records. Sampling and assaying of blast-hole cuttings determine the estimated amount of copper contained in the material delivered to the mill stockpiles. Expected copper recovery rates are determined by metallurgical testing. The recoverable copper in mill stockpiles can be extracted into copper concentrate almost immediately upon processing. Estimates of copper contained in mill stockpiles are reduced as material is removed and fed to the mill. At December 31, 2004, the estimated amount of recoverable copper contained in mill stockpiles was 0.4 million tons on a consolidated basis (0.3 million tons on a pro rata basis) with a carrying value of $56.5 million (on a consolidated basis). At December 31, 2003, the estimated amount of recoverable copper contained in mill stockpiles was 0.2 million tons (on a pro rata basis) with a carrying value of $40.6 million (on a pro rata basis).

     The quantity of material in leach stockpiles is based on surveyed volumes of mined material and daily production records. Sampling and assaying of blast-hole cuttings determine the estimated amount of copper contained in material delivered to the leach stockpiles. Expected copper recovery rates are determined using small-scale laboratory tests, small- and large-scale column testing (which simulates the production-scale process), historical trends and other factors, including mineralogy of the ore and rock type. Estimated amounts of copper contained in the leach stockpiles are reduced as stockpiles are leached, the leach solution is fed to the electrowinning process, and copper cathodes are produced. Ultimate recovery of copper contained in leach stockpiles can vary from a very low percentage to over 90 percent depending on several variables, including type of processing, mineralogy and particle size of the rock. Although as much as 70 percent of the copper ultimately recoverable may be extracted during the first year of processing, recovery of the remaining copper may take many years. At December 31, 2004, the estimated amount of recoverable copper contained in leach stockpiles was 1.4 million tons on a consolidated basis (1.3 million tons on a pro rata basis) with a carrying value of $100.7 million (on a consolidated basis). At December 31, 2003, the estimated amount of recoverable copper contained in leach stockpiles was 1.4 million tons (on a pro rata basis) with a carrying value of $71.0 million.

     In preparing our Consolidated Financial Statements, we recognize income taxes in each of the jurisdictions in which we operate. For each jurisdiction, we estimate the actual amount of taxes currently payable or receivable as well as deferred tax assets and liabilities attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

     With the exception of amounts provided for dividends expected to be received in 2005 from certain South American operations, deferred income taxes have not been provided on the Company’s share of undistributed earnings of certain foreign subsidiaries and unconsolidated affiliates because we consider these earnings to be reinvested indefinitely. The recent enactment of the American Jobs Creation Act of 2004 (the Act) has caused us to begin the process of re-evaluating this policy. The Act provides an effective U.S. federal tax rate ranging from 3 percent to 5.25 percent on certain foreign earnings repatriated during a one-year period (2005 for Phelps Dodge), but also results in the loss of any foreign tax credits associated with these earnings. The maximum amount of the Company’s foreign earnings that qualify for this one-time deduction is approximately $638 million. At the present time, other than the previously mentioned dividends from certain South American operations, we do not have enough information to determine whether and to what extent we might repatriate foreign earnings. We expect to finalize our assessment by the end of the 2005 third quarter, at which time any tax impact would be recognized.

     A valuation allowance is provided for those deferred tax assets for which it is more likely than not that the related benefits will not be realized. In determining the amount of the valuation allowance, we consider estimated future taxable income as well as feasible tax planning strategies in each jurisdiction. If we determine that we will not realize all or a portion of our deferred tax assets, we will increase our valuation allowance with a charge to income tax expense. Conversely, if we determine that we will ultimately be able to realize all or a portion of the related benefits for which a valuation allowance has been provided, all or a portion of the related valuation allowance will be reduced with a credit to income tax expense.

     At December 31, 2004, our valuation allowances totaled $282.8 million and covered a portion of our U.S. federal minimum tax credits, a portion of our state net operating loss carryforwards and the deferred tax assets of our Brazilian wire and cable manufacturing subsidiary. At December 31, 2003, our valuation allowances totaled $461.3 million and covered all or a portion of our U.S. federal minimum tax credit and capital loss carryforwards, our state net operating loss carryforwards, and El Abra’s deferred tax assets, consisting primarily of its net operating loss carryforwards.

     The $178.5 million net decrease in our valuation allowances during 2004 is attributable to the net impact of the utilization of U.S. federal, state and foreign net operating loss carryforwards as a result of increased taxable income resulting from improved copper prices ($219.8 million), the utilization of previously reserved capital loss carryforwards as a result of transactions generating capital gains during the year ($29.4 million) and changes in our assessment of future realization with respect to state ($30.0 million) and Chilean ($15.7 million, net of minority interest) net operating losses also resulting from our improved operating results. These reductions were partially offset by increases in valuation allowances resulting from the impact of fully consolidating El Abra ($39.2 million), a valuation allowance established for deferred tax assets at our Brazilian wire and cable operation ($9.0 million) and other adjustments ($68.2 million) primarily related to alternative minimum taxes.

     Phelps Dodge has trusteed, non-contributory pension plans covering substantially all its U.S. employees and some employees of international subsidiaries. The applicable plan design determines the manner in which the benefits are calculated for any particular group of employees.

 


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     Under current financial accounting standards, any significant year-to-year movement in the rate of interest on long-term, high-quality corporate bonds necessitates a change in the discount rate used to calculate the actuarial present value of our accumulated pension and other postretirement benefit obligations. The discount rate was 5.75 percent at December 31, 2004, compared with 6.25 percent at December 31, 2003, and 6.75 percent at December 31, 2002. For our U.S. pension plans, the discount rate assumption is designed to reflect yields on high-quality, fixed-income investments for a given duration. We utilized a nationally recognized, third-party actuary to construct a bond portfolio comprising non-callable bonds from the S&P bond listing rated AA- or higher. The portfolio was constructed such that cash flow generated by the portfolio matched projected future cash flow from the pension plan. The model portfolio constructed used 29 bonds resulting in a discount rate of approximately 5.75 percent for our pension plans. Changes in this assumption are reflected in our benefit obligation and, therefore, in our liabilities and income or expense we record. Changes in the discount rate affect several components of pension expense/income, one of which is the amount of the cumulative gain or loss that will be recognized. Because gains or losses are only recognized when they fall outside of a calculated corridor, the effect of changes in the discount rate on pension expense may not be linear. For example, the first 25-basis-point increase in our assumed discount rate assumption as of the beginning of 2005 would decrease our pension expense by approximately $3 million per year during the next three years. Each of the next six 25-basis-point increases would decrease our pension expense by approximately $1 million per year. Any additional 25-basis-point increase above the 175-basis-point increment previously discussed would decrease our pension expense by approximately $3 million per year during the next three years. Each 25-basis-point decrease in our assumed discount rate assumption would increase our pension expense by approximately $3 million per year during the next three years. The change would not affect the minimum required contribution.

     Our pension plans were valued between December 1, 2002, and January 1, 2003, and between December 1, 2003, and January 1, 2004. Obligations were projected and assets were valued as of the end of 2003 and 2004. The majority of plan assets are invested in a diversified portfolio of stocks, bonds and cash or cash equivalents. A small portion of the plan assets is invested in pooled real estate and other private investment funds.

     The Phelps Dodge Corporation Defined Benefit Master Trust (Master Trust), which holds plan assets for the Phelps Dodge Retirement Plan and U.S. pension plans for bargained employees, constituted 95 percent of total plan assets as of year-end 2004. These plans accounted for approximately 90 percent of benefit obligations. The investment portfolio for this trust as of year-end 2004 had an asset mix that included 56 percent equities (36 percent U.S. equities, 12 percent international equities and 8 percent emerging market equities), 34 percent fixed income (17 percent U.S. fixed income, 5 percent international fixed income, 3 percent emerging market fixed income, 5 percent U.S. high yield, and 4 percent treasury inflation-protected securities), 6 percent real estate and real estate investment trusts, and 4 percent other.

     Our policy for determining asset-mix targets for the Master Trust includes the periodic development of asset/liability studies by a nationally recognized, third-party investment consultant (to determine our expected long-term rate of return and expected risk for various investment portfolios). Management considers these studies in the formal establishment of asset-mix targets that are reviewed by the finance committee of the board of directors.

     Our expected long-term rate of return on plan assets is updated at least annually, taking into consideration our asset allocation, historical returns on the types of assets held in the Master Trust, and the current economic environment. Based on these factors, we expect our pension assets will earn an average of 8.5 percent per annum over the 20 years beginning December 1, 2004, with a standard deviation of 10.7 percent. The 8.5 percent estimation was based on a passive return on a compound basis of 8.0 percent and a premium for active management of 0.5 percent. On an arithmetic average basis, the passive return would have been 8.5 percent with a premium for active management of 0.5 percent. Our rate of return and standard deviation estimates remain unchanged from December 31, 2003.

     For estimation purposes, we assume our long-term asset mix generally will be consistent with the current mix. Changes in our asset mix could impact the amount of recorded pension income or expense, the funded status of the plan and the need for future cash contributions. A lower-than-expected return on assets also would decrease plan assets and decrease the amount of recorded pension income (or increase recorded pension expense) in future years. When calculating the expected return on plan assets, the Company uses a market-related value of assets that spreads asset gains and losses over five years. As a result, changes in the fair value of assets prior to January 1, 2005, will be reflected in the results of operations by January 1, 2010. A 25 basis point increase/decrease in our expected long-term rate of return assumption as of the beginning of 2005 would decrease/increase our pension expense by approximately $2 million per year during the next three years. In addition, a 25 basis point decrease in the long-term rate of return assumption would not affect the minimum required contribution to our pension plan during the same three-year period. Due to better than expected returns in 2003 and 2004, combined with pension funding legislation passed in April 2004, there is no minimum 2005 cash contribution for the Phelps Dodge Retirement Plan and U.S. pension plans for bargained employees. We are currently analyzing five-year funding strategies under various economic scenarios to effectively manage future contribution requirements.

