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Trends in resource acquisition measures of the Japanese copper industry Younker, Richard Stewart 1970

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TRENDS IN RESOURCE ACQUISITION MEASURES OF THE JAPANESE COPPER INDUSTRY ty RICHARD STEWART YOUNKER B.Comm.(Hon,s) Queen's University, I969 A THESIS SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE DEGREE OF MASTER OF BUSINESS ADMINISTRATION in the Faculty of Commerce and Business Administration We accept this thesis as conforming to the required standard THE UNIVERSITY OF BRITISH COLUMBIA May, 1970 In presenting th i s thes i s in p a r t i a l f u l f i lment of the requirements fo r an advanced degree at the Un ivers i ty of B r i t i s h Columbia, I agree that the L ibrary sha l l make i t f r ee l y ava i l ab le for reference and study. I fur ther agree that permission for extensive copying of th i s thes i s for scho lar ly purposes may be granted by the Head of my Department or by his representat ives. It i s understood that copying or pub l i ca t i on of th i s thes i s fo r f i nanc ia l gain sha l l not be allowed without my wr i t ten permission. Department of Business Administration The Univers i ty of B r i t i s h Columbia Vancouver 8, Canada D a t e Mav 2 7 . 1970 i i ABSTRACT This thesis seeks to explore trends and develop-ments in the direction of new capital investment decisions by the Japanese copper industry, in order to determine what factors may influence the nature and extent of participations by Japanese interests in overseas copper mining, exploration, and development ventures. Japan i s becoming an increasingly important factor i n the world copper market, and i t i s argued that the policies which the Japanese adopt i n securing their raw material resources w i l l have an important bearing on the world copper industry. It i s assumed that Japanese interest in securing raw material resources for her copper industry can be expressed as a dynamic model which i s dependent upon Japanese expectations of future market supply and demand comditions for copper both at home and abroad. For purposes of analysis a theoretical model i s constructed to explain the nature and extent of Japanese overseas participations in copper. The model i s based on an analysis of the financial risks involved i n copper mining, exploration and development, and on an analysis of trends taking place in the world copper industry today. Selected case examples are used to il l u s t r a t e the hypotheses of the model. i i i The price at which Japan buys and sells her copper i s fixed in the world market by supply and demand conditions largely beyond her control. It i s argued that a reorganization of existing marketing structures i s probable and that this i s l i k e l y to lead to more stable prices within the industry. It also appears probable that the U . S . producer price and the LME price w i l l con-verge as the LME Increasingly comes to reflect a l l rather than marginal market forces. In future, prices within the industry w i l l come to increasingly reflect the long run average cost of production for mine output, plus a reasonable margin for profit. In order to maintain control over the form and delivery of her copper needs, and to increase the pr o f i t -a b i l i t y of her metal mining firms i t i s argued that Japan must find and develop mines at a production cost below the long run world market price of copper* To accomplish this goal, Japan must spread her exploration efforts abroad and invest wherever she finds worthwhile develop-ment prospects In a conducive economic and p o l i t i c a l environment. iv TABLE OF CONTENTS CHAPTER I. INTRODUCTION 1 Objectives of Study f Importance of Study Research Methodology Development of the Model Area of Investment Supply Contract Terms Organizational Structure I I . THE ANALYTICAL FRAMEWORK 1 7 Overview The Reinvestment Decision P r o f i t a b i l i t y Analysis The Nature of Risk Current P o s i t i o n of the Industry Planning Operations Summary I I I . TRENDS AND DEVELOPMENTS IN WORLD COPPER 3 1 Current Developments P r i c i n g Price Hypotheses Recent Price History The London Metal Exchange Future Price Outlook IV. JAPAN"S POSITION IN THE WORLD COPPER MARKET 55 Prospects f o r Economic Growth Foreign Exchange Control Government Aid, Regulations and Incentives to Japanese Foreign Investment v:: The Metallic Minerals Explorations Agency of Japan Copper Consumption in Japan Sources of Supply Industry Organization Current Developments within the Industry V. RECENT JAPANESE OVERSEAS PARTICIPATION IN COPPER -SOME CASE EXAMPLES 90 Purchase Contracts for Concentrates Purchase Contracts with Financial Aid Selected Case Examples Bouganville Freeport Indonesia Mamut Musoshi Bethlehem Copper Brenda Mines Davis-Keays VI. OUTLOOK FOR THE FUTURE INVESTMENT POLICIES OF JAPANESE COPPER INTERESTS 126 BIBLIOGRAPHY 1 3 0 .APPENDIX A 1 3 5 A Note on the Copper Industry APPENDIX B 140 Risk Analysis at Various Operating Levels of the Industry Fabricating Operations Refining and Smelting Operations Mining Operations ACKNOWLEDGED ENTS The author wishes to acknowledge h i s deep appreciation f o r the help and thoughtful suggestions provided by h i s thesis advisors, professors W. Winiata and E.C. Roper, In the preparation of t h i s thesis. I am further indebted to the many in d i v i d u a l s and firms who kindly gave f r e e l y of t h e i r time and provided me with information f o r t h i s study. Chris M i t c h e l l and Nigel Stonestreet, two of my classmates i n the M.B.A. program at U.B.C, provided me with valuable insights into current developments within the copper industry. I owe a p a r t i c u l a r debt of gratitude to my father not only f o r the Information which he provided but also f o r his continuing support throughout the time t h i s thesis was being written. L a s t l y , I wish to express my appreciation to Maureen Hockin f o r her valued help i n typing t h i s manuscript. CHAPTER I INTRODUCTION One of the most Important factors of our time i s the r a p i d l y increasing demand on the world's supply of raw material resources. The f a s t pace of economic growth and i n d u s t r i a l i z a t i o n which has taken place i n recent years must i n e v i t a b l y lead to greater in t e r n a t i o n a l competition f o r markets and new sources of raw material supplies. One of the countries i n the forefront of t h i s i n t e r n a t i o n a l competition i s Japan. Despite a lack of major reserves of most raw material resources^ Japan has been able to re b u i l d her economy from i t s state of war-time devastation to the point where she i s now the t h i r d 2 most powerful i n d u s t r i a l i z e d nation i n the world. To sustain t h i s economic growth, Japan has be-come a merchant to the world - buying raw materials and s e l l i n g f i n i s h e d goods i n an endless, and p r o f i t a b l e turn-over. Today, Japan purchases and imports more non-ferrous metals i n the form of ore and concentrates, than any other A"A red-hot economy's quest f o r raw material," Business Week. January 24, 1970, pp.46-47. 2 "Japan-Salesman to the World," Newsweek. March 9, 1970, pp.64-68. - 1 -nation i n the world. These minerals are esse n t i a l to the Japanese economy, and i t appears increasingly evident that the p o l i c y of Japanese Government and Industry i s to seek commitments from abroad to assure a steady flow of these resources into the Japanese economy. Objectives of Study This thesis seeks to explore one element of the Japanese non-ferrous metal industry; that of copper-a metal which has been much In the news In the past year. The focus of analysis i s on the d i r e c t i o n of new c a p i t a l investment decisions by firms within the Japanese copper 2 industry. S p e c i f i c a l l y , I am interested i n determining trends which may influence the nature and extent of part-3 i c i p a t i o n s ^ by Japanese i n t e r e s t s i n overseas copper mining, exploration and development. ^.O. A r g a l l , J r . , "Japan i n the World of Mining," World Mining. Vol.22 no.11. (Oct.1969) p.37. ^The Japanese copper industry i s here defined as the eight major non-ferrous metal companies dealing i n the purchase and processing of copper concentrates. Ranked i n descending order of smelting capacity they arei Nippon Mining, Mitsubishi Metal Mining, Sumitomo Metal Mining, Mitsui Mining & Smelting, Dowa Mining, Furukawa Mining, Toho Zinc and Nittetsu Mining. While these companies are l a r g e l y autonomous f o r reasons to be developed l a t e r , I assume that these companies can be regarded as one unit from the point of view of industry analysis. ^ " P a r t i c i p a t i o n " throughout i s used In i t s broad-est sense, to mean not only f i n a n c i a l support through debrt or equity financing, but also market support through the signing of long term contracts. - 3 -The analysis takes a global outlook on the act i v i t i e s of the Japanese copper industry rather than focusing on the nature and extent of their operations in any one area. This view i s taken as copper i s a homo-geneous product and i t i s argued that the level of Japanese interest in any one producing area must be a function of a l l opportunities available to them elsewhere. It i s further argued that a study of their a c t i v i t i e s i n any one producing region might not, for reasons of local economic, social and p o l i t i c a l con-ditions, be representative of their a c t i v i t i e s elsewhere. Thus to deduce the general trend of the industry's efforts to secure new sources of raw material supplies, i t i s necessary to take a global outlook on their operations. Importance of Study It i s believed that trends in the Japanese outlook developed in this study may indicate a general pattern of development which w i l l be followed over the next decade by Japanese interests i n acquiring their raw material resources. If this i s so, i t i s argued that the study may have implications extending beyond those for the copper industry alone. Japan has now moved from the position of being a net capital importer to one of being a net capital exporter. It i s argued that this should speed a trend to investment in overseas sources of raw material supplies. While the model which has been developed i s specific to the Japanese copper industry, a similar analysis could well be applied to analyse the future development of any resource based material currently being imported by the Japanese. Whatever p o l i c i e s are adopted by the Japanese i n securing t h e i r copper supplies, these w i l l have important implications f o r the world copper exporting nations, of which Canada i s one. In 1968, copper (In a l l basic forms) displaced wheat as our single largest trading item with Japan* In the future, our exports of copper concentrates should increase s u b s t a n t i a l l y as new mines such as Brenda, Fox Lake, Lornex and Island Copper come into production. The primary impact of t h i s increased trade can be expected to be f e l t i