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Codelco Waning Copper Pressures $17.5 Billion Bet to Catch Boom

Andres Avendano steps out of his Toyota Hilux pickup halfway down a 20-kilometer-long tunnel under Chile’s Chuquicamata copper mine. He lifts a cylindrical chunk of rock from the diamond-bit-studded drilling machine that extracted the sample.

“The copper is quite disseminated,” Avendano says, adjusting the light from his white hard hat to identify a sprinkling of gold-colored specks. In the mine’s early days, a similar specimen would have been brimming with the metal, he says.

Avendano, 33, who is in charge of mine design, and geologists from government-owned copper giant Codelco are searching around the clock for new deposits at Chuquicamata, Bloomberg Markets magazine reports in its June issue. The complex, 1,650 kilometers (1,025 miles) north of Santiago in the Atacama Desert, is so massive the open pit is visible from space.

The copper they’re hunting is becoming scarcer -- and more expensive -- just as more people in the developing world are demanding cars, TVs and modern trappings like iPads that use it and builders are relying on its ability to conduct electricity and heat for new houses and offices.

Chile, the world’s biggest copper producer, risks missing out unless Codelco can update mines built in the early 1900s. For the past 30 years, the country has let Chuquicamata and three other copper mines languish.

‘Slow to Make Decisions’

Australian giant BHP Billiton Ltd. (BHP)’s Escondida mine overtook Chuquicamata as Chile’s largest in 1996. Escondida now produces more than 1 million tons a year on Chilean soil, about double Chuquicamata’s output. Annual production at Codelco, which sits on 10 percent of the world’s copper reserves, has fallen in five of the past six years.

“They are very slow to make decisions,” says Wayne Atwell, managing director at New York-based Casimir Capital LP, who has visited Chilean mines 10 times in the past 30 years. “Their middle management probably has two to three times as many people as they should have.”

China’s copper appetite is driving the boom. Prices soared to a record $10,190 a metric ton on Feb. 15. On April 28, copper was trading at $9,320. It may drop as low as $8,500 before rocketing to $11,000 by Dec. 31 amid the biggest shortages since 2004, according to a Bloomberg survey of 24 analysts and traders.

China already consumes about 40 percent of the global supply. It will use 8 percent more this year as it begins constructing 36 million affordable homes and expanding its urban footprint, state research firm Beijing Antaike Information Development Co. predicts.

‘We Can’t Delay’

“There are not a lot of copper deposits in the world,” says Walter “Bucky” Hellwig, who helps manage $17 billion at BB&T Wealth Management in Birmingham, Alabama. “When you find one, it does take time to develop and bring production onstream.”

Diego Hernandez, the new Codelco chief executive officer that Chile’s billionaire President Sebastian Pinera recruited from BHP in April 2010, says he has overhauled senior management and is moving down the ranks. Now, the task is to make up for chronic underinvestment.

“We can’t delay anything; we have to do it now,” says Hernandez, 62, in Codelco’s Santiago office, which has displays of prehistoric tradable copper ingots.

Pharaonic Feats

Pinera is backing the copper revival. While unveiling an expansion at the El Teniente mine in the Andes Mountains on Sept. 8, he promised to invest $15 billion in Codelco during the next five years. Hernandez has since said Codelco needs $17.5 billion.

As ore diminishes in Chuquicamata’s pit and the threat of landslides makes further digging less profitable, Codelco will spend $2.2 billion through 2019 to develop deposits below ground. Without the money, Chuquicamata will run out of copper by decade’s end, Avendano says.

To prevent that calamity, Hernandez is proposing pharaonic feats. Codelco will build two 7-kilometer-long tunnels to tap ore buried as deep as the height of two and a half Eiffel Towers beneath the current pit. Underground crushers will break up 140,000 tons of rock a day. The industry’s longest conveyor will haul rock to the surface. The largest air-injection system in mining will ventilate the shaft at a rate of 8 million cubic feet (230,000 cubic meters) per minute. More than 4,000 workers will man the site.

Mine Rescue

Chile’s mining endeavors riveted global attention last year when 33 men were trapped half a mile below the Atacama for more than two months. They all were saved in the world’s longest- running mine rescue effort. Codelco engineers led a government team in charge of the mission.