     Phelps Dodge has postretirement medical and life insurance benefit plans covering most of its U.S. employees and, in some cases, employees of international subsidiaries. Postretirement benefits vary among plans, and many plans require contributions from employees. We account for these benefits on an accrual basis. Our funding policy provides that payments shall be at least equal to our cash basis obligation, plus additional amounts that may be approved by us from time to time.

     A 1 percentage-point increase in the assumed health care cost trend rate would increase net periodic benefit cost by approximately $1 million and increase our postretirement benefit obligation by approximately $12 million; a 1 percentage-point decrease in the as-

 


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sumed health care cost trend rate would decrease net periodic benefit cost by approximately $1 million and decrease our postretirement benefit obligation by approximately $11 million. The long-term expected rate of return on plan assets for our postretirement medical and life insurance benefit plans and the discount rate were determined on the same basis as our pension plan. Based on our asset allocation, historical returns on the types of assets held in the trust, and the current economic environment, we expect our postretirement medical and life insurance benefit assets will earn an average of 6.50 percent per annum over the long-term beginning December 1, 2004. The cash flow generated by the constructed bond portfolio comprising non-callable bonds from the S&P bond listing rated AA- or higher that was matched to projected future cash flow from the postretirement medical and life insurance benefit plans resulted in a discount rate of approximately 5.75 percent for the retirement medical plan and 6.00 percent for the retiree life plan. Changes in this assumption are reflected in our benefit obligation and, therefore, in our liabilities and income or expense we record. For example, the first 25-basis-point increase and each of the next six 25-basis-point increases in our assumed discount rate assumption as of the beginning of 2005 would decrease our periodic benefit cost by approximately $0.1 million per year during the next three years. Any additional 25-basis-point increase would decrease our periodic benefit cost by approximately $1 million per year during the next three years. Each 25-basis-point decrease in our assumed discount rate assumption would increase our periodic benefit cost by approximately $1 million per year during the next three years.

     Phelps Dodge develops natural resources and creates products that contribute to an enhanced standard of living for people throughout the world. Our mining, exploration, production and historic operating activities are subject to various laws and regulations governing the protection of the environment which require, from time to time, significant expenditures. These environmental expenditures for closed facilities and closed portions of operating facilities are expensed or capitalized depending upon their future economic benefits. The general guidance provided by U.S. GAAP requires that liabilities for contingencies be recorded when it is probable that a liability has been incurred before the date of the balance sheet and that the amount can be reasonably estimated. Refer to page 98 for a more extensive discussion on our accounting policy for environmental expenditures.

     Significant management judgment and estimates are required to comply with this guidance. Accordingly, each month senior management reviews with the Company’s environmental remediation management, as well as with its financial and legal management, changes in facts and circumstances associated with its environmental obligations. The judgments and estimates are based upon available facts, existing technology, and current laws and regulations, and they take into consideration reasonably possible outcomes. The estimates can change substantially as additional information becomes available regarding the nature or extent of site contamination, required remediation methods, and other actions by or against governmental agencies or private parties.

     At December 31, 2004, environmental reserves totaled $303.6 million. The cost range for reasonably possible outcomes for all environmental remediation sites for which a liability was recognized was estimated to be from $270 million to $578 million. In addition, Phelps Dodge has a number of sites that are not the subject of an environmental remediation liability because it is not probable that a successful claim will be made, but for which there is a reasonably possible likelihood of an environmental remediation liability. At December 31, 2004, the cost range for reasonably possible outcomes for all such sites for which an estimate can be made was estimated to be from $3 million to $17 million.

     Reclamation is an ongoing activity that occurs throughout the life of a mine. Effective January 1, 2003, we adopted Statement of Financial Accounting Standards (SFAS) No. 143, “Accounting for Asset Retirement Obligations.” We recognize asset retirement obligations (AROs) when incurred, with the initial measurement at fair value. These liabilities are accreted to full value over time through charges to income. In addition, asset retirement costs (ARCs) are capitalized as part of the related asset’s carrying value and are depreciated primarily on a units-of-production basis over the asset’s respective useful life. Reclamation costs for future disturbances will be recognized as an ARO and as a related ARC in the period incurred. Our AROs consist primarily of costs associated with mine reclamation and closure activities. These activities, which tend to be site specific, generally include costs for earthwork, revegetation, water treatment and demolition. Refer to pages 98 and 99 for a more extensive discussion on our accounting policy for ARO costs.

     Generally, ARO activities are specified by regulations or in permits issued by the relevant governing authority. Significant management judgment and estimates are required in estimating the extent and timing of expenditures based on life-of-mine planning. Accordingly, each quarter senior management reviews with the Company’s environmental and remediation management, as well as its financial and legal management, changes in facts and circumstances associated with its AROs. The judgments and estimates are based upon available facts, existing technology and current laws and regulations, and they take into consideration reasonably possible outcomes.

     At December 31, 2004, AROs totaled $275.2 million, compared with estimated ARO costs, including anticipated future disturbances, of approximately $1.3 billion (unescalated, undiscounted and on a third-party cost basis), leaving approximately $1.0 billion to be accreted over the remaining reclamation period. These aggregate costs may increase or decrease materially in the future as a result of changes in regulations, technology, mine plans, or other factors and as actual reclamation spending occurs. For example, the fair value cost estimate for our Chino Mines Company has increased from an initial estimate (third-party cost basis) of approximately $100 million in early 2001 to approximately $393 million primarily resulting from negotiations with the relevant governing authorities. (Refer to Note 20, Contingencies, for additional discussion on our New Mexico closure and reclamation programs.)

     Liabilities for contingencies and litigation are recorded when it is probable that obligations have been incurred and the costs reasonably can be estimated. Gains for contingencies and litigation are recorded when realized.

     Refer to Note 1, Summary of Significant Accounting Policies, to the Consolidated Financial Statements.

 


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Consolidated Financial Results

     As discussed in Note 1, Summary of Significant Accounting Policies, in accordance with FIN 46-R, we determined during the 2004 first quarter that our El Abra and Candelaria copper mining operations in Chile, which had been consolidated historically on a proportional basis, should be fully consolidated. Therefore, these entities were fully consolidated beginning January 1, 2004. As a result, at December 31, 2004, our Consolidated Balance Sheet included increases in total assets of $604.6 million, total liabilities of $136.7 million and minority interests in consolidated subsidiaries of $467.9 million. There was no impact on consolidated shareholders’ equity at December 31, 2004. The impact for the year ended December 31, 2004, on our Statement of Consolidated Operations comprised increases (decreases) in sales and other operating revenues of $273.2 million, operating expenses of $80.9 million, operating income of $192.3 million, net interest expense of $7.0 million, pre-tax early debt extinguishment costs of $4.4 million, net miscellaneous income and expense of $(1.9) million, provision for taxes on income of $(1.9) million and minority interests in consolidated subsidiaries of $180.9 million. There was no impact on consolidated net income for the year ended December 31, 2004.

     As discussed in Note 2, Acquisitions and Divestures, we acquired, through a wholly owned subsidiary, the one-third partnership interest in Chino Mines Company held by Heisei Minerals Corporation (Heisei) on December 19, 2003. Prior to the acquisition, we owned a two-thirds partnership interest in Chino and applied the proportional consolidation method of accounting. The results of operations for Chino have been included in the consolidated financial results for the year ended December 31, 2004.

     Consolidated financial results for the years 2004, 2003 and 2002 were as follows:

     
   
 
($ in millions except per share data)
   
                         
    2004*     2003*     2002*  
     
Sales and other operating revenues
  $ 7,089.3       4,142.7       3,722.0  
Operating income (loss)
  $ 1,503.6       197.6       (209.3 )
Minority interests in consolidated subsidiaries
  $ (201.8 )     (7.7 )     (7.8 )
 
                       
Income (loss) before extraordinary item and cumulative effect of accounting changes
  $ 1,046.3       18.1       (315.2 )
Extraordinary gain on acquisition of partner’s interest in Chino
          68.3        
Cumulative effect of accounting changes
          8.4       (22.9 )
     
 
Net income (loss)
  $ 1,046.3       94.8       (338.1 )
     
 
                       
Basic earnings (loss) per common share before extraordinary item and cumulative effect of accounting changes
  $ 11.06       0.06       (3.86 )
Extraordinary gain on acquisition of partner’s interest in Chino
          0.77        
Cumulative effect of accounting changes
          0.09       (0.27 )
     
Basic earnings (loss) per common share
  $ 11.06       0.92       (4.13 )
     
 
                       
Diluted earnings (loss) per common share before extraordinary item and cumulative effect of accounting changes
  $ 10.58       0.06       (3.86 )
Extraordinary gain on acquisition of partner’s interest in Chino
          0.76        
Cumulative effect of accounting changes
          0.09       (0.27 )
     
Diluted earnings (loss) per common share
  $ 10.58       0.91       (4.13 )
     

*   2004 reflected full consolidation of El Abra and Candelaria; 2003 and 2002 reflected El Abra and Candelaria on a pro rata basis (51 percent and 80 percent, respectively).
     
