"COMMENTARY9:05 AM, 12 Dec 2008 Tony BoydRed metal riskThe 70...

"COMMENTARY

9:05 AM, 12 Dec 2008



Tony Boyd
Red metal risk


The 70 per cent collapse in the copper price in the past four months has exposed a critical weakness in the risk management methods of some copper producers.

Suppliers of copper who were paid for shipments when the copper price was high, and failed to agree a fixed price, are being hit or have been hit with negative pricing adjustments upon delivery.

These pricing adjustments are triggering severe cash flow problems for copper producers. In some cases the cash flow squeeze has caused terminal problems.

Negative provisional pricing adjustments were behind the collapse of small Australian copper miner CopperCo. Analysts say negative pricing adjustments are contributing to cash flow problems at debt-laden miner Oz Minerals.

Questions are being raised in the industry about the impact of negative pricing adjustments on other copper producers. The focus is on companies with little financial flexibility such as those with high debt and large capital expenditure commitments.

Copper quoted in US cents per pound has fallen 67 per cent since July. Copper on the London Metal Exchange quoted in metric tonnes is down a similar percentage.

Copper smelters in Japan, China and India are believed to be concerned that they will not be paid the provisional adjustments due to them from copper producers. There is little they can do.

Under provisional pricing a copper supplier sells production to a smelter and gets paid the London Metal Exchange cash settlement price up front.

A provisional pricing adjustment is made when the final price is determined at a future date agreed between the buyer and the seller. The final price can be at the time of shipment of the copper or several months after the date of delivery.

There is flexibility built into the system that allows the miners and the smelters to negotiate depending on their views of the future copper price. It is possible and not uncommon for producers to hedge their exposure to a fall in price by laying off the risk to a bank.

CopperCo gave no indication before its collapse that a big move in the copper price would mean it could not meet its debts. Its directors put the company into voluntary administration with the appointment of Shaun Fraser from McGrathNicol in late November.

Macquarie Bank, which is owed $143 million by CopperCo, appointed Darren Weaver of Ferrier Hodgson as receiver and manager.

It is believed that the receivers and managers have found that following its June 30 balance date, CopperCo was hit with $10 million to $15 million in negative provisional adjustment payments from its customers.

These liabilities hit as CopperCo faced capital expenditure commitments and debt interest payments following its takeover of Mineral Securities.

However, there was nothing to stop CopperCo from hedging its exposure to the 70 per cent fall in the copper price.

Some provisional pricing agreements stretch out to three or four months after delivery so it could take several months for the impact of negative price adjustments to wash through the system. "