Hernandez’s expansion plan requires more than extraordinary manpower and engineering. Codelco and Chile’s government will have to break with their past neglect, says Grimaldo Ponce, a supervisors union leader who is retiring this year after more than three decades at Chuquicamata.

Ponce, 69, says he’s not sure the new plan will actually happen.

“We have always had this problem that the money isn’t there to invest,” he says. “Codelco is slowly dying every day because there is no money.”

BB&T’s Hellwig is betting that Codelco’s copper will stay underground for lack of investment.

‘Game Is Called China’

“Like all state-owned enterprises, they exist to provide cash flow to the government,” he says of Codelco. “All too frequently, that is at the expense of the business.”

Chile’s government taps Codelco revenue that topped $13 billion last year to fund social programs and boost its sovereign wealth funds, which totaled $16.6 billion in 2010.

Juan Villarzu, who ran Codelco from 1994 to 1996 and from 2000 to 2006, says the board blocked him from expanding even after he saw in 2003 that China was on the verge of explosive growth.

“I said, ‘Look, guys, the game is called China,’” he recalls telling the board. Directors at the time included Chile’s finance minister and members of the armed forces, which get 10 percent of Codelco’s sales.

Chile is already enmeshed in another rebuilding project following the 8.8-magnitude earthquake that struck on Feb. 27, 2010, a week before Pinera became president. Pinera has been using sovereign-wealth-fund money, raising taxes and selling state assets to come up with $8.4 billion for reconstruction.

Cash Machine

Codelco is a tempting cash machine in lean economic times. It generates about 13 percent of government revenue, Hernandez says. Even with its mines depleted, Codelco sold $13.5 billion of copper last year, 30 percent more than the $10.3 billion in 2009.

The revenue is helping put Chile on course to become Latin America’s most prosperous nation. It will have Latin America’s highest gross domestic product per capita this year, leapfrogging Uruguay, the International Monetary Fund says.

Pinera says his support for Codelco will proceed -- even amid national hardships.

“We need to find the equilibrium in making that investment and not holding back and leaving the riches below the earth,” he said in September. “Codelco is a company with a lot of experience, but above all, it’s a company with a big future.”

Raising Debt

Still, Pinera isn’t handing over the cash. Instead, he has told Codelco to raise capital in international financial markets before the government considers reinvesting profits back into the company.

“Where raising debt is possible, while maintaining our investment grade, we are going to make that the first alternative,” Mining and Energy Minister Laurence Golborne says.

Copper buyers in China -- and the rest of the world -- are counting on Codelco.

“There is a demand for copper, and a company like Codelco needs to invest so that it’s doing more than just replacing its declining volumes,” says Joe Bormann, a Chicago-based managing director at Fitch Ratings.

Fitch upgraded Codelco and the Chilean government’s long- term credit rating to A+ in early February, the fifth highest of Fitch’s 10 investment grades and the best in Latin America for a resource company.

‘Freeze the Projects’

Villarzu, who’s now chairman of Vancouver-based exploration company AQM Copper Inc. (AQM), says he’d planned to raise Codelco’s production to 2.3 million metric tons a year by 2009 from an average of about 1 million tons during his first tenure. The board balked at the expense. Last year, production was 1.76 million tons.

“Essentially, what they did was freeze the projects,” says Villarzu, sitting in a restaurant in the Las Condes area of Santiago, which is nicknamed Sanhattan because of its skyscrapers.

Codelco, like its rivals, is also fighting battles with nature in the Atacama. BHP is trying to expand Escondida in the desert, where water to separate copper from sterile rock is scarce. Escondida’s production has slid for three consecutive years because of diminishing ore quality.

Codelco, BHP, Anglo American Plc (AAL), Rio Tinto Group and others are competing for engineers and for tires for mining trucks.

‘World Trend’

Banco de Chile CEO Arturo Tagle says Codelco should have looked to Brazil as a mining mentor. That nation opened Petroleo Brasileiro SA (PETR4), its former state-owned oil company, and Vale SA (VALE5), its former state-owned mining company, to private capital.

“We would be following the world trend taking this path,” Tagle says. “The best time to sell something is when it is generating a lot of profit.”