n B r i t i s h Columbia which s e l l s more copper concentrates to Japan than any other Canadian province. Indeed, without the presence of Japanese markets, and the help of Japanese financing, i t i s hard to envision that the current expansion of the copper industry i n B r i t i s h Z Columbia would have been able to take place at thi s time. XS.G. Harris, "Japan," Foreign Trade, Vo. 132 No. 8. (Oct. 11, 1969)-Canadian Department of Industry, Trade and Commerce, p .7» 2Japan now purchases about 90% of B r i t i s h Columbia's copper concentrate production, which was worth an estimated $11^ m i l l i o n i n 1969. - seei " B i l l i o n s at Stake i n Bennett's resource development plan f o r B.C.," The Globe and Mail, May 8, 19,70, p.Bl - see alsot "Canada-Japan Trading Booms," Vancouver Sun, Jan. 30, 1970. p.22. - 5 -Research Methodology Data for this study have been gathered from many sources. These include current journals and period-ica l s (cited i n the selected bibliography) and a series of interviews with Canadian and Japanese o f f i c i a l s connected with the copper mining industry. It i s assumed that Japanese interest i n securing raw material supplies for her copper industry can be expressed as a function of Japanese expectations of future market supply and demand conditions for copper both at home and abroad. A forecast of trends both in the world and Japanese copper industries i s made on the basis of an analysis of three distinct sets of data gathered from publicly available current sources of information. The f i r s t set of data i s primarily concerned with the state of the Japanese economy and the Japanese copper industry. Information i s presented on the prospects for Japan's future economic growth and on the role of Government aid, regulations and incentives to Japanese foreign investment. Data i s presented covering the role of Government ministries directly associated with giving aid to the copper industry. Existing sources of supply are examined in relation to projections of future demand for copper to 1975* The industry's financial position i s compared with that of the large - 6 -U.S. and European producers. This analysis i s used as the basis for presenting the reasons underlying current developments within the industry. The second set of data i s concerned with trends and developments within the world copper industry which may influence future supply-demand-price relationships. Emphasis i s placed on developments which may influence the future price of copper, as i t i s argued that this w i l l have an important bearing on the future supply of copper and the Japanese capital investment decisions. These data provide the basis for the construction of a working model which i s designed to explain the nature and extent of Japanese participation in overseas copper mining, exploration and development. The third set of data i s concerned with a study of selected case examples covering contract provisions and financial arrangements involved in recent Japanese copper contracts. These are used to i l l u s t r a t e and to test the hypotheses of the working model. Development of the Model The set of facts, definitions and hypotheses that are presented below i s Intended as a brief sketch of those factors that determine the nature and extent of Japanese overseas participations in the copper industry. These items provide a framework for future discussions. - 7 -1. Japanese demand for copper now exceeds available native supplies. This d e f i c i t must be made up by importing copper in the form of concentrates, scrap, semi-refined or refined copper. 2. To date, the Japanese copper industry has shown a preference for the importation of copper concen-trates over semi-refined or refined copper. 3 . If uncommitted supplies of copper in world markets are not expected to be adequate to meet total expected demands upon them, given existing marketing structures and price relationships, then one may reason-ably expect prices to fluctuate widely or supplies to be rationed. It w i l l be argued that neither of these alternatives i s acceptable to the Japanese. 4. It i s hypothesized that the primary aim of Japanese policy i s to secure dependable sources of supply to meet her expected copper needs, and that the secondary aim of Japanese industry policy i s to secure these sources of supply at a profit to i t s e l f . 5. It Is argued that the Japanese outlook on the future price of copper w i l l be one of the key determinants in their analysis of the^profit potential to be gained by entering overseas mining operations. Their assessment of this profit potential, i t i s argued, w i l l determine the nature and extent of their commitment to overseas mining act i v i t i e s subject to the constraints of acceptable risk - 8 -levels; the availability of sufficient human, tech-nological and capital resources; and the ava i l a b i l i t y of opportunities to pursue acti v i t i e s at the mining level. 6. A distinction i s made between the actual and desirable level of investment associated with the over-seas investment decision. The former i s that which the industry would wish to undertake i f i t were not restricted by lack of resources or Japanese government controls on overseas investment, and may be greater or less than the actual investment. It i s contended that i f , on the one hand, actual investment i s less than desirable investment, this implies that one or more of the following conditions prevailt (a) either the industry lacks sufficient opportunities to secure an equity participation in overseas mining ventures, or (b) i t has the opportunities but lacks sufficient financial, human and technical resources to pursue them, or (c) i t has the resources and opportunities, but re-strictions on overseas investments imposed by the Japanese Government limits the industry's opportunities to do so. On the other hand, i t i s argued that i f actual investment i s greater than the desirable level, this implies that from the Japanese point of view, the expected free sources of copper supply on the world market presently producing or planned for production w i l l not be sufficient to meet the anticipated demands upon them. Thus the - 9 -Japanese producers w i l l have invested funds over and above the desirable level in order to secure commitments of supplies in the form desired. (This may particularly be the case where the Japanese have provided debt financing in order to secure new mine development without securing an equity participation,) 7. The industry does not have the funds to achieve f u l l scale vertical integration at this time. Hence i t i s argued that the desirable level of investment from the Japanese point of view w i l l be a function of their opport-unities to secure an equity participation or other trade concessions in return for their investment. 8 . It i s argued that the desirable and actual levels of investment are dynamic variables subject to change over time. It i s argued that prices which appear to have risen far above their "true value" as a result of exaggerated scarcity due to marketing imperfections may shortly f a l l to more normal values thus lowering the apparent p r o f i t a b i l i t y of mining operations. It i s argued that should a reorganization of existing marketing structures take place, this could lead to more stable prices within the industry. The view i s presented that i t seems probable that the U.S. producer price and the LME price w i l l converge as the LME comes Increasingly to reflect a l l rather than marginal market forces. It i s hypothesized that in future,prices w i l l come to reflect the long run average cost of production - 10 -1 for mine output, plus a margin for reasonable profit. Prices w i l l be stabilized by a movement to an inter-nationalization of copper production (thereby reducing the destabilizing influence of having to rely on a small number of supplying countries) and by the action of governments in the major producing areas which w i l l endeavour to bring about a rationalization of marketing practises and structures i n order to bring a greater st a b i l i t y to copper prices. It i s argued that these governments w i l l take this action to maintain the pr o f i t -a b i l i t y of their mining operations and to preserve their market share. Prices i n future w i l l present a ri s i n g trend as a result of the necessity to exploit lower grade and more inaccessible ores to meet the world's expected copper needs. Should these developments take place, i t i s argued that the stabilization of copper prices would reduce the apparent riskiness of entering mining operations, and that the level of desirable investment might therefore be increased. On the other hand, i t i s argued that should the view be held that copper prices w i l l continue to fluctuate substantially this may imply that the Japanese w i l l be 1 M. Sobral, "Prospects for Copper Markets i n W. Europe," - an unpublished report prepared by the Economic Research Department of EUROFINANCE, (a private study organization) April 15» 1970 p.38 - this report contains estimates of)future production costs for mine production over the next decade. - 11 -forced to Increase their actual level of investment, possibly beyond i t s desirable level, in order to obtain the increased production which they may feel they w i l l require in order to meet their anticipated needs. By implication, i f independent firms are unwilling to run the risk of increasing mine production to supply the expected future needs of the Japanese firms, without exacting some form of price support or financial part-icipation; the Japanese interests may find i t less expensive and a better policy in the long run to increase their own investment ac t i v i t i e s overseas. It,Is hypothesized that the easing of r e s t r i c t -ions on overseas investments by the Japanese Government and the increased government support of the mining industry may lead to an increase i n the actual level of investment. 9. The desirable and actual levels of investment are determined by the planning operations of the Japanese copper industry, and w i l l depend upon their assessment of the future demand for copper at home and abroad (given their predictions of future average price) and their assessment of the amount of free supplies which w i l l be available in the market. The function of the planning cycle i s to deter-mine the planning gap - that i s , the anticipated d e f i c i t i n supply over each year i n the planning cycle - and - 12 -secondly to find the "feest combination of policies to f i l l this gap. The planning gap determines the upper limit on the amount of new supplies to be contracted for. However, the industry structure at home w i l l determine the most desirable form in which supplies should be obtained. (That i s , there must be a balance between the Industry's smelting capacity and i t s imports of copper concentrates.) It i s argued that i n future, i t may be desirable for the industry to import some of i t s copper needs i n semi-refined or refined form and to concentrate i t s capital resources on mining and fabric-ating a c t i v i t i e s . With adequate analysis, the preceding facts, definitions and hypotheses are sufficient to determine the nature and extent of the overseas activities of the Japanese copper interests. It i s argued that the analysis should probe deeper than this however, and should explore those factors influencing the terms signed between Japanese copper interests and individual suppliers of copper. Assuming that the present limitation of the industry's investment funds forces the industry to choose amongst competing alternative sources of supply, i t i s of interest to study what factors (particularly non-monetary) may influence the Japanese decision to invest in one area as opposed to another. Thus to complete'this section, the - 13 -following hypotheses are presented which w i l l be examined in chapters IV and V. Area of Investment The selection of a geographical area of activity w i l l depend on several variables. It i s proposed that the following are primary. 