   

     In 2004, the Company had consolidated net income of $1,046.3 million, or $10.58 per common share, including a special, net charge of $50.4 million, or 51 cents per common share, after taxes. (All references to per share earnings or losses are based on diluted earnings per share.) In 2003, consolidated net income was $94.8 million, or 91 cents per common share, including a special, net gain of $46.7 million, or 52 cents per common share, after taxes. Excluding special items, the $1,048.6 million increase in consolidated earnings in 2004, compared with 2003, was primarily due to higher copper prices including premiums and copper pricing adjustments (approximately $1,068 million), higher primary molybdenum earnings (approximately $94 million) due to higher prices, higher miscellaneous income (approximately $33 million) primarily due to higher cost-basis investment dividends of $20.4 million, and lower interest expense ($19.6 million) primarily due to the current year payoff of long-term debt; partially offset by a higher tax provision ($156.8 million) primarily due to higher earnings.

     In 2002, the consolidated net loss was $338.1 million, or $4.13 per common share, including a special, net charge of $208.9 million, or $2.48 per common share. Excluding special items, the $177.3 million increase in consolidated net income in 2003, compared with 2002, was primarily due to higher copper prices including premiums and copper pricing adjustments (approximately $198 million) and lower interest expense ($41.2 million); partially offset by a higher tax provision ($81.9 million), resulting primarily from higher earnings at inter-

 


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national operations that could not be offset by losses at domestic operations.

Special Items and Provisions

     Throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations there is disclosure and discussion of what management believes to be special items and provisions. We view special items as unpredictable and atypical of our operations in the period. We believe consistent identification, disclosure and discussion of such items, both favorable and unfavorable, provide additional information to assess the quality of our performance and our earnings or losses. In addition, management measures the performance of its reportable segments excluding special items. This supplemental information is not a substitute for any U.S. GAAP measure and should be evaluated within the context of our U.S. GAAP results. The tax impacts of the special items were determined at the marginal effective tax rate of the appropriate taxing jurisdiction, including provision for a valuation allowance, if warranted. Any supplemental information references to earnings, losses or results excluding special items or before special items is a non-GAAP measure that may not be comparable to similarly titled measures reported by other companies.

Note: Supplemental Data

     The following table summarizes consolidated net income (loss), special items and provisions, and the resultant earnings (losses) excluding these special items and provisions for the years ended December 31, 2004, 2003 and 2002:

     
   
($ in millions)
   
                         
    2004     2003     2002  
     
Net income (loss)
  $ 1,046.3       94.8       (338.1 )
Special items and provisions, net of taxes
    (50.4 )     46.7       (208.9 )
     
Earnings (losses) excluding special items and provisions (after taxes)
  $ 1,096.7       48.1       (129.2 )
     
     
   

Note: Supplemental Data

     The following table summarizes the special items and provisions for the year ended December 31, 2004:

     
   
($ in millions except per share data)
   
                         
    2004
                    $/Share  
    Pre-tax     After-tax     After-tax  
     
Special items and provisions, net:
                       
PDMC (see Business Segment disclosure)
  $ (11.3 )     (8.3 )     (0.09 )
     
PDI (see Business Segment disclosure)
    (17.3 )     (12.8 )     (0.13 )
     
Corporate and Other -
                       
Environmental provisions, net
    (41.8 )     (31.8 )     (0.32 )
Historical legal matters
    2.7       (0.5 )      
Environmental insurance recoveries, net
    0.2       0.1        
     
 
    (38.9 )     (32.2 )     (0.32 )
     
 
    (67.5 )     (53.3 )     (0.54 )
     
 
                       
Interest expense:
                       
Texas franchise tax matter
    (0.9 )     (0.7 )     (0.01 )
     
 
Early debt extinguishment costs
    (43.2 )     (34.3 )     (0.35 )
     
 
                       
Miscellaneous income and expense, net:
                       
Cost-basis investment write-downs
    (11.1 )     (9.9 )     (0.10 )
Gain on sale of miscellaneous asset
    10.1       10.1       0.10  
Historical legal matters
    9.5       7.2       0.07  
     
 
    8.5       7.4       0.07  
     
 
                       
Benefit (provision) for taxes on income:
                       
Reversal of El Abra deferred tax asset valuation allowance
          30.8       0.31  
Reversal of U.S. deferred tax asset valuation allowance
          30.0       0.31  
PD Brazil deferred tax asset valuation allowance
          (9.0 )     (0.09 )
Foreign dividend tax
          (9.6 )     (0.10 )
     
 
          42.2       0.43  
     
Minority interests in consolidated subsidiaries:
                       
Reversal of El Abra deferred tax asset valuation allowance
          (15.1 )     (0.15 )
Candelaria early debt extinguishment costs
          2.5       0.03  
El Abra early debt extinguishment costs
          0.9       0.01  
     
 
          (11.7 )     (0.11 )
     
 
 
  $ (103.1 )     (50.4 )     (0.51 )
     
     
   

     A net charge for environmental provisions of $58.9 million ($44.7 million after-tax) was recognized for closed facilities and closed portions of operating facilities. (Refer to Note 20, Contingencies, for further discussion of environmental matters.)

     In January 2004, Phelps Dodge Magnet Wire announced plans to consolidate its North American manufacturing operations to reduce costs and strengthen its competitiveness in the global marketplace. This action resulted in the closure of the manufacturing plant in El Paso, Texas, which ceased operations during the 2004 fourth quarter and affected approximately 100 employees. Our magnet wire customers are moving their operations to China, Mexico and other offshore locations, leaving us with excess capacity in our North American plants. To remain competitive as a global provider of magnet wire, it is critical that we operate close to our customer base. Production capacity began transferring to our other North American locations in the 2004 first quarter. We recognized a $7.2 million charge

 


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($4.9 million after-tax) in 2004 and expect approximately $10 million (before taxes) in total to be incurred in connection with this restructuring program, which is projected to be completed in 2005.

     In the 2004 third quarter, Phelps Dodge Magnet Wire entered into a strategic partnership with Schwering und Hasse Elektrodaht Ltd. in Germany to produce its product at its Lugde, Germany, facility that will primarily serve European and Middle Eastern customers. This action resulted in the closure of the PD Austria facility, which ceased operations during the 2004 fourth quarter in order to reduce costs, as well as to better position the Magnet Wire division. In 2004, we recognized a charge of $3.3 million ($2.7 million after-tax), which included severance-related, plant removal and dismantling expenses, and take-or-pay contracts. We do not expect to incur any other material charges in connection with this restructuring program, which is projected to be completed in the first half of 2005.

     In the 2004 second quarter, $0.6 million ($0.5 million after-tax) was recognized for asset impairment at our Hopkinsville, Kentucky, magnet wire facility, which resulted from continued depressed market conditions. The amount of the asset impairment was determined through an assessment of fair market value, as determined by an independent appraisal.

     In the 2004 third quarter, $1.1 million ($0.9 million after-tax) was recognized for asset impairment at our Hidalgo facility. This action resulted from the anticipated sale of the Hidalgo townsite. The amount of Hidalgo’s asset impairment was determined through the assessment of fair market value, as determined by independent appraisals.

     In the 2004 fourth quarter, due to continued excess capacity in the North American market, we recognized a charge of $5.9 million ($4.5 million after-tax) for asset impairment at our Specialty Chemicals’ El Dorado, Arkansas, facility. The amount of the asset impairment was determined through fair market value based on an assessment of discounted projected cash flows.

     Net insurance recoveries of $9.3 million ($7.4 million after-tax) were received in 2004 from settlements reached with several insurance companies on historical environmental liability claims.

     Net gains of $9.7 million ($4.7 million after-tax) were recognized in connection with the settlement of historical legal matters.

     In the 2004 first quarter, we recognized a charge of $0.9 million ($0.7 million after-tax) associated with interest for a Texas franchise tax matter.

     A $43.2 million charge ($30.9 million after-tax and net of minority interests) was recognized for early debt extinguishment costs. (Refer to Note 13, Debt and Other Financing, for further discussion.)

     An $11.1 million charge ($9.9 million after-tax) was recognized for the write-down of two cost-basis investments.

     A $10.1 million gain (before and after taxes) was recognized for the sale of a miscellaneous asset associated with uranium royalty rights in Australia.

     In 2004, a tax benefit of $30.8 million ($15.7 million, net of minority interest) was recognized for the reversal of the valuation allowance associated with deferred tax assets that are expected to be realized after 2004 at our 51 percent-owned El Abra copper mine. Also, a tax benefit of $30.0 million was recognized for the reversal of the valuation allowance associated with deferred tax assets that are expected to be realized after 2004 in the United States. Additionally in 2004, tax expense of $9.0 million was recognized for a valuation allowance for deferred tax assets at our Brazilian wire and cable operation. (Refer to Note 6, Income Taxes, for further discussion.)

     The Company does not provide deferred income taxes on the undistributed earnings of certain foreign subsidiaries as such earnings are considered to be indefinitely reinvested. However, in the 2004 fourth quarter, a tax expense of $9.6 million was recognized for U.S. and foreign taxes expected to be incurred with respect to dividends anticipated to be received from certain South American operations in 2005.