Chile’s richest family, headed by brothers Andronico, Guillermo and Jean-Paul Luksic, is defying the downward production spiral.

Besides their majority interest in Banco de Chile, the Luksics own 65 percent of Antofagasta Plc (ANTO), which operates Esperanza, Chile’s first new copper mine in three years. It started producing this year less than 100 kilometers from Chuquicamata and will turn out 190,000 tons in 2012, about 20,000 more than Codelco’s Ministro Hales mine is expected to yield when it begins producing copper in the last quarter of 2013.

When the Guggenheim family began looking for copper in the early 1900s, Chile’s deposits were there for the taking. The Guggenheims formed Chile Exploration Co. and went on to become billionaires, using Chuquicamata’s wealth to erect the family’s iconic art museum in New York.

‘Che’ Guevara

Guerrilla leader Ernesto “Che” Guevara documented the conditions of peasant workers who migrated from Chile’s greener south to work in the harsh desert mines in the 1950s.

In 1966, Chile’s congress passed a law that gave the state a 51 percent interest in the mines, then owned by U.S. companies Anaconda Corp. and Kennecott Corp. Socialist President Salvador Allende nationalized Chile’s copper industry outright in 1971. Military dictator Augusto Pinochet, who overthrew Allende in a 1973 coup, didn’t return the mines to their former owners and created Codelco in 1976.

Since then, the state-owned company has been slow to bring new mines into production, Casimir’s Atwell says. It opened the Radomiro Tomic mine in 1995 and Gabriela Mistral in 2008.

“If they make decisions, they can get criticized,” says Atwell, who has tracked the industry since 1969. “If they don’t make decisions, then nobody can criticize them for making the wrong decision.”

Hernandez at Helm

Pinera proposed selling part of Codelco to private investors when he embarked on his presidential campaign in 2009. He dropped the plan from his platform and now backs a bill to abolish the Pinochet-created law that transfers one-tenth of Codelco’s revenue to the army each year.

The bulk of the Codelco resurrection rests with Hernandez, who studied mine engineering at the Ecole Nationale Superieure des Mines de Paris. At BHP, he helped boost copper production 26 percent to 1.2 million tons in the year ended in June 2009 from the same period in 2004, when he became head of the company’s base-metals division.

Hernandez says Codelco has more room for progress than most publicly traded rivals because it hasn’t been run as efficiently.

‘Quite Substantial’

He has announced that 2,200 workers accepted the company’s voluntary retirement plan, reducing a workforce that totaled 19,347 in 2010. He has replaced mine managers and named new executives, including Chief Financial Officer Thomas Keller, formerly a managing director at Toronto-based Brookfield Asset Management Inc. (BAM)

“The improvement in results could be quite substantial,” Hernandez says.

In the past, Chile’s government shunned the type of investment Pinera is pledging because benefits wouldn’t turn up until the president had left office, Hernandez says.

These days, Codelco is in a stronger position to invest and raise capital because of surging copper prices. He predicts copper will average about $4 a pound next year -- or $8,819 a ton.

Rivals are plowing ahead to reap that bounty. London-based Anglo American and Rio Tinto and others will spend $42 billion to quadruple neighboring Peru’s copper output by 2020, Peruvian Energy and Mines Minister Pedro Sanchez Gamarra said on March 9.

In Mongolia, Rio Tinto plans to start operating its Oyu Tolgoi mine with Vancouver-based Ivanhoe Mines Ltd. by 2012. Antofagasta, along with Barrick Gold Corp. (ABX), is pursuing a new copper and gold mining district in Pakistan near its border with Afghanistan.

Avendano, the engineer who’s scouring Chuquicamata for new deposits, says there’s life in that old mine yet. He points to the walls around him, noting copper-rich rock in a 500-meter- wide fault line that runs down the spine of the Andes. The millions counting on Chile’s rich lode are hoping the government’s will to invest and the billions of dollars pledged for Codelco don’t run out before the copper does.

To contact the reporter on this story: Matt Craze in Santiago at mcraze@bloomberg.net

To contact the editor responsible for this story: Dale Crofts in Buenos Aires at dcrofts@bloomberg.net

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