1. Activity i n any one area may be restricted by policy considerations to a fixed percentage of total requirements to reduce the risk that supply operations from any one source might seriously r e s t r i c t or disrupt smelting operations. 2. The selection w i l l depend on the number of opportunities available, and may be influenced by the terms offered in contracts (Including the capital required and the opportunities available for equity participation.) 3» The selection of an area may be a function of the perceived r i s k s - p o l i t i c a l and economic - in a given area. 4. This selection may also be influenced by the taxation regulations i n the host country including the host country's restrictions, i f any, on the repatriation of capital and dividends. 5. It i s also possible that the selection of an area, or areas, of activity may be influenced by special incentives provided by the Japanese Government to encourage investment i n the developing countries. - 1 * 1 . -Supply Contract Terms It i s argued that the f i n a l terms agreed upon in contract settlements negotiated between Japanese purchasers and independent supplying mines w i l l most probably be dependent upon the relative bargaining power of the two parties. The major factors influencing this bargaining power are probably the following! 1. The form of supply offered, and the Japanese desire to secure such supplies. 2. The number of outside competitors bidding for the available supplies. 3. The technology and infrastructure of the buying country - i.e. the a b i l i t y to recover and u t i l i z e more economically than other nations, the by-products of smelting operations. k . The degree of participation offered. 5 . The amount of financing required. The hypotheses made concerning the area of investment may at f i r s t appear to give a high weight to p o l i t i c a l and other factors external to the Japanese copper industry. However, under present conditions of extreme capital rationing within the industry i t s e l f , the industry's capital investment decisions may very well be influenced by the amount of financial aid and govern-ment support which the industry may be able to obtain from the Government and i t s parent industrial groups. - 1 5 -To the extent that the industry accepts such aid, i t may become more influenced by the policies and constraints imposed on i t by these groups. Organizational Structure The actual construction of the theoretical framework and limitations of the model are the subjects of chapter i i . In this chapter, I select the c r i t i c a l environmental factors internal and external to the Jap-anese copper industry which are thought to influence the Industry's long range planning. Emphasis i s placed on risk and p r o f i t a b i l i t y analysis at the various operating levels of the industry. Chapter III i s a statement of important trends within the world copper industry in the last decade which I feel are l i k e l y to influence the future outlook for copper. The focus i s on the nature of existing demand-supply-price relationships within the industry, and on the likelihood of changes in the existing marketing structure which would influence the course of future price adjustments. Chapter IV focuses on Japan's present position i n the world copper market and discusses at a practical level, issues which are only dealt with at a theoretical level in chapter II. Relationships between firms, their respective levels of pr o f i t a b i l i t y , and their strengths and weaknesses are examined. The role of the Government - 16 -Ministries and of the large industrial groups i s examined in relation to their influence on the policies of the Japanese copper producers. This relationship i s amplified by a review of Japanese Government aid, regulations and incentives to the copper industry. Chapter V focuses on an examination of the background and nature of selected Japanese participations i n the development of new overseas sources of copper supply. Selected case examples, particularly of major contract and loan agreements signed or under negotiation in the last year are used as illustrations in testing the hypotheses of the theoretical models which have been developed. Attention i s placed on the nature of risk sharing by the Japanese in outside mine development and on the negotiation and signing of long term contracts. Chapter VI i s devoted to a summary of the main findings and conclusions of my thesis. CHAPTER II THE ANALYTICAL FRAMEWORK Overvlew This chapter expands upon the th e o r e t i c a l hypotheses which were developed i n chapter I. Much of the focus deals with planning within the Japanese copper industry. For purposes of analysis, I assume that the industry must operate within an external environment which i s heavily influenced by conditions i n the world copper industry, and by the needs and r e s t r i c t i o n s placed on i t by Industry and Government at home. The Reinvestment Decision One way of examining the strategic alternatives available to the copper industry would be to construct a decision tree of the possible reinvestment alternatives available to the Japanese copper producers f o r t h e i r net cash flow a f t e r operating expenses, taxes, dividends and contractual obligations a r i s i n g from the repayment of debt. Such an analysis would indicate the close i n t e r -dependence of a l l stages of operations on one another, and thus the necessity of maintaining an o v e r a l l industry view-point i n making any investment decision. The assumption i s made that the Japanese.. copper producers w i l l tend to act so as to maximize t h e i r long run expected p r o f i t s , subject to c e r t a i n constraints (which I s h a l l develop l a t e r ) imposed on them by forces - 17 -- 18 -internal and external to the industry. The f i r s t question raised by the construction of a decision table would be whether there are more profitable investment opportunities outside of the copper industry? Hence, should investment be directed into new channels? It should be pointed out here that the copper producers do not produce copper alone, but are concen-trated for the most part in the non-ferrous metal industries. Copper was chosen for study because of i t s great import-ance to these firms, and because of i t s recent turbulent history In world markets. To a great extent, the problems faced by the Japanese industry in securing their sources of other non-ferrous metals (lead, zinc, nickel) are the same as those of copper. Thus the methods of analysis used to examine the copper industry could be equally well applied to these metals. For opportunities outside the metal industry, I am unable to make any analysis because I lack adequate data on other investment possibilities suited to the copper producers* technical and managerial resources. I therefore re s t r i c t myself to the assumption that a l l reinvestment w i l l be made within the copper industry. This assumption seems dictated by industrial need as much as any other motive. Given that there is a growing need for copper in Japan, the Japanese are - 19 -committed to f u l f i l l i n g this need as a matter of policy. In my opinion, the Japanese industrial groups would not be willing to rely on foreign producers and fabricators for their copper needs at this time, nor would the Japanese Government approve of such a situation, as a matter of economic policyl To a great extent, the Japanese copper producers are subservient to the Japanese 2 Industrial groups of which they are a part. Thus, they are not l i k e l y to go against the wishes of these groups upon whom they depend for markets and financial support. At this time, the Japanese producers appear very short 3 of funds for investment purposes. The funds that they are now employing appear to be largely borrowed from their parent industrial groups and from the various government ministries. Thus at this time, they are part-icularly subject to the constraints imposed on the usage of these funds by these groups. I have already assumed that the Japanese copper producers w i l l tend to act so as to attempt to maximize *S.G. Harris, (Commercial Secretary, Tokyo-Canadian Department of Industry, Trade and Commerce) i n "Japan," Foreign Trade. Vol.132 No.8 (Oct. 11, 1969) p.7 -here he saysi "as a matter of policy, Japan prefers to import her raw materials in the crudest form possible." 2 This relationship w i l l be amplified in chapter V. 3 "Reorganization of Copper Industry," The  Oriental Economist. July 1969, pp.40-44. - 20 -their long run expected profits subject to certain levels of business and financial risk, above which they w i l l not be prepared to go. As a result of the preceding discussion one further constraint should be adopted in postulating the strategy of firms within the industry. I believe that firms w i l l tend to act so as to meet the minimum requirements of their traditional customers for fabricated goods and at the same time they w i l l act so as to match competition within the industry. While these assumptions cannot be verified empirically,they seem reasonable in that they appear to conform with present trends within the industry. Later, through observations of Japanese overseas investment policies and the provisions of long-term contracts, I attempt to show that the Japanese copper firms have consistently attempted to follow a strategy of risk minimization wherever this has proven feasible. P r o f i t a b i l i t y Analysis Profit planning must invariably be tied to risk analysis. As a general rule, i t i s expected that under conditions of uncertainty, the potential for profit at various operating levels of the industry i s proportion-ate to the r i s k 1 entailed. If I assume that the Japanese i Under conditions of uncertainty, the expected cash flows from an Investment w i l l be random variables with a given mean and variance. Risk analysis, as used in this context, refers to the determination of the - 21 -are interested in attempting to maximize their profits, then.I might also assume that the Japanese