     The following table summarizes the special items and provisions for the year ended December 31, 2003:

     
   
($ in millions except per share data)
   
                         
    2003
                    $/Share  
    Pre-tax     After-tax     After-tax  
     
Special items and provisions, net:
                       
PDMC (see Business Segment disclosure)
  $ (5.5 )     (5.2 )     (0.06 )
     
PDI (see Business Segment disclosure)
    1.7       0.9       0.01  
     
Corporate and Other –
                       
Environmental provisions, net
    (23.8 )     (22.7 )     (0.25 )
Environmental insurance recoveries, net
    0.5       0.5       0.01  
Historical Cyprus Amax legal matters
    (2.9 )     (2.9 )     (0.03 )
Potential Texas franchise tax matter
    (8.0 )     (8.0 )     (0.09 )
     
 
    (34.2 )     (33.1 )     (0.36 )
     
 
    (38.0 )     (37.4 )     (0.41 )
     
 
                       
Miscellaneous income and expense, net:
                       
Gain on sale of cost-basis investment
    6.4       6.4       0.07  
     
 
                       
Benefit (provision) for taxes on income:
                       
Tax benefit for additional 2001 net operating loss carryback
          1.0       0.01  
     
 
                       
Extraordinary gain on acquisition of partner’s one-third interest in Chino Mines Company
    68.3       68.3       0.76  
     
 
                       
Cumulative effect of accounting change
    9.7       8.4       0.09  
     
 
  $ 46.4       46.7       0.52  
     
     
   

     A net charge for environmental provisions of $28.4 million ($27.0 million after-tax) was recognized for closed facilities and closed portions of operating facilities. (Refer to Note 20, Contingencies, for further discussion of environmental matters.)

     In the 2003 fourth quarter, we determined that due to continuing reduced market conditions in North America for magnet wire and high performance conductors, the Laurinburg, North Carolina, and West Caldwell, New Jersey, facilities, both temporarily closed in the 2002 fourth quarter, would not be re-opened. This action resulted in further impairment charges of $1.3 million related to these assets. The amount of the additional asset impairment was determined through an assessment of fair value based on independent appraisals of the existing assets at these two plants. No additional severance related charges were required. Additionally, a further write-down of $0.4 million was recognized to reduce the carrying value of the assets of our Hopkinsville, Kentucky, facility closed in 2000. This adjustment reflected our current view of the fair value of these assets. We also performed an impairment test on goodwill at our magnet wire and

 


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high performance conductor facilities through a comparison of the carrying value to the respective fair value (using an estimate of discounted cash flows) and determined that a $0.9 million charge was required to write-off Magnet Wire’s remaining goodwill balance. Also during the quarter, we recorded a $0.2 million gain (before and after taxes) for the reassessment of termination benefits associated with the September 2002 restructuring program.

     A gain of $3.2 million ($2.4 million after-tax) was recognized from the termination of a foreign postretirement benefit plan associated with our Specialty Chemicals segment.

     Net insurance recoveries of $0.5 million (before and after taxes) were received in 2003 from settlements reached with several insurance companies on historical environmental liability claims.

     In the 2003 fourth quarter, a charge of $8.0 million (before and after taxes) was recognized for a potential Texas franchise tax matter. (Refer to Note 20, Contingencies, for further discussion.)

     A charge of $2.9 million (before and after taxes) was recognized for historical Cyprus Amax Mineral Company (Cyprus Amax) legal matters. The Company acquired Cyprus Amax in October 1999.

     A $6.4 million gain (before and after taxes) was recognized for the sale of a wire and cable cost-basis investment.

     In the 2003 fourth quarter, we determined that an additional $1.0 million income tax benefit could be recognized for a net operating loss carryback for 2001 resulting from 2002 U.S. tax legislation. (Refer to Note 6, Income Taxes, for further discussion.)

     An extraordinary gain of $68.3 million (before and after taxes) was recognized for our acquisition of Heisei’s one-third share in Chino Mines Company, located in New Mexico. (Refer to Note 2, Acquisitions and Divestitures, for further discussion.)

     A $9.7 million gain ($8.4 million after-tax) was recorded for the cumulative effect of an accounting change due to the adoption of SFAS No. 143. (Refer to Note 1, Summary of Significant Accounting Policies, under New Accounting Pronouncements for further discussion.)

     The following table summarizes the special items and provisions for the year ended December 31, 2002:

     
   
($ in millions except per share data)
   
                         
    2002
                    $/Share  
    Pre-tax     After-tax     After-tax  
     
Special items and provisions, net:
                       
PDMC (see Business Segment disclosure)
  $ (116.9 )     (119.5 )     (1.42 )
     
PDI (see Business Segment disclosure)
    (22.0 )     (21.4 )     (0.25 )
     
Corporate and Other —
                       
Environmental provisions, net
    (12.7 )     (12.7 )     (0.15 )
Environmental insurance recoveries, net
    17.4       14.8       0.18  
Historical Cyprus Amax lawsuit settlements
    (54.7 )     (53.0 )     (0.63 )
Historical Cyprus Amax arbitration award
    (46.5 )     (45.0 )     (0.54 )
Legal settlement
    (1.0 )     (1.0 )     (0.01 )
     
 
    (97.5 )     (96.9 )     (1.15 )
     
 
    (236.4 )     (237.8 )     (2.82 )
     
 
                       
Early debt extinguishment costs
    (31.3 )     (26.6 )     (0.32 )
     
 
                       
Miscellaneous income and expense, net:
                       
Cost-basis investment write-offs
    (1.2 )     (1.2 )     (0.01 )
     
 
                       
Benefit (provision) for taxes on income:
                       
Release of taxes provided with regard to Plateau Mining
          13.0       0.15  
Tax benefit for 2001 net operating loss carryback
          66.6       0.79  
     
 
          79.6       0.94  
     
 
                       
Cumulative effect of accounting change
    (33.0 )     (22.9 )     (0.27 )
     
 
  $ (301.9 )     (208.9 )     (2.48 )
     
     
   

     In December 2002, PDMC recorded special, pre-tax charges for asset impairments and closure provisions of $153.5 million (before and after taxes) at Cobre, Hidalgo and Ajo. The Company recognized an impairment charge to write down Cobre’s assets by $115.5 million (before and after taxes). We took this action after revising mine plans and assessing recoverability. The revised mine plans and associated cash flows used a copper price lower than the prior-year assumption, reflecting moving average historical copper prices representing full economic and pricing cycles. The amount of Cobre’s impairment was determined through an assessment of the discounted cash flows of the remaining ore reserves. The Hidalgo impairment included a $12.9 million write-down (before and after taxes) of assets. As a result of the Company’s ability to use acid more efficiently and an updated assessment of PDMC’s long-term acid production and consumption balance, the Company determined (i) that Hidalgo probably would not be reconfigured to produce acid as originally anticipated, and (ii) the net book value of Hidalgo assets probably would not be recovered. At the time of the impairment, it was determined that the power facilities would continue to generate electricity when needed, and the facility would continue to be a backup source of acid if conditions warranted. The remaining Hidalgo assets were written down to their estimated fair value. The Company also recognized a $7.0 million charge (before and after taxes) for the estimated remaining cost of its closure obligation at Hidalgo. Phelps Dodge has reclassified material previously characterized as reserves at Ajo to mineralized material and, as a result, recognized an impairment charge to write down Ajo’s assets by $18.1 million (before and after taxes). This action resulted from updating mine plans at this prospective development property.

 


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The amount of Ajo’s impairment was determined through an assessment of the fair value of its assets.

     On September 10, 2002, we announced the temporary closure of two U.S. wire and cable plants and other actions to improve efficiencies and consolidate certain wire and cable operations. These temporary closures and internal changes reduced our costs and aligned our business with current market conditions. The actions included: (i) the temporary closure of the Laurinburg, North Carolina, magnet wire plant at the end of 2002, with production being shifted to the El Paso, Texas, and Fort Wayne, Indiana, facilities; (ii) the temporary closure of the West Caldwell, New Jersey, high performance conductor facility pending recovery of markets served by this location, with production of certain products relocated to our Inman, South Carolina, facility; (iii) operational and production support at other high performance conductor facilities being streamlined in order to reduce costs and increase operating efficiencies; and (iv) the restructuring and consolidation of certain administrative functions. These actions resulted in special, pre-tax charges of $23.0 million ($22.2 million after-tax) in the 2002 third quarter and $0.6 million ($0.8 million after-tax) in the 2002 fourth quarter. Of these amounts, $16.9 million (before and after taxes) was recognized as asset impairments and $6.7 million ($6.1 million after-tax) was recognized for severance-related and relocation expenses associated with the restructuring and temporary closures. The amount of the asset impairment was determined through an assessment of fair market value, which was based on independent appraisals, of the existing assets at the wire and cable plants. The restructuring plan included the reduction of approximately 300 positions and charges associated with employee severance and relocation ($3.9 million) and pension and other postretirement obligations ($2.8 million).

     A net charge for environmental provisions of $14.0 million (before and after taxes) was recognized in 2002 for closed facilities and closed portions of operating facilities. (Refer to Note 20, Contingencies, for further discussion of environmental matters.)

     The net effect of the reassessment of prior restructuring programs was zero (before and after taxes) for 2002. PDMC recorded a $5.1 million gain (before and after taxes) for the reassessment of October 2001 restructuring programs and a $6.4 million charge (before and after taxes) for additional pension-related benefits for employees at our Chino, Miami, Sierrita and Bagdad operations because these operations will remain curtailed beyond one year from their January 2002 curtailment. PDI recorded a $1.3 million gain (before and after taxes) for the reassessment of prior restructuring programs associated with its Specialty Chemicals segment ($0.5 million before and after taxes) and its Wire and Cable segment ($0.8 million before and after taxes).