copper producers would tend to gravitate towards high risk level operations. This assumption however, tends to ignore the level of risk which these firms can afford, the need for vertical integration within the industry, and the presence of governmental restrictions on the export of capital for overseas investments. Here planning operations can play an important part. By producing accurate forecasts of future demand-supply-price relationships for "both the world copper Industry and the Japanese market, the industry planners can act so as to reduce much of the uncertainty surround-ing their investment analysis. These planning operations are particularly important for investment decisions dealing with mining exploration and development analysis. Expectations concerning the future price of copper w i l l have a considerable effect on the perceived p r o f i t a b i l i t y of mining operations, but l i t t l e direct influence 1 on the expected variances in cash flows to be generated by a given investment. As i t i s generally assumed that investors are averse to risk and uncertainty, a higher average rate of potential return must be available in fields offering such investment characteristics in order to induce capital investment in these areas. - seei James C.T. Mao, Quantitative Analysis of Financial Decisions. (MacMillan Company, 1969) pp.266-271. i It w i l l be shown i n chapter V that this state-ment i s not exactly true in the case of the Japanese industry. In order to obtain supplies of concentrates, the Japanese smelters have in some instances entered into - 22 -p r o f i t a b i l i t y of smelting, refining and fabricating operations (other than changes In working capital required to carry inventories and receivables.) The Nature of Risk For these reasons, an analysis of risk i s of crucial importance to the industry's capital investment decisions in order to ascertain the probable variances which may be encountered which might influence the expected p r o f i t a b i l i t y of operations. Risk analysis i s particularly important at a time when the industry faces a shortage of capital available for reinvestment, at the same time that i t i s trying to meet a growing demand for a l l non-ferrous metals. In order to gain an understanding of the risks involved, i t i s necessary to study the inter-relationships i of the various operating levels of the industry. The alternative investment possibilities which would be outlined in our modified decision table suggest that there are three major stages at which the industry could reinvest i t s funds. These are the fabricating, refining agreements to guarantee floor prices for copper purchased by them. In return, they have extracted concessions which provide either a ceiling on the price which they must pay or some form of supranormal profit sharing arrangement. Thus above or below certain bounds, the profits of the copper smelters are directly effected by world price movements. AAn analysis of risk at the various operating stages of the industry i s contained in Appendix B. - 23 -and smelting, and mining stages. Fabricating operations can be divided into two levels, primary and secondary, while mining operations can be segmented into four levels of operations - exploration, development, production and benefication stages. As has been suggested, these operations are highly dependent upon one another, as sources of raw materials and for markets for their prod-uction output. The purpose of risk analysis i s to identify the nature of risks inherent at different operating levels of the Industry and to classify these into controllable and non-controllable risks. Those factors which are largely beyond the control of the Japanese copper industry arei (a) changes in world price levels, (b) changes i n world supply con-ditions as a result of strikes, natural disaster, or government intervention, (c) changes in demand as a result of changes in standards of liv i n g , technological developments or substitution, and (d) changes in world mining technology or metallurgical processing. While these changes may l i e outside the direct control of the Japanese interests, proper planning operations can serve to identify the nature of these risks. By accurately predicting trends i n these developments, the Japanese copper mining interests can attempt to make the best possible usage of their scarce human and capital - 24 -resources. By obtaining good sources of reliable i information on the p o l i t i c a l , social and economic trends within the major supplying nations; the Japanese can attempt to forsee changes in attitudes which might be detrimental to their own interests. Depending upon their assessment of the risks involved in dealing with any particular country, the Japanese may make an informed decision as to whether or not to invest i n that nation, or to rely on i t as a source of supply. Current Position of the Industry Currently, the Japanese copper industry appears to be almost f u l l y Integrated through the smelting, refining and primary fabricating stages. However, at the mining level, Japan provides only 15 percent of her 2 copper needs from native sources. Furthermore, the level and intensity of Japanese exploration for new copper reserves in Japan has been such that no new major reserves •'-The Japanese are well known for their inform-ation gathering techniques. They rely on their consular and trade offices, as well; as the branch offices main-tained by their large trading offices, to supply detailed economic and p o l i t i c a l reports to their home offices con-cerning events happening in their host countries. This information Is then used as the basis of economic planning in Japan. In 1969, Japan mined only 15% of her own copper needs. The rest was purchased from foreign mines (in the form of concentrates and refined copper) in which Japanese interests had l i t t l e equity participation, see - G.O. Argall, Jr., "Japan i n the World of Mining," World Mining. Vol.22, no.11. (Oct. 1969), p.40. - 25 -can "be expected to be found. At current mining rates, the Government predicts that copper deposits within 2 Japan w i l l be exhausted within 17 years. Thus, Japan must turn abroad to obtain her future copper needs. In the past decade, Japan has relied increas-ingly on the import of copper from other countries in the form of concentrates, scrap, b l i s t e r and ingots. Up un t i l now, the industry has concentrated i t s capital investment i"n Japan, in expanding i t s existing smelting and refining f a c i l i t i e s and has not participated to any extent in the equity financing of i t s supplying mines. The Japanese industry has been geared to the 3 smelting of concentrates as part of Japan's foreign policy of importing her raw materials in the crudest form possible. In addition the industry has profited by the recovery of by-products from smelting operations such as 4 sulphur gases used in the manufacture of sulphuric acid. •"•My conclusion, based on an analysis of the 1969 report of the Metallic Minerals Exploration Agency of Japan provided to me by the Japanese Consul in Vancouver. -Reserves however, are a function of price. If the price of copper rises substantially, this could lead to an ex-pansion i n mineable ore reserves. 2"A red-hot economy's quest for raw materials," Business Week. January 24, 1970, p.46. ^This may change as a result of certain overseas developments and also as a result of Japan's rising stand-ard of l i v i n g and labour shortage. TLrgall, op.cit.pp.50-55* - note that the recovery of sulphur gas may not be so advantageous in future. At the moment, sulphur prices are depressed and Japan's petrochemical and o i l refining industries may prove a cheaper source of sulphur for the manufacture of - 26 -This commitment to concentrates has created several problems. One has been the necessity of finding sources of supply which are not already committed to other markets. This i s becoming increasingly d i f f i c u l t as more and more countries are insisting on the refining of copper within their own countries prior to export. With the increasing costs of mining operations It i s becoming more and more d i f f i c u l t for independent mines to raise their own production financing to bring their mines into production. One way in which the Japan-ese interests have helped these mines to secure financing has been through their willingness to sign long-term contracts for the purchase of a mine's copper concentrate production. With these purchase contracts in hand, mining officers have been able to approach local banks for financial support* Thus these long-term contracts have become an important factor in the industry. By reducing the business risk faced by new mines coming into production, they have enabled some new mines to start up which would otherwise have been unable to secure the necessary production financing 2 through traditional sources. sulphuric acid. (A typical concentrate might be composed of roughly equal parts of copper, iron and sulphur; and small quantities of precious metals and impurities.) 1"Japan's Drive to Outstrip U.S.," U.S. News &  World Report. April 6, 1970 p.70. 2This w i l l be illustrated i n chapter V. - 27 -Other d i f f i c u l t i e s yet to be seriously encount-ered are the problems of a i r pollution 1 in Japan and the forces of nationalism abroad. The smelting of copper concentrates under traditional processes, tends to give off considerable amounts of sulphur gases. While much of this is recovered, some escapes into the atmosphere and contributes to the already heavy pollution existing in some of Japan's large Industrial c i t i e s . Depending on the future level of public reaction to these d i f f i c u l t i e s , Japan could see a movement away from increasing any 2 smelting capacity using traditional technology. Turning abroad, there i s a growing tendency on the part of the copper producing nations to encourage further processing of copper ore produced within their own countries. Thus the Japanese copper industry i s faced with several important issues in the coming years. Premier Eisaku Sato has singled out two prob-lems in particular which face Japan today. These are the problems of an extreme housing shortage (which could create a demand for copper) and pollution. - see,"Toward the Japanese Century," Time. March 2, 1970. p.33. 2 Much research i s now being done by the world copper industry in new methods of recovering copper through chemical and bacterialogical processes. To date, the re-sults have been encouraging and these methods promise to come into greater use in the next few years. It would however, require an individual who i s intimately familiar with world metallurgical technologies to make value judg-ments as to the possible implications of these developments. - 28 -It must decide upon the level of i t s future expected copper needs and find ways of meeting i t s goals within the framework allowed "by industry and government policies. Because of the great amount of capital investment required to enter into, and construct, new production f a c i l i t i e s at any stage of the industry; i t must take particular care in planning i t s capital investment decisions. At the same time the industry must make a decision as to whether or not i t w i l l adopt a policy of backward integration to the mining stage of operations. Such a step may be necessary to improve the profit position of the industry and to secure Japan's future sources of copper supplies in a form desired by the industry. Planning Operations If demand levels are expected to change as a result of price changes or future technological develop-ments, this too w i l l have an important bearing on the Japanese copper industry's investment decisions. The extent to which changes in disposable income and the planned level of capital investments may vary, both i n the domestic and world markets, may have a considerable influence on the expected level of aggregate demand in the Japanese marketplace (resulting in a shifting of the demand function.) It has already been assumed that the Japanese are committed to copper and to meeting the minimum - 29 -requirements of the fabricators to whom they s e l l . Further, i t has been assumed that for planning purposes the domestic sources of copper supply can be considered to be predetermined variables subject only to minor alteration. With domestic supplies predetermined, the planners' predictions of expected demand (given their predictions of expected price levels for copper) w i l l determine the gap which must be f i l l e d from overseas sources of copper supply, in order to equate expected demand and supply. Since some overseas sources of supply w i l l already be committed to Japanese copper interests by way of long term contracts, the function of the planning cycle i s to determine the planning gap - that i s the anticipated unfulfilled d e f i c i t in supply over each year in the planning cycle - and secondly, to find the best combination of policies to f i l l this gap. The necessity of f i l l i n g this planning gap in order to meet the anticipated needs of Japanese fabricators, has served as a serious constraint on the efforts of the Japanese copper industry to maximize i t s profits except over the very long run. Summary This chapter has established the analytical framework for the analysis of those factors influencing the nature and extent of Japanese interests i n overseas - 30 -copper mining ventures. The focus has "been on the capital investment decision, and emphasis has been placed on the need for complementarity in production planning at a l l stages in the industry. Emphasis was placed on risk and p r o f i t a b i l i t y analysis as prime considerations in the Japanese investment decision. It was hypothesized that the industry must act under certain constraints which limit i t s freedom of action. These constraints are both internal and external to the firm. Within the bounds of these constraints, i t has been assumed that the industry w i l l act so as to attempt to maximize i t s long run profits. As yet, no conclusions have been drawn as to where or to what extent, the Japanese producers should reinvest their funds at any stage in the industry, alth-ough i t has been suggested that the mining end of operations would appear to be the most logical and profitable route to go. CHAPTER III TRENDS AND DEVELOPMENTS IN WORLD COPPER Certain developments have taken place in the world copper industry in recent years which may have a considerable Influence on the investment decisions of the Japanese copper industry. The focus of this chapter i s on the nature of existing demand-supply-price relation-ships within the industry, and on the likelihood of changes in the existing marketing structure which would influence the course of future price adjustments. The formation of CIPEC, and the investigation of the copper industry by the Houthakker commission are cited as two examples of develop-ments which may bring a greater degree of price s t a b i l i t y to the copper industry. Current Developments Several events within recent years have sparked considerable reassessment within the industry concerning the future outlook for copper. By January of this year, the growing forces of nationalism in Chile and Zambia had resulted in the government takeover of a 51 percent controlling interest in the major producing copper mines in those countries 1 This followed on the heels of the seizure of the copper properties of Union Mlniere de Haut 1 For details of these takeovers see - "In Latin America the going gets bumpy for mining," Engineering - 31 -- 32 -Katanga, the Congo interests, by General Joseph Mobutu president of the Congo* At the same time as these events have been taking place, there has been growing unrest in Peru. While Velasco, President of Peru, has not yet made any moves to nationalize the copper interests of his country; his ministers have announced that the new mining code, to be released in April of this year, w i l l contain much stricter regulat-ions on mining interests, giving the Government greater control over the marketing and refining of the nation's 2 copper output. These moves follow as a natural outgrowth of the formation of CIPEC (Conseil Intergouvernemental des Pays Exportateurs de Cuivre.) This organization was formed after a meeting i n Lusaka, Rhodesia, in June 1967, between representatives of Chile, Peru, Zambia, and the Congo. Its intended purpose i s to harmonize interests Mining Journal. Vol.l?0, No.?. (July, 1969) pp. 59-60. - see also Juan Cameron, "Threatening Weather in South America," Fortune. (Oct. 1969) pp. 100-101. - and see "Politics Dictate," Mining Journal. Vol. 272, No.6979, London, May 23, 1969. For an interesting account of the role the Japanese played in this, see Newsweek. March 9, 1970 p.65. /i"Everyone's Happy," The Economist. January 10, 1970 p.62. - 33 -amongst the copper exporting nations (by gaining a greater say over marketing and pricing.) The assumption of a c o n t r o l l i n g i n t e r e s t i n a l l major copper producing mines i n the CIPEC countries can be seen as the f i r s t necessary step i n carrying out t h i s p o l i c y . To supplement th i s move the CIPEC countries have recently commissioned two studies 2 on short and long term s t a b i l i z a t i o n of copper prices; and i t can be anticipated that they w i l l attempt to imple-ment the recommendations of these studies as soon as they 3 are completed. It i s argued that the CIPEC nations w i l l place t h e i r primary emphasis on the maintenance of a stable price f o r copper i n order to maintain an orderly market. This p o l i c y i s necessary i n order to a t t r a c t the investment c a p i t a l to t h e i r countries essential f o r the construction of new mines and the maintenance of t h e i r market share. President Velasco i s reported to have told the CIPEC ministers i n Lima l a s t December that, through CIPEC, Chile, Peru, Zambia and the Congo "have i n t h e i r hands the power to change the point of decision-making. Through an i n t e l l i g e n t l y co-ordinated policy, our countries w i l l no longer be at the mercy of i n t e r e s t s which are not our own, since we hold the key to the world's copper exports." sourcej Forbes, March 1, 1970. p.27. 2The Economist. January 10, 1970. -'For more background on CIPEC see: R. I. Grant-Suttie , "Copper Substitution," Finance & Development #2 1969, pp.49-55. - 3^ -In January of 1970 the Houthakker commission was established to investigate the copper market and to deter-mine why, a f t e r f i v e years, no end to the copper shortage 1 i s yet i n sight. Appointed by President Nixon to head the special subcommittee of the Cabinet Committee on Economic p o l i c y was Hendrick S. Houthakker, a Harvard economist and a member of the President's Council of Economic Advisers. It i s important to understand the background of th i s study f o r the committee's report i s l i k e l y to have a s i g n i f i c a n t influence on the future of the industry. Forbes, writing on Houthakker*s approach to the invest-2 i g a t i o n , reports: The special subcommittee was created i n January - days a f t e r the big U.S. producers raised t h e i r price for the f i f t h time i n a year - but Houthakker says the CEA has been watching the s i t u a t i o n at le a s t since l a s t summer. "We have not asked the copper companies to r o l l back t h e i r increases," Houthakker explains, and he implies that they have no intention of doing so. "That i s not our p h i l o -sophy," he says. "We are looking at the structure of the market, p a r t i c u l a r l y at the two price system, to see why these shortages continue. Our basic attitude i s to see that the market works the way any market should - which i s to say, i t should bring about a reasonable equilibrium between supply and demand." Houthakker has a suspicion he knows why the shortage continuesi "The p r i c i n g methods used i n the copper industry may conceivably have prevented a x"How the U.S. i s handling i t s copper c r i s i s , " Northern Miner, January 22, 1970. p.15-2"What goes down must go u p - f i r s t ? "Forbes, March 1, 1970. p.36. - 35 -balance from being attained before now. Most of the production i s in the hands of the major prod-ucers, and i t ' s conceivable that their lower price -lower than the free market price - prevents supply from increasing as much as i t otherwise would have, If the price level had equalled the present free market price, we would probably have had a lot more copper available for consumption, and this would have had a favourable influence on the markets." While the committee's report has not yet been released, i t is already clear from preliminary evidence that the committee has found so many inequities and such lack of competition in the domestic copper market that i t w i l l propose major changes in how that market functions 1 The study group i s reported to have found that the big producers have tended to favour their steadiest customers and have not sold on a first-come, first-serve basis; but rather have alloted their available supplies to their long standing customers on the basis of their 2 traditional buying patterns. Thus some users have been able to get virtua l l y a l l the copper they need at the producer price, while many others can get l i t t l e or no copper at a l l . As a result, they may end up paying as much as 35 percent more for their raw material. The "Getting a handle on the copper market," Business Week. March ?, 1970. p.24. 