     A gain of $22.6 million (before and after taxes) was recognized for the sale of a non-core parcel of real estate in New Mexico in 2002. (Refer to Note 2, Acquisitions and Divestitures, for further discussion.)

     Net 2002 insurance recoveries of $34.3 million ($29.1 million after-tax) were received from settlements reached with several insurance companies on historical environmental liability claims.

     A $54.7 million pre-tax charge ($53.0 million after-tax) was recognized in 2002 for settlement of lawsuits related to Cyprus Amax. This included an $11.2 million pre-tax charge ($9.5 million after-tax) for the settlement of a lawsuit related to Amax Oil & Gas, and a $43.5 million charge (before and after taxes) for the settlement of a lawsuit with RAG American Coal Company (RAG). In addition, there was a $46.5 million charge ($45.0 million after-tax) associated with an award made in a binding arbitration proceeding filed against Cyprus Amax by Plateau Mining Corporation (a former subsidiary of Cyprus Amax).

     A net $1.0 million charge (before and after taxes) was recorded for the settlement of legal matters.

     A $1.2 million charge (before and after taxes) was recorded for the write-off of two cost-basis investments.

     A $31.3 million charge ($26.6 million after-tax) was recognized for early debt extinguishment costs. (Refer to Note 13, Debt and Other Financing, for further discussion.)

     A $33.0 million charge ($22.9 million after-tax) was recorded for the cumulative effect of an accounting change due to the adoption of SFAS No. 142. (Refer to Note 1, Summary of Significant Accounting Policies, under New Accounting Pronouncements, for further discussion.)

     In 2002, the tax benefit included a benefit of $13.0 million for the release of deferred taxes previously provided with regard to Plateau Mining Corporation and a tax benefit of $66.6 million for net operating loss carryback prior to 2002 resulting from 2002 U.S. tax legislation. (Refer to Note 6, Income Taxes, for further discussion.)

     (Refer to Note 3, Special Items and Provisions, for further discussion.)

Business Divisions

     Results for 2004, 2003 and 2002 can be meaningfully compared by separate reference to our reporting divisions, PDMC and PDI. PDMC is a business division that includes our worldwide copper operations from mining through rod production, marketing and sales; molybdenum operations from mining through manufacturing, marketing and sales; other mining operations and investments; and worldwide mineral exploration and technology and project development programs. PDI, our manufacturing division, produces engineered products principally for the global energy, transportation and specialty chemical sector. PDI includes our Specialty Chemicals segment and our Wire and Cable segment. The Company currently is exploring strategic alternatives for PDI that may include potential subsidiary sales, selective asset sales, restructurings, joint ventures and mergers, or, alternatively, retention and selective growth. Significant events and transactions have occurred within each segment that, as indicated in the separate discussions presented below, are material to an understanding of the particular year’s results and to a comparison with results of the other periods. (Refer to Note 22, Business Segment Data, for further segment information.)

 


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RESULTS OF PHELPS DODGE MINING COMPANY

     PDMC is our international business division that comprises our vertically integrated copper operations from mining through rod production, primary molybdenum operations from mining through conversion to chemical and metallurgical products, marketing and sales; and worldwide mineral exploration, technology and project development programs. PDMC includes 12 reportable segments and other mining activities.

     In 2004, the Company reassessed its reportable segments. The reassessment considered the significant increase in copper and molybdenum prices. Based upon our assessment, we are separately disclosing Bagdad, Sierrita, Manufacturing and Sales as individual reportable segments in 2004, whereas, in 2003 and 2002 Bagdad and Sierrita, and Manufacturing and Sales were aggregated. Segment information for 2003 and 2002 has been revised to conform with the 2004 presentation.

     PDMC has six reportable copper production segments in the United States (Morenci, Bagdad, Sierrita, Miami/Bisbee, Chino/Cobre, and Tyrone) and three reportable copper production segments in South America (Candelaria/Ojos del Salado, Cerro Verde and El Abra). These segments include open-pit mining, underground mining, sulfide ore concentrating, leaching, solution extraction and electrowinning. In addition, the Candelaria/Ojos del Salado and Chino/Cobre segments produce gold and silver. The Bagdad, Sierrita and Chino mines produce molybdenum and rhenium as by-products.

     The Manufacturing segment consists of conversion facilities including our smelters, refineries and rod mills. The Manufacturing segment processes copper produced at our mining operations and copper purchased from others into copper anode, cathode and rod. In addition, at times it smelts and refines copper and produces copper rod for customers on a toll basis. Toll arrangements require the tolling customer to deliver appropriate copper-bearing material to our facilities, which we then process into a product that is returned to the customer. The customer pays PDMC for processing its material into the specified products.

     The Sales segment functions as an agent to sell copper from our copper production and manufacturing segments. It also purchases and sells any copper not sold by the South American mines to third parties. Copper is sold to others primarily as rod, cathode or concentrate, and as rod to PDI’s Wire and Cable segment.

     The Primary Molybdenum segment consists of the Henderson and Climax mines, related conversion facilities and a technology center. This segment is an integrated producer of molybdenum, with mining, roasting and processing facilities producing high-purity, molybdenum-based chemicals, molybdenum metal powder and metallurgical products. It also includes a process technology center that directs its primary activities at developing new engineered products and applications. In addition, at times it roasts and/or processes material on a toll basis. Toll arrangements require the tolling customer to deliver appropriate molybdenum-bearing material to our facilities, which we then process into a product that is returned to the customer. The customer pays PDMC for processing its material into the specified products.

     Major operating and financial results of PDMC for the years 2004, 2003 and 2002 are illustrated in the following table:

     
   
($ in millions except per pound amounts)
   
                         
    2004     2003     2002  
     
Sales and other operating revenues to unaffiliated customers*
  $ 5,443.4       2,828.6       2,485.8  
Operating income (loss)*
  $ 1,606.7       265.2       (65.0 )
Operating income before special items and provisions*
  $ 1,618.0       270.7       51.9  
Minority interests in consolidated subsidiaries*
  $ (196.8 )     (3.5 )     (3.5 )
 
                       
Copper production (thousand short tons):
                       
Total copper production
    1,323.6       1,305.6       1,275.6  
Less undivided interest (A)
    63.0       63.3       61.9  
     
Copper production on a consolidated basis
    1,260.6       1,242.3       1,213.7  
Less minority participants’ shares previously accounted for on a pro rata basis (B)
    161.8       183.0       184.9  
     
Copper production on a pro rata basis
    1,098.8       1,059.3       1,028.8  
     
 
                       
Copper sales (thousand short tons):
                       
Total copper sales from own mines
    1,331.9       1,317.4       1,300.9  
Less undivided interest (A)
    63.0       63.3       61.9  
     
Copper sales from own mines on a consolidated basis
    1,268.9       1,254.1       1,239.0  
Less minority participants’ shares previously accounted for on a pro rata basis (B)
    162.6       184.8       187.9  
     
Copper sales from own mines on a pro rata basis
    1,106.3       1,069.3       1,051.1  
     
 
                       
Purchased copper (thousand short tons):
                       
Total purchased copper
    433.0       374.5       443.0  
     
 
Total copper sales on a consolidated basis
    1,701.9       N/A       N/A  
     
 
Total copper sales on a pro rata basis
    N/A       1,443.8       1,494.1  
     
 
LME average spot copper price per pound — cathodes
  $ 1.300       0.807       0.707  
COMEX average spot copper price per pound — cathodes
  $ 1.290       0.811       0.717  
 
                       
Molybdenum production (million pounds)
    57.5       52.0       45.0  
Molybdenum sales (million pounds):
                       
Net Phelps Dodge share from own mines
    63.1       54.2       46.7  
Purchased molybdenum
    12.9       8.2       7.4  
     
Total molybdenum sales
    76.0       62.4       54.1  
     
Metals Week:
                       
Annual molybdenum Dealer Oxide mean price per pound
  $ 16.41       5.32       3.77  
     
   

*   2004 reflected full consolidation of El Abra and Candelaria; 2003 and 2002 reflected El Abra and Candelaria on a pro rata basis (51 percent and 80 percent, respectively).

(A)   Represented a 15 percent undivided interest in Morenci, Arizona, copper mining complex held by Sumitomo Metal Mining Arizona, Inc.

(B)   Minority participant interests included (i) a one-third partnership interest in Chino Mines Company in New Mexico held by Heisei Minerals Corporation through December 18, 2003, (ii) a 20 percent partnership interest in Candelaria in Chile held by SMMA Candelaria, Inc., a jointly owned indirect subsidiary of Sumitomo Metal Mining Co., Ltd., and Sumitomo Corporation, and (iii) a 49 percent partnership interest in the El Abra copper mining operation in Chile held by Corporación Nacional del Cobre de Chile (CODELCO).
     
   

 


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(thousand short tons)
   
                         
    2004     2003     2002  
     
Minority participants’ shares previously accounted for on a pro rata basis:
                       
Chino
          13.7       19.3  
Candelaria
    44.1       46.9       43.9  
El Abra
    117.7       122.4       121.7  
     
 
    161.8       183.0       184.9  
     
     
   

     There is no established common standard for calculating unit production costs in the copper industry. In prior periods, the Company reported implied full and cash unit costs of copper production per pound before special items and provisions on a basis, which to allow for comparability across companies, was based on the LME average spot copper price per pound. However, because these calculations are non-GAAP measures, the Company has discontinued reporting these unit cost calculations.

Total PDMC Division – Sales

     PDMC’s sales and other operating revenues to unaffiliated customers increased $2,614.8 million, or 92 percent, in 2004 compared with the corresponding 2003 period. The increase reflected higher average copper prices (approximately $1,480 million), the impact of fully consolidating El Abra and Candelaria (approximately $273 million), higher average molybdenum realizations (approximately $521 million), higher copper sales volumes (approximately $232 million), higher primary molybdenum sales volumes (approximately $79 million) and higher copper rod sales volumes and prices (approximately $29 million).

     In 2003, the increase of $342.8 million, or 14 percent, in sales and other operating revenues to unaffiliated customers, compared with 2002, reflected higher average copper prices (approximately $267 million), higher average molybdenum realizations (approximately $76 million), higher primary molybdenum sales volumes (approximately $38 million) and slightly higher precious metals sales (approximately $1 million); partially offset by lower copper sales volumes (approximately $40 million) primarily reflecting decreased purchases and sales of third-party copper.

Total PDMC Division – Operating Income (Loss)

     PDMC reported operating income of $1,606.7 million in 2004 including special, net pre-tax charges of $11.3 million, compared with operating income of $265.2 million in 2003 including a special, net pre-tax charge of $5.5 million, and an operating loss of $65.0 million in 2002 including $116.9 million of special, net pre-tax charges.

     Excluding special items, the increase in operating income of $1,347.3 million for 2004, compared with 2003, primarily resulted from higher copper prices including premiums and copper pricing adjustments (approximately $1,068 million), the impact of fully consolidating El Abra and Candelaria (approximately $192 million), higher primary molybdenum earnings (approximately $94 million) primarily due to higher prices, and higher copper sales volumes (approximately $10 million); partially offset by higher exploration and research expense (approximately $11 million).

     Excluding special items, the increase in 2003 operating income of $218.8 million, compared with 2002, primarily resulted from higher average copper prices including premiums and copper pricing adjustments (approximately $198 million).

     For both 2004 and 2003, the higher average copper prices including premiums reflected improved copper fundamentals and an improved economic environment.

     During the 2002 fourth quarter, PDMC recorded special, pre-tax charges for asset impairments and closure provisions of $153.5 million at Cobre, Hidalgo and Ajo. The Company recognized an impairment charge to write down Cobre’s assets by $115.5 million. Phelps Dodge took this action after revising mine plans and assessing recoverability. The revised mine plans and associated cash flows used a copper price lower than the prior-year assumption, reflecting moving average historical copper prices representing full economic and pricing cycles. The amount of Cobre’s impairment was determined through an assessment of discounted cash flows of the remaining ore reserves.

     The Hidalgo impairment included a $12.9 million write-down of assets to their estimated fair value. As a result of the Company’s ability to use acid more efficiently and an updated assessment of PDMC’s long-term acid production and consumption balance, the Company determined (i) that Hidalgo probably would not be reconfigured to produce acid as originally anticipated and (ii) the net book value of the Hidalgo assets probably would not be recovered. At the time of the impairment, it was determined that the power facilities would continue to generate electricity when needed, and the facility would continue to be a backup source of acid if conditions warranted. The remaining Hidalgo assets were written down to their estimated fair value in the 2002 fourth quarter. The Company also recognized a $7.0 million charge for the estimated remaining cost of its closure obligation at Hidalgo. As a result of the sale of a portion of the facility, in the 2004 third quarter the remaining Hidalgo assets were written down to fair value. The smelter and ancillary buildings currently are expected to be demolished in 2005 and 2006.

     In 2002, PDMC reclassified material previously characterized as reserves at Ajo to mineralized material and, as a result, recognized an impairment charge to write down Ajo’s assets by $18.1 million. This action resulted from updating mine plans at this prospective development property. The amount of Ajo’s impairment was determined through an assessment of the fair value of its assets.

     Copper is an internationally traded commodity, and its price is effectively determined by the major metals exchanges – COMEX, LME and SHFE. The prices on these exchanges generally reflect the worldwide balance of copper supply and demand, but also are influenced significantly from time to time by speculative actions and by currency exchange rates.

     The price of copper, our principal product, was a significant factor influencing our results over the three-year period ended December 31, 2004. We principally base our selling price for U.S. sales on the COMEX spot price per pound of copper cathode, which averaged $1.290 in 2004, 81.1 cents in 2003 and 71.7 cents in 2002. Internationally, our copper selling prices are generally based on the LME spot price for cathode. The LME spot price per pound of copper averaged $1.300 in 2004, 80.7 cents in 2003 and 70.7 cents in 2002. The COMEX and LME prices averaged $1.463 and $1.474 per pound,

 


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respectively, for the first 62 days of 2005, and closed at $1.475 and $1.510, respectively, on March 3, 2005.

     Following is a table summarizing the net copper pricing adjustments for the years 2004, 2003 and 2002:

     
   
($ in millions)
   
                         
    2004     2003     2002  
     
Provisionally priced copper sales, including final settlements and Candelaria’s swap contracts
  $ 21.1       9.0       6.2  
     
     
   

     Certain of PDMC’s sales agreements provide for provisional pricing based on either COMEX or LME (as specified in the contract) when shipped. Final settlement is based on the average applicable price for a specified future period (quotational period or QP), generally from one to three months after arrival at the customer’s facility. PDMC records revenues upon passage of title using the forward rate in place for the QP. For accounting purposes, these revenues are adjusted to fair value through earnings each period until the date of final copper pricing. Provisionally priced pounds outstanding at December 31, 2004, increased compared with December 31, 2003, reflecting a change in the pricing election of certain of Candelaria’s customers effective January 1, 2004. The change primarily reflected movement away from pricing in the month of shipment to pricing three months after the month of arrival, an annual pricing election that must be declared by contract customers at the beginning of each contract year. Following are the provisionally priced copper sales outstanding at December 31, 2004, 2003 and 2002:

     
   

Provisionally Priced Copper Sales Outstanding at December 31,:

         
2004      
  117.0    
million pounds priced at $1.4720 per lb. with a final January 2005 QP
  46.4    
million pounds priced at $1.4546 per lb. with a final February 2005 QP
  45.6    
million pounds priced at $1.4388 per lb. with a final March 2005 QP
  59.5    
million pounds priced at $1.4197 per lb. with a final April 2005 QP
     
 
  268.5    
million pounds priced at $1.4518 per lb. with a final January to April 2005 QP
     
 

74 percent of the provisionally priced pounds outstanding at December 31, 2004, were at Candelaria.

         
2003      
  43.3    
million pounds priced at $1.0463 per lb. with a final January to April 2004 QP
     
 

41 percent of the provisionally priced pounds outstanding at December 31, 2003, were at Candelaria.

         
2002      
  25.8    
million pounds priced at $0.7021 per lb. with a final January 2003 QP
     
 

None of the provisionally priced pounds outstanding at December 31, 2002, were at Candelaria.

     
   

     In 2004, Phelps Dodge entered into copper swap contracts to hedge provisionally priced sales exposure in a manner that allows us to receive the average LME price for the month of shipment while our Candelaria customers receive the QP price they requested (i.e., one to three months after month of arrival at the customer’s facility). These hedge contracts are in accordance with our Copper Quotational Period Swap Program discussed in Note 21, Derivative Financial Instruments and Fair Value of Financial Instruments. As of February 15, 2005, we completed our copper swap contracts for approximately 92 percent of Candelaria’s provisionally priced copper sales outstanding at December 31, 2004, at an average of $1.382 per pound. This program is expected to substantially alleviate the volatility that provisional priced copper sales could have on our revenues.

     Energy, including electricity, diesel fuel and natural gas, represents a significant portion of production costs at our operations. In response to volatile energy markets in 2000 and 2001, we implemented a power cost stabilization plan that moderated electricity-related costs at our U.S. mining operations. Under the plan, we use a combination of multi-year energy contracts that we put in place at favorable points in the price cycle as well as self-generation and natural gas hedging.

     We continue to explore alternatives to moderate or offset the impact of increasing energy costs. To address volatility associated with a shortfall of power generation capacity experienced in the 2000 energy crisis in the western United States, in late 2004 we purchased a one-third interest in a partially constructed power plant in New Mexico owned by Duke Energy Luna, LLC. The plant is expected to be operating by the 2006 second quarter. One-third of its electricity (approximately 190 megawatts) is expected to be consumed by PDMC operations in New Mexico and Arizona. This investment in an efficient, low-cost plant is expected to continue to stabilize our southwest U.S. operations’ energy costs and increase the reliability of our energy supply.

     To mitigate the Company’s exposure to increases in diesel fuel and natural gas prices, we utilize several price protection programs designed to protect the Company against a significant short-term upward movement in prices. The Company’s diesel fuel price protection program consists of a combination of purchased, out-of-the-money (OTM) diesel fuel call options and fixed-price diesel fuel swaps for our North American and Chilean operations. The OTM call options give the holder the right, but not the obligation, to purchase a specific commodity at a pre-determined dollar cost, or “strike price.” OTM call options are options with a strike price above the prevailing market price for that commodity when purchased.

     OTM diesel fuel call options mitigate a portion of our exposure to volatile markets by capping the cost of the commodity if prices rise above the strike price. If the price of diesel fuel is less than the strike price, the Company has the flexibility to purchase diesel fuel at prices lower than the strike price and the options expire with no value. The swaps allow us to establish a fixed price for a specific commodity product for delivery during a specific future period.

     Our natural gas price protection program consists of purchasing OTM call options for our North American operations. OTM call options cap the commodity purchase cost at the strike price while allowing the Company the ability to purchase natural gas at a lower cost when market prices were lower than the strike price.