2 "Dark Cloud with a Copper Lining," Forbes, March 1, 1970,, "We have by and large f e l t that the fairest way was to give our copper to our long-standing customers," says George Munroe, president of Phelps Dodge. "We don't know how else to handle i t . Obviously, i f you've got a product selling for 20 cents less than i t does at the store down the street, everybody wants to buy i t from you." - p.28. - 36 -commission i s said to feel that the present system i s inequitable because i t imposes unjust economic hardships on the have-nots and inhibits free competition. It also restricts entry by-newcomers into market areas dependent 1 on copper. The important question for the copper industry i s what changes the commission w i l l recommend. In March of this year, the commission met privately with the major producers to see i f they were willing to make changes voluntarily. Some industry observers believe that the government would like to settle for a dual approach to tackling the problem, by achieving some revision of market 2 ing patterns and by inducing a modest price ri s e . At least in the latter case they have been successful for prices in the U.S. were raised another 4 cents at the end of March. In order to understand why the government would be interested in encouraging a price increase at a time when i t i s also attempting to fight inflationary pressures, i t i s necessary to understand something about world pricing measures, and the history of copper in the 1960»s. Pricing There are three prices normally referred to in i •'Getting a handle on the copper market," Business Week. March 7, 1970. p.24. 2 Ibid. - 37 -the copper industryi - the American producer's price - the Metal Week (MW) Export Refinery price(EMJ) - the LME price, cash and three months forward The f i r s t of the above prices i s quoted by the large American producers for sale in the United States on a delivered basis* The second price reflects the weighted average price of sales in foreign markets on a daily basis reduced to the fob refinery equivalent, Atlantic seaboard. This price is also known as the EMJ Export Refinery Price and i s the basis for mbst copper concent-2 rate sales by Canadian interests to Japan. The London Metal Exchange i s a commodities exchange dealing in non-ferrous metals. Prices determined by trading on the LME are now used as a basis of establishing prices for approximately 60 percent of the copper sold i n the free world. Most of this i s on a spot (cash) basis. The CIPEC governments require their producers to s e l l on the basis of the spot price as this has usually tended to be higher than the forward priced *Up unti l this past year, the Canadian price has followed the American price. Since then, Government intervention has interfered with normal price adjustments. 2 These prices are published monthly in the Engineering Mining Journal* This journal contains the basis on which quotations are established. ^"Copper's Future," Barron's. March 9, 1970 p.26. According to J.L. Chender (one of the world's leading copper traders) "Backwardation has been predominant in the market since the ' F i f t i e s , more or less." - 38 -The following hypotheses are offered concerning the influence^of price factors on the Japanese overseas investment decision. 1. For the purposes of planning their capital investment decisions i t i s argued that the Japanese decision makers use the current price system negotiated in long-term contracts as an opportunity cost basis for calculating the expected prof i t a b i l i t y of mining ventures. They are, therefore, interested in any developments which might lead to a change in the price structure. 2. The current pricing system may be such that i t encourages non-optimal production patterns. 3. It i s probable that the expected supply of copper i s positively related to i t s expected price which, in turn, i s largely determined by the marketing structure. It follows that any change in the marketing structure which may occur as a result of the efforts of the CIPEC countries or the U.S. investigation of the copper industry, w i l l affect the future expected supply of copper coming on the world market, and hence the outlook for Japanese investment. 4. A potential conflict of interest exists between the CIPEC countries and Japan. To earn foreign exchange, the CIPEC countries w i l l wish to keep the price of copper high. To conserve foreign exchange the Japanese might be interested in taking speculative action - 39 -to lower- the price of copper to what they consider to be more normal values. Their incentive to do so w i l l be high so long as they have no major equity participation in mining operations. The f i r s t hypothesis introduces an opportunity cost concept, which i t i s assumed the Japanese w i l l use in their planning operations. This price i s what the Japanese must pay for their copper supplies (less agreed to l l s for smelting and refining) and i t also represents their expectations of the price at which they could expect to s e l l any excess copper supplies beyond their needs. By obtaining the weighted average of projected prices for each year over the planning horizon and by comparing this with projections of cost in each of these years, a basis may be found for measuring the expected return on equity In a mining venture. It i s axiomatic that any change in the price structure i s bound to affect the perceived p r o f i t a b i l i t y of mining operations. The second hypothesis w i l l be discussed shortly, while the third has already been discussed to some extent and more w i l l be said concerning i t after a discussion of the workings 'sof the LME. If, as some observers believe, speculators have more influence on the LME price than do consumers* .'then the price of copper on the LME may ^•"Copper's Future," Barron's. March 9» 1970,p.1. - 40 -be driven far out of line from i t s true value. Thus most observers argue that the price of copper today i s too 1 high and that i t w i l l go higher s t i l l . These same people argue that in other times, the price of copper selling on the LME has been driven far below i t s true 2 value by the actions of speculators. If this i s true, and I believe i t to be so, then this could result in the reinforcement of a cycl i c a l pattern within the industry. To the extent that current prices are used as a barometer for the planning of new production f a c i l i t i e s and as a signal for exploration a c t i v i t i e s then these forces may be stimulated to over-react as a result of major price swings caused by the activ i t i e s of speculat-ors operating on the LME. While these swings are unlikely to have as much influence on the planning of the large producers they w i l l have a considerable bearing on the smaller producers who may not have as much knowledge or feel for the market. This i s particularly so, because the major producers being integrated have some bu i l t - i n protection for their production act i v i t i e s and are not 1 "Copper speculation in centre stage," Northern  Miner. April 23, 1970. p.75« they write in part - "Copper took the spotlight last week by hitting a 2-year high i n London. Uncertainty about strike settlements in Peru, plus stepped-up purchases by China, have served to keep the red metal in the forefront of speculative activity." 2 This view i s expressed by Ian MacGregor, past president and now chairman of American Metal Climax. -see "Copper's Future," Barron's. March 9» 1970. p.3. - 41 -solely dependent upon profits from their mining operations. At the same time, because the U.S. domestic price i s an administered price, i t cannot be used as a good measure for indicating the extent to which supply should be expanded or contracted. (It may only signal the need.) These reasons a l l suggest the need for a more effective pricing system which w i l l bring about a better balance between supply and demand* If i t i s true that speculative act i v i t i e s on the LME can drive the price of copper far below i t s true value, then this argument adds credence to hypoth-esis 4. Above a l l , the CIPEC countries are interested in maintaining a high value for copper ( i f possible, above i t s true value) and i t can be expected that they would not long tolerate any actions which carried the price of copper to depressed levels. Their recently commissioned studies on short and long term price stabilization are suggestive of two factors. The f i r s t of these, i s that they believe that market forces could soon cause a f a l l in the price of copper. The second, i s that they are determined to make every effort to stabilize the price of copper should i t f a l l off. *Sir Ronald L. Prain expresses the opinion that an absolute balance between supply and demand i s impossible except for very short periods. (He does not say, however, i f he feels this i s so because of price relationships i n -fluencing market supply and demand.) see - Sir Ronald L. Prain, "Copper," Mining Congress Journal. February, 1968. Vol. 54. No.2. p.oT^ - 42 -While i t i s uncertain as to what recommend-ations these studies w i l l make, i t i s implicit that the CIPEC countries w i l l attempt, as a minimum to stabilize the price of copper at a floor level which they consider to be i t s true value. In order to accomplish this, they w i l l have to find some acceptable manner of dealing with the downside* speculative activity of the LME i f they are to continue to use that pricing mechanism; or at some stage, they w i l l have to abandon the LME and establish 2 their own pricing system. A review of the recent history of copper prices, prior to an examination of the workings of the LME, w i l l serve to i l l u s t r a t e the v o l a t i l i t y of copper prices and the differences in spread which may exist between the U.S. and LME quotations. There i s an inherent weakness in this strategy in that efforts to reduce downside speculative activity are l i k e l y to work against speculative act i v i t i e s which tend to push copper prices on the LME above their "true" value. The latter a c t i v i t i e s appear desirable from the point of view of the CIPEC countries, thus they would not wish to interfere with these a c t i v i t i e s . 2 There have been a number of attempts by prod-ucers to control the price of copper, a l l of which have failed. - see A.F. K i l l i n , "The Canadian Copper Industry  in 1966." Mineral Information Bulletin MR 88, Mineral Resources Division, Department of Energy, Mines and Resources, Ottawa (1967) p.l58» - 43 -Recent Price History Standard & Poor Corporation make the following comments concerning price changes i n the United States 1 since the Second World War. As noted e a r l i e r , copper prices have f l u c t -uated widely with changes i n supply and demand. Following the wartime s t a b i l i z a t i o n of copper (at 12 cents a pound i n the U.S.), there have been b a s i c a l l y three major periods of copper booms. The f i r s t of these was during the Korean c o n f l i c t , when prices ran from 16 cents i n mid-1949 to a b r i e f high of 32 .25 cents i n early 1953• The let-down a f t e r t h i s period was r e l a t i v e l y easy, with prices s t a b i l i z i n g around 30 cents. In 1955i another uptrend started, b o l -stered by a high l e v e l of economic a c t i v i t y and interruptions by s t r i k e s , with copper prices reaching a high of 46 cents i n early 1956* The subsequent decline took prices to a low of 25 cents i n early 1958. The U.S. price movement was magnified i n  foreign markets, the LME pri c e going from 26 .5 cents i n 1954 to 54.5 cents i n 1956 and down to 20 cents i n 1958. Following a period of r e l a t i v e s t a b i l i t y , the l a t e s t boom started i n early 1.964, again r e f l e c t i n g r i s i n g economic a c t i v i t y , production interruptions, and the Vietnam c o n f l i c t . The domestic producer's price d i d not r i s e as sharply as i n previous periods, going from 31 cents i n 1961-64 to 42 cents i n mid-1968, r e f l e c t i n g producer's concerns about s u b s t i t - ution and the i n f l a t i o n f i g h t i n g a c t i v i t i e s of the . Administration. Standard & Poor's Corporation go on to describe the 2 reaction of foreign producers during t h i s period... Major foreign producers also attempted to hold down prices, but eventually were forced to raise them  by government intervention i n such countries as Chile & Zambia, Thus a f t e r f l u c t u a t i n g about i n l i n e with "Copper," Standard & Poor's Corporation (1969), p. M 103. 