     As a result of the above-mentioned plans and programs, in 2004, 2003 and 2002 Phelps Dodge was able to reduce and partially mitigate the impacts of volatile electricity markets and rising diesel fuel and natural gas prices.

     Any material change in the price we receive for copper, or in PDMC’s cost of copper production, has a significant effect on our results. Based on expected 2005 annual production of approximately 2.7 billion pounds of copper, each 1 cent per pound change in the

 


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average annual copper price, or in average annual cost of copper production, causes a variation in annual operating income before taxes and adjustments for minority interests of approximately $27 million.

     Due to the market risk arising from the volatility of copper prices, our objective is to sell copper cathode and rod produced at our U.S. operations at the COMEX average price in the month of shipment, and copper cathode and concentrate produced at our international operations at the LME average price in the month of settlement with our customers. During 2004, PDMC sold approximately 50 percent, 31 percent and 19 percent of its copper as copper rod, copper cathode and concentrates, respectively.

     Additionally in 2004, operations outside the United States provided 30 percent of PDMC’s sales (including sales through PDMC’s U.S.-based sales company), compared with 26 percent in 2003 and 27 percent in 2002. During 2004, operations outside the United States (including international exploration) contributed 44 percent of the division’s operating income, compared with 63 percent for 2003 and a reduction of 94 percent of the division’s operating loss for 2002.

     From time to time, we may purchase or sell copper price protection contracts for a portion of our expected future sales of our mine production. We do this to limit the effects of potential decreases in copper selling prices. Refer to pages 80 and 81 for further discussion of our copper price protection programs.

     The 2004 exploration program continued to place emphasis on the search for and delineation of large-scale copper and copper/gold deposits. Phelps Dodge expended $35.6 million on worldwide exploration during 2004, compared with $25.8 million in 2003 and $20.0 million in 2002. Approximately 40 percent of the 2004 expenditures occurred in the United States, with approximately 31 percent being spent at our U.S. mine sites, and the remainder for support of U.S. and international exploration activities. Approximately 16 percent was spent at our South American mine sites and the balance of exploration expenditures was spent principally in Chile, Central Africa, Australasia, Europe, Peru, Mexico, Brazil and Canada.

Note: Supplemental Data

     The following table summarizes PDMC’s operating income (loss), special items and provisions, and the resultant earnings (losses) excluding these special items and provisions for the years 2004, 2003 and 2002:

     
   
($ in millions)
   
                         
    2004     2003     2002  
     
Segment operating income (loss):
                       
U.S. Mining Operations*
  $ 796.4       74.0       (139.0 )
South American Mines**
    707.0       182.6       65.4  
Primary Molybdenum
    103.3       8.6       8.6  
     
 
  $ 1,606.7       265.2       (65.0 )
     
Special, pre-tax items and provisions:
                       
U.S. Mining Operations*
  $ (11.6 )     (5.5 )     (117.9 )
South American Mines**
                 
Primary Molybdenum
    0.3             1.0  
     
 
  $ (11.3 )     (5.5 )     (116.9 )
     
Segment operating income (loss) excluding special items and provisions:
                       
U.S. Mining Operations*
  $ 808.0       79.5       (21.1 )
South American Mines**
    707.0       182.6       65.4  
Primary Molybdenum
    103.0       8.6       7.6  
     
 
  $ 1,618.0       270.7       51.9  
     
     
   

*   U.S. Mining Operations comprised the following reportable segments: Morenci, Bagdad, Sierrita, Miami/Bisbee, Chino/Cobre, Tyrone, Manufacturing and Sales, along with other mining activities.
 
**   South American Mines comprised the following segments: Candelaria/Ojos del Salado, Cerro Verde and El Abra. 2004 reflected the full consolidation of El Abra and Candelaria; 2003 and 2002 reflected El Abra and Candelaria on a pro rata basis (51 percent and 80 percent, respectively).

Note: Our non-GAAP measure of special items may not be comparable to similarly titled measures reported by other companies.

     
   

 


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Note: Supplemental Data

     Special, pre-tax items and provisions in operating income (loss) were as follows:

     
   
($ in millions)
   
                         
    2004
    U.S.     South     Primary  
    Mining     American     Molyb-  
    Operations     Mines     denum  
     
Environmental provisions, net
  $ (17.1 )           0.3  
Environmental insurance recoveries, net
    9.1              
Hidalgo asset impairment
    (1.1 )            
Historical legal matters
    (2.5 )            
     
Special, pre-tax items
  $ (11.6 )           0.3  
     
     
   
($ in millions)
   
                         
    2003
    U.S.     South     Primary  
    Mining     American     Molyb-  
    Operations     Mines     denum  
     
Environmental provisions, net
  $ (5.5 )            
     
     
   
($ in millions)
   
                         
    2002
    U.S.     South     Primary  
    Mining     American     Molyb-  
    Operations     Mines     denum  
     
December 2002 impairments and provisions:
                       
Asset impairment charges
  $ (146.5 )            
Accrued closure costs
    (7.0 )            
Environmental provisions, net
    (2.6 )           1.0  
October 2001 restructuring:
                       
Reassessments of employee activities and take-or-pay contracts
    5.1              
Additional retirement benefits
    (6.4 )            
Environmental insurance recoveries, net
    16.9              
Sale of non-core real estate
    22.6              
     
Special, pre-tax items
  $ (117.9 )           1.0  
     
     
   

Note: Our non-GAAP measure of special items may not be comparable to similarly titled measures reported by other companies.
     
   

 


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58


PDMC Results By Reportable Segments

The following tables summarize, on a segment basis, production and sales statistics, operating income (loss), special items and provisions, net, and operating income (loss) excluding special items and provisions for 2004, 2003 and 2002:

                                                                                         
    U.S. Mines     South American Mines  
                            Miami/     Chino/                     Candelaria/     Cerro              
    Morenci     Bagdad     Sierrita     Bisbee     Cobre     Tyrone     Subtotal     Ojos del Salado*     Verde     El Abra*     Subtotal  
 
2004
                                                                                       
Copper production (thousand short tons):
                                                                                       
Total production
    420.3       110.1       77.5       9.8       91.7       43.1       752.5       230.9       97.6       240.3       568.8  
Less undivided interest
    63.0                                     63.0                          
         
Copper production on a consolidated basis
    357.3       110.1       77.5       9.8       91.7       43.1       689.5       230.9       97.6       240.3       568.8  
Less minority participants’ shares previously accounted for on a pro rata basis
                                              44.1             117.7       161.8  
         
Copper production on a pro rata basis
    357.3       110.1       77.5       9.8       91.7       43.1       689.5       186.8       97.6       122.6       407.0  
         
Copper sales (thousand short tons):
                                                                                       
Total copper sales from own mines
    420.3       111.9       79.2       10.9       91.7       43.1       757.1       233.5       98.2       240.8       572.5  
Less undivided interest
    63.0                                     63.0                          
         
Copper sales from own mines on a consolidated basis
    357.3       111.9       79.2       10.9       91.7       43.1       694.1       233.5       98.2       240.8       572.5  
Less minority participants’ shares previously accounted for on a pro rata basis
                                              44.6             118.0       162.6  
         
Copper sales from own mines on a pro rata basis
    357.3       111.9       79.2       10.9       91.7       43.1       694.1       188.9       98.2       122.8       409.9  
         
Purchased copper (thousand short tons):
                                                                                       
Total purchased copper
                                              37.1                   37.1  
         
Total copper sales on a consolidated basis
    357.3       111.9       79.2       10.9       91.7       43.1       694.1       270.6       98.2       240.8       609.6  
         
 
                                                                                       
($ in millions)
                                                                                       
Operating income (loss)
  $ 375.7       174.9       264.3       (5.1 )     57.6       22.9       890.3       303.3       130.0       273.7       707.0  
Special items and provisions, net
    (0.6 )                 (0.1 )     (1.2 )     (5.8 )     (7.7 )                        
         
Operating income (loss) excluding special
items and provisions
  $ 376.3       174.9       264.3       (5.0 )     58.8       28.7       898.0       303.3       130.0       273.7       707.0  
         
 
 
2003
                                                                                       
Copper production (thousand short tons):
                                                                                       
Total production
    421.2       107.0       75.6       17.8       39.9       56.9       718.4       234.5       96.3       249.8       580.6  
Less minority participants’ shares
    63.3                         12.5             75.8       46.9             122.4       169.3  
         
Copper production on a pro rata basis
    357.9       107.0       75.6       17.8       27.4       56.9       642.6       187.6       96.3       127.4       411.3  
         
Copper sales (thousand short tons):
                                                                                       
Copper sales from own mines on a pro rata basis
    357.9       111.0       79.3       20.0       27.4       56.9       652.5       187.4       95.6       128.4       411.4  
Purchased copper
                                              22.1             7.3       29.4  
         
Total copper sales on a pro rata basis
    357.9       111.0       79.3       20.0       27.4       56.9       652.5       209.5       95.6       135.7       440.8  
         
 
                                                                                       
($ in millions)
                                                                                       
Operating income (loss)
  $ 77.4       30.1       50.9       (6.0 )     (5.4 )     (17.2 )     129.8       100.5       42.7       39.4       182.6  
Special items and provisions, net
    (1.1 )                 (0.5 )     (1.3 )     (0.5 )     (3.4 )                        
         
Operating income (loss) excluding special items and provisions
  $ 78.5       30.1       50.9       (5.5 )     (4.1 )     (16.7 )     133.2       100.5       42.7       39.4       182.6  
         
 
 

Refer to segment discussion on pages 62 through 68.