2 Ibid. - 44 -the U.S. price for most of 1964-65, the foreign producers* price rose rapidly. The peak was 70 cents a pound for Chilean copper for a short while in mid-1966, but a l l foreign quotations were over 60 cents for a short while in this period. Prices on the London Metal Exchange reached a high of 98.75 cents in the f i r s t half of 1966, but l i t t l e copper was sold on this basis at that time. The LME prices fluctuated  downward in late 1966 and early 1967,and reached a low of close to 40 cents a pound i n the second quarter of 1967. However, the effects of the U.S. industry  strike put renewed pressure on overseas prices in late 19o7 and early 196b. with the LME reaching "a  high of 86 cents a pound. Following settlement of  the strike, prices trended downward and by September, 1968, were around 4? cents a pound.1 This short history of copper prices since the 1940*s illustrates both their volatile nature, and the relatively greater i n s t a b i l i t y of the LME price. Also indicated, has been the willingness of governments both in the U.S. and abroad to intervene in the marketplace to influence price changes. The examination now focuses on a study of those factors which cause the LME price to be unstable. The London Metal Exchange 2 The London Metal Exchange i s a commodities 3 exchange dealing in non-ferrous metals. It serves as a Emphasis mine. 2 For a history and background on the LME oper-ations, see - H.S. Cordero and L.H. Tarring, In A Metal Merchant*s Office (2nd ed.; Londoni Quin Press Ltd., 19581 3 It i s assumed that the reader i s familiar with the basic operations of the commodity exchanges and the commodity futures markets. If not, see» Commodity Research Bureau, Inc., Understanding the Commodity Futures  Markets. (New York, Commodity Research Publications Corp. 1969.) pp.3-40. - 45 -clearing market for the surplus production of small prod-ucers, a vehicle for hedging on purchases and sales, and as a clearinghouse for the adjustment of fabricators' inventories. Like other commodities markets, i t i s also a vehicle for speculators. Of the two million tons of wire bar traded over the LME during the last year, only about 160,000 tons were actually delivered. This means that about 8 percent of the volume set the trend of\prices* 2 In the view of at least four industry experts, the LME as i t i s currently operated, i s not a good pric-ing mechanism for pegging prices (at least for American sales.) In their view, with which I concur, the actions of speculators in this market have more influence than do those of consumers. They point out that the London Metal Exchange was never designed to be a pricing mech-anism but that i t has been used as an ersatz substitute on account of the i n a b i l i t y of the producers to success-f u l l y establish and maintain a producer price. Part of the failure in these efforts i s attributable to govern-ment intervention (as has already been mentioned.) In part these efforts have failed, because the producers Figures cited by Jules Chender in "Copper's Future," op. c i t . p . l . 2 The four experts are James Boyd of Copper Range; Jules Chender of Engelhard Minerals & Chemicals; Ian MacGregor of American Metal Climax and Simon Strauss of American Smelting & Refining. Their views on the short and long range outlook for copper are synthesized here from a feature article "Copper's Future," op.cit.pp. 1-3. _ 46 -were unable to supply copper at a time when demand increased substantially over a short period of time. 1 Ronald Prain elaborates on the reasons for this as being the industrys concentration on thinking in terms of 100 percent production as ideal whereas actual experience since the war has shown that the industry has only oper-ated at about 93 percent of capacity. Thus the industrys plans provide no leeway for meeting sudden surges i n demand. In his view, assurance of dependable supplies i s probably one of the most important considerations in creating confidence in the industry on the part of pre-sent and would be users of copper throughout the world. As he sees i t , this goal can be accomplished only by holding large stocks of copper above ground or by holding mine capacity in reserve. In speaking on the question of stocks, he points out that not only does this require considerable sums of money, but also; that the copper industry unlike i t s comp-etitors, must deal through the medium of a commodities exchange whose level of price i s greatly influenced by the level of stocks. Thus in attempting to achieve price stabilization through the build up of stocks, producers These views are synthesized from an ar t i c l e by Prain, "Copper," op.cit. pp.59-60. - 47 -may actually act against their own interests i f the price of copper i s driven below i t s true value. (This concept of true value i s implicit in the writings and speeches of many experts on copper - a normative definition of this concept i s provided by Jim Boyd of Copper Range -he says, "we expect to keep prices as close as possible to the value which the consuming market would place upon 1. the product." ) If one were to make an estimate of the minimum amount of reserves necessary to stabilize prices one would have to choose a figure at least i n excess of the maximum fluctuation i n the U.S. government stockpile. In 1965-66 when the pressure of higher world prices began to mount in the U.S., the Johnson Administration ordered the selling off of over 670,000 tons of copper from the U.S. government stockpile in an effort to relieve the pressure on prices. Even this was not enough however, and the larger U.S. producers attempted to raise the price to 38 from 36 cents per pound only to have this move r o l l -2 ed back by the Johnson Administration. If one were to think in terms of an average producer cost of 25 cents per ^"Dark Cloud with a Copper Lining," Forbes. March 1, 1970. p.37. 2 Ibid p.28., for data on copper inventories and production statistics, seei George Cleaver, "Copper," Engineering Mining Journal, March, 1968 vol.l69-no.3« pp.100-101. - 48 -pound, a stockpile of 700,000 short tons (about 10 per-cent of projected 1972 production ) would require f i n -ancing in the order of $350 million to maintain. In Prain*s view, a cheaper form of insurance in order to assure the free availability of supplies at a l l times 2 might be for the industry to hold reserve mine capacity. This too requires a very high capital outlay, i n i t i a l l y higher than the cost of holding stocks. (One estimate of current capital construction cost in the U.S. per ton of milling capacity, i s $3,000 a ton, vs. $1,500 in I960?) The salient point of this digression has been to show the d i f f i c u l t i e s that producers would have to face in order to achieve price stabilization, or in establishing a producer price Independent of the LME. While i t i s clear that the CIPEC producers at some stage may be desirous of making efforts in these directions, i t i s uncertain that they w i l l be able to raise the necessary capital to support such moves. If, as I believe li k e l y , the U.S. producers start to put more copper through the LME in order to see "Copper," Engineering Mining Journal. March, 1969. pp.103-104. Prain, op.cit.p.60. 3 "Dark Cloud with a Copper Lining," Forbes. March 1, 1970. p.33. make i t a better barometer, this i s l i k e l y to have a stabilizing influence on prices (by reducing the relat-ive influence, of speculators in that market.) Such a move however, may add further impetus to the efforts of the CIPEC producers to move away from the LME in order to attempt to maintain a higher price. Since they now control approximately 80 percent of the copper moving in world trade, they may over the next five to ten years be successful in their efforts to maintain the price of copper above i t s true value. To the extent that they are successful in these efforts, they w i l l encourage develop-ment of new f a c i l i t i e s in other areas. Evidence of this already exists. Between 1965 and 1969 capacity in the CIPEC countries, where prices averaged 6l cents a pound, expanded, only 8.6 percent. In the U.S., capacity expanded by 22.5 percent during this same period, despite a sharply lower price averaging 2 only 41 cents per pound. The failure of the producers to expand in the CIPEC countries reflected their concern, since confirmed, of increased government interference and This policy has been suggested by both Jim Boyd and Jules Ghender in their discussion on "Copper's Future," op.cit. p . l . The reason that this has not previously been done to any extent i s that many U.S. producers (Strauss i s one) argue that there must be a continuing relationship between supplier and consumer which can only be achieved when they deal directly with one another. 2 Forbes. March 1, 1970. p.33. the p o s s i b i l i t y of the takeover of control of t h e i r mining operations. In part, i t also r e f l e c t e d the high, and sometimes confiscatory, l e v e l s of taxation i n these countries. Future Price Outlook While i t i s hazardous to make projections of future prices, my own view i s that they are l i k e l y to be much more stable than they have been. In the past, prices have been held down by the U.S. producers f o r fear of substitution. This fear has la r g e l y passed, and producers have started to regard aluminum and p l a s t i c s as complementary rather than competitive products! Now also, they are s t a r t i n g to recognize what Prain has long said, that "the s u b s t i t -ution of copper i s a continuing process and one which i s governed as much by technological as by economic consid-erations. One would therefore expect copper to continue to lose ground i n ce r t a i n uses and to gain ground i n others, as well as increasing i t s growth as a r e s u l t of 2 new uses and new applications." As f a r as government intervention i s concerned, I think that t h i s w i l l now move i n only one d i r e c t i o n . •'•see Forbes. March 1, 1970 pp.36-37 f o r some well expressed views on thi s topic. 