Revenues, operating costs and expenses of PDMC’s segments included allocations that may not be reflective of market conditions. Additionally, certain costs were not allocated to the reportable segments. (Refer to page 62 for further discussion.)

* 2004 reflected full consolidation of El Abra and Candelaria; 2003 and 2002 reflected El Abra and Candelaria on a pro rata basis (51 percent and 80 percent, respectively).

 


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59


PDMC Results By Reportable Segments (continued)

                                                                                         
 
    U.S. Mines     South American Mines  
                            Miami/     Chino/                     Candelaria/     Cerro              
    Morenci     Bagdad     Sierrita     Bisbee     Cobre     Tyrone     Subtotal     Ojos del Salado*     Verde     El Abra*     Subtotal  
 
2002
                                                                                       
Copper production (thousand short tons):
                                                                                       
Total production
    412.7       84.0       76.2       10.6       53.8       69.9       707.2       219.5       95.3       248.2       563.0  
Less minority participants’ shares
    61.9                         17.9             79.8       43.9             121.7       165.6  
         
Copper production on a pro rata basis
    350.8       84.0       76.2       10.6       35.9       69.9       627.4       175.6       95.3       126.5       397.4  
         
Copper sales (thousand short tons):
                                                                                       
Copper sales from own mines on a pro rata basis
    350.8       92.3       83.8       15.3       35.8       69.9       647.9       174.6       94.9       129.6       399.1  
Purchased copper
                                              35.8             56.5       92.3  
         
Total copper sales on a pro rata basis
    350.8       92.3       83.8       15.3       35.8       69.9       647.9       210.4       94.9       186.1       491.4  
         
 
                                                                                       
($ in millions)
                                                                                       
Operating income (loss)
  $ 24.1       6.0       14.2       (15.6 )     (110.4 )     1.6       (80.1 )     47.6       24.8       (7.0 )     65.4  
Special items and provisions, net
    (0.5 )     0.8       (0.5 )     (2.3 )     (117.2 )           (119.7 )                        
         
Operating income (loss) excluding special items and provisions
  $ 24.6       5.2       14.7       (13.3 )     6.8       1.6       39.6       47.6       24.8       (7.0 )     65.4  
         
 
 

Refer to segment discussion on pages 62 through 68.

Revenues, operating costs and expenses of PDMC’s segments included allocations that may not be reflective of market conditions. Additionally, certain costs were not allocated to the reportable segments. (Refer to page 62 for further discussion.)

* 2004 reflected full consolidation of El Abra and Candelaria; 2003 and 2002 reflected El Abra and Candelaria on a pro rata basis (51 percent and 80 percent, respectively).

 


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60


PDMC Results By Reportable Segments (continued)

                                                 
    Primary                     PDMC              
    Molybdenum     Manufacturing     Sales     Segments     Other     Total PDMC  
 
2004
                                               
Copper production (thousand short tons):
                                               
Total production
          2.3             1,323.6             1,323.6  
Less undivided interest
                      63.0             63.0  
     
Copper production on a consolidated basis
          2.3             1,260.6             1,260.6  
Less minority participants’ shares previously accounted for on a pro rata basis
                      161.8             161.8  
     
Copper production on a pro rata basis
          2.3             1,098.8             1,098.8  
     
Copper sales (thousand short tons):
                                               
Total copper sales from own mines
          2.3             1,331.9             1,331.9  
Less undivided interest
                      63.0             63.0  
     
Copper sales from own mines on a consolidated basis
          2.3             1,268.9             1,268.9  
Less minority participants’ shares previously accounted for on a pro rata basis
                      162.6             162.6  
     
Copper sales from own mines on a pro rata basis
          2.3             1,106.3             1,106.3  
     
Purchased copper (thousand short tons):
                                               
Total purchased copper
          394.0       1.9       433.0             433.0  
     
Total copper sales on a consolidated basis
          396.3       1.9       1,701.9             1,701.9  
     
Molybdenum production (thousand pounds):
                                               
Primary - Henderson
    27,520                   27,520             27,520  
By-product
    29,969                   29,969             29,969  
     
Total production
    57,489                   57,489             57,489  
     
 
                                               
Molybdenum sales (thousand pounds):
                                               
Net Phelps Dodge share from own mines
    63,108                   63,108             63,108  
Purchased molybdenum
    12,844                   12,844             12,844  
     
Total molybdenum sales
    75,952                   75,952             75,952  
     
 
                                               
($ in millions)
                                               
Operating income (loss)
  $ 103.3       29.1       4.1       1,733.8       (127.1 )     1,606.7  
Special items and provisions, net
    0.3       (3.2 )           (10.6 )     (0.7 )     (11.3 )
     
Operating income (loss) excluding special items and provisions
  $ 103.0       32.3       4.1       1,744.4       (126.4 )     1,618.0  
     
 
 
2003
                                               
Copper production (thousand short tons):
                                               
Total production
          6.6             1,305.6             1,305.6  
Less minority participants’ shares
          1.2             246.3             246.3  
     
Copper production on a pro rata basis
          5.4             1,059.3             1,059.3  
     
Copper sales (thousand short tons):
                                               
Total copper sales from own mines on a pro rata basis
          5.4             1,069.3             1,069.3  
Purchased copper
          274.6       70.5       374.5             374.5  
     
Total copper sales on a pro rata basis
          280.0       70.5       1,443.8             1,443.8  
     
 
                                               
Molybdenum production (thousand pounds):
                                               
Primary - Henderson
    22,247                   22,247             22,247  
By-product
    29,747                   29,747             29,747  
     
Total production
    51,994                   51,994             51,994  
     
 
                                               
Molybdenum sales (thousand pounds):
                                               
Net Phelps Dodge share from own mines
    54,158                   54,158             54,158  
Purchased molybdenum
    8,199                   8,199             8,199  
     
Total molybdenum sales
    62,357                   62,357             62,357  
     
 
                                               
($ in millions)
                                               
Operating income (loss)
  $ 8.6       26.4       5.5       352.9       (87.7 )     265.2  
Special items and provisions, net
          (0.1 )           (3.5 )     (2.0 )     (5.5 )
     
Operating income (loss) excluding special items and provisions
  $ 8.6       26.5       5.5       356.4       (85.7 )     270.7  
     
 
 

Refer to segment discussion on pages 62 through 68.

Revenues, operating costs and expenses of PDMC’s segments included allocations that may not be reflective of market conditions. Additionally, certain costs were not allocated to the reportable segments. (Refer to page 62 for further discussion.)

 


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61


PDMC Results By Reportable Segments (continued)

                                                 
    Primary                     PDMC              
    Molybdenum     Manufacturing     Sales     Segments     Other     Total PDMC  
 
2002
                                               
Copper production (thousand short tons):
                                               
Total production
          5.4             1,275.6             1,275.6  
Less minority participants’ shares
          1.4             246.8             246.8  
     
Copper production on a pro rata basis
          4.0             1,028.8             1,028.8  
     
Copper sales (thousand short tons):
                                               
Total copper sales from own mines on a pro rata basis
          4.1             1,051.1             1,051.1  
Purchased copper
          267.7       83.0       443.0             443.0  
     
Total copper sales on a pro rata basis
          271.8       83.0       1,494.1             1,494.1  
     
 
                                               
Molybdenum production (thousand pounds):
                                               
Primary - Henderson
    20,517                   20,517             20,517  
By-product
    24,448                   24,448             24,448  
     
Total production
    44,965                   44,965             44,965  
     
 
                                               
Molybdenum sales (thousand pounds):
                                               
Net Phelps Dodge share from own mines
    46,665                   46,665             46,665  
Purchased molybdenum
    7,393                   7,393             7,393  
     
Total molybdenum sales
    54,058                   54,058             54,058  
     
 
                                               
($ in millions)
                                               
Operating income (loss)
  $ 8.6       13.9       (8.8 )     (1.0 )     (64.0 )     (65.0 )
Special items and provisions
    1.0       0.2             (118.5 )     1.6       (116.9 )
     
Operating income (loss) excluding special items and provisions
  $ 7.6       13.7       (8.8 )     117.5       (65.6 )     51.9  
     
 
 

Refer to segment discussion on pages 62 through 68.

Revenues, operating costs and expenses of PDMC’s segments included allocations that may not be reflective of market conditions. Additionally, certain costs were not allocated to the reportable segments. (Refer to page 62 for further discussion.)

 


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62
   

Sales of Copper (U.S. and South America) and Molybdenum

     The Manufacturing and Sales segments are responsible for selling all copper produced at the U.S. mines. Intersegment revenues of the individual U.S. mines represent an internal allocation based on PDMC’s sales to unaffiliated customers. Therefore, the following discussion and analysis combines the U.S. Mine segments and Other with the Manufacturing and Sales segments. The Sales segment purchases and sells any copper not sold by the South American mines to third parties. In 2004, the South American mines sold approximately 41 percent of their copper to the Sales segment, compared with approximately 44 percent in 2003 and 2002. Intersegment sales by the South American Mines are based upon arms-length prices at the time of the sale. Intersegment sales of any individual mine may not be reflective of the actual prices PDMC ultimately receives due to a variety of factors including additional processing, timing of sales to unaffiliated customers, and transportation premiums. These sales are reflected in the Manufacturing and Sales segments.

     
   
($ in millions)
   
                         
    2004     2003     2002