2 S i r Ronald L. Prain, "Copper," Mining Congress  Journal. Feb. 1968, Vol. 54. no. 2. p.59. - 51 -The CIPEC countries w i l l t r y to hold or increase the pr i c e of copper.. The United States, s t i l l faced with a d e f i c i t of copper, w i l l not intervene to reduce the price of copper (out of a desire to increase production i n the United States, and thereby to remove i t from the control of the CIPEC countries.) With a more b u l l i s h attitude p r e v a i l i n g on the part of U.S. producers, I see them maintaining t h e i r prices closer to those of the LME. Should the LME price f a l l o f f p r e c i p i t o u s l y under downward speculative press-ures, I would expect that American and CIPEC producers would enter the market to support the price at some acceptable f l o o r l e v e l . An al t e r n a t i v e step would be to ignore the l e v e l of prices on the LME and f o r both the U.S. and CIPEC producers to abandon the LME and establish t h e i r own price systems with a f l o o r price which they f e l t they could maintain. However, I see no reason other than the p o s s i b i l i t y of a major recession temporarily reducing demand (as a r e s u l t of reduced c a p i t a l expend-itur e s ) to cause either of these events to come about. European consumers of copper have apparently developed an almost psychotic attitude towards t h e i r dependence on copper supplies o r i g i n a t i n g from the CIPEC 1 countries. This attitude i s more a reaction to the lack "Copper's Future," Barron's. March 9, 1970, p.3. - 52 -of p o l i t i c a l s t a b i l i t y in these nations, than i t i s to act-ual production interruptions. (In fact, actual production interruptions from these nations i s less than that occuring in the U.S.) In the view of many experts, this attitude would prevent any sudden collapse of the LME price, as 1 has happened in the past. More important however, this attitude w i l l reinforce a drive already existing to diver-2 sif y their dependence on any one market area. Thus the European refiners and fabricators w i l l themselves have an incentive to maintain a high price of copper, i f only to make mining operations appear more profitable; and thereby, to encourage new production. For these reasons, I see a high and relatively stable price for copper being maintained over the forseeable future. The views presented on the future outlook for copper prices do not necessarily agree with those held by executives within the industry, many of whom would argue that prices, in future, w i l l be as unstable as they have been in past. To the extent that this opinion may be widely shared by these executives, i t may serve to reduce the expansion of capacity within the industry for fear of creating a surplus of production which might drive marginal prices below long run average costs of production. The 1Xbi&. p.27. 2 Witness the purchase of 1,000,000 treasury shares of Bethlehem Copper by Grangesburg Co., Sweden's leading metal company, - see details of agreement, The  Vancouver Province, November 21, 1969« - 53 -implications of a hesitancy on the part of world prod-ucers to bring about an expansion of capacity without substantial financial and price supports may be such as to force the Japanese copper industry to enter over-seas mining operations in order to obtain the necessary production supplies which they may feel they require. Even should outside producers be willing to run the risks of mining operations, the financial and price supports which they require may be such as to make i t appear more profitable in the long run for the Japanese to enter the mining stage of operations as they obtain the necessary resources and opportunities. Summary This chapter has provided a summary of those factors related to demand-price-supply relationships within the world copper industry which are thought to be relevant to the decision making processes of the Japanese copper industry. It has been argued that the expected supply of copper i s positively related to i t s expected price which, in turn i s largely determined by the marketing structure. Certain current developments within the industry (such as the recent industry studies by the Houthakker commission and the CIPEC countries) may have a considerable influence on the future price of copper by bringing about changes in the existing marketing structures. The opinion was express - 54 -ed that copper prices are l i k e l y to be more stable in future than they have been in the past, and that they w i l l come increasingly to reflect costs of production plus a reasonable margin for profit. A trend to the internationalization of copper production w i l l reduce the control of any one group of nations over the pricing mechanism. Should prices become more stable, this would tend to reduce the perceived risks of mining operations and might increase the level of investment which the Japanese perceive to be desirable. On the other hand should prices continue to fluctuate to the same degree as they have in the past, Japanese interests may be forced into overseas mining operations to obtain their anticipated copper needs, or they may be called upon to supply more capital and financial support in the way of price guarantees than they would actually desire. CHAPTER IV JAPAN'S POSITION IN THE WORLD COPPER MARKET Chapter IV focuses on Japan's present position in the world copper market. The analysis w i l l center on a practical discussion of issues raised in chapter I. Attention i s placed on the strength of the Japanese economy and i t s prospects for continuing growth as a measure of determining the government's attitude toward overseas investment. Projected levels of demand and supply over the next five years are made to determine the existing planning gap. Relationships between firms, their respective strengths and weaknesses, and levels of p r o f i t a b i l i t y are examined and compared with those reported by the major American and British copper producers. The role of the Government Ministries and of the large industrial groups i s examined in relation to their influence on the policies of the Japanese copper producers. This relation-ship i s amplified by a review of Japanese government aid, regulations and incentives to the copper industry. A summary at the end of the chapter focuses on an integration of the outlook for the Japanese and world copper markets, and concentrates on the current problem areas faced by the Japanese copper producers in determining their foreign investment policies. - 55 -- 56 -Prospects for Economic Growth The buoyancy and strength of the Japanese economy has important implications for the Japanese copper industry both in terms of the expected demand for copper and intterms of the ava i l a b i l i t y <3f funds for overseas investment. Moreover, any discussion of capital investment decisions must be based not only on current capital costs but also on projections of future operating costs. An analysis of the latter i s dependent upon projections of future trends and developments expected to occur as a result of changing economic conditions, within Japan and abroad, over the anticipated useful l i f e of the proposed acquisitions. To review Japan's recent experience* over the last two decades, her record of growth has been remark-able. Real national output has grown nearly ten times over, showing an average annual growth rate of over 11 percent, a rate unmatched by any other industrial nation. For the past four years, the average growth rate has been almost 13 percent as compared to 6 percent for the OECD countries. This year's GNP i s expected to be equivalent to U.S. $180 b i l l i o n s , giving Japan the second •••"Japan: The Yen For Growth," Monthly Review. (The Bank of Nova Scotia, Toronto) March, 1970. - 57 -highest gross national product of the western world, and a standard of li v i n g now comparable with that of the major countries of Western Europe. During the last decade, the 1 level of the Japanese economy quadrupled in terms of GNP. Now, the foreign minister, Mr. Aichi, i s talking of the 2 possibility of Japan's GNP quintupling by the early 1980's. Some long range projections see Japan's per capita income surpassing that of the United States within 3 twenty to forty years, thereby giving her the highest standard of liv i n g in the world. Growth estimates made by the Ministry of Finance place the prospective increase of the Japanese national income at 12.9 percent u n t i l 1976, 11.9 percent during the 1977-86 period and 9.9 percent during the period from 1987 to 2000. While the assumptions underlying these rates of growth are open to question, i t seems clear that most observers, including the Government i t s e l f , are forecasting sustained high ••Japan - Socialism on he Ropes," Time, January 12, 1970. p.31. 2 "Holding down the Yen," The Economist, (London), November 8, 1969. p.81. 3 In 1968 Herman Kahn and Anthony J. Wiener of the Hudson Institute published a paper "The Year 2000 -A Framework for Speculation on the Next Thirty Three years," - this paper predicted the economic growth of each country to the year 2000, based on long term trends which seem l i k e l y to continue and the current and future pace of change. - see The Oriental Economist. April,1969. p.2. The Oriental Economist. April, 1969 p.2. - 58 -growth rates for Japan, much above the projected world average. Looking at more immediate prospects, the Japan Economic Research Centre i s predicting a growth rate of 12.4 percent over the next five years. This growth w i l l be bolstered by a continuing upswing in consumer demand, a high level of gross domestic investment, and by a further strong expansion of exports. During this time, labour productivity for the economy as a whole i s expect-ed to increase by 11 percent per annum, however wages are expected to rise by 16 percent annually u n t i l 1975* This i s l i k e l y to lead to a much higher standard of l i v i n g and higher labour costs for Japan's work force. Such growth would not have been possible had i t not been for the great degree of co-operation which has existed between the government and the major economic groups of the nation, in planning the nation's economic development. Apparently, a great number of Japan's b r i l l i a n t young men start their careers in the C i v i l Service and then retire from there to become directors of 2 the big companies, banks, and trading houses. This helps to explain why there has been such a remarkably close ^'Japani* The Yen For Growth," Monthly Review. (The Bank of Nova Scotia, Toronto) March, 1970. 2Ibid. - 59 -co-operation between the government and private sectors and why "administrative guidance" has been so effective in pushing and steering the economy! Japan now appears to have passed the stage where she must carefully gear her expansion to her foreign exchange position which four times in the past has forced serious contractions in the business boom. Since 1965, Japan has continued to run a basic surplus and in the last two years the level of Japan's reserves has started to rise rapidly, reflecting the strength of the Japanese economy. Some forecasters now say that on present .trade trends, Japan could run a basic surplus of over $5,000 million by the mid - 1970's, with a trade surplus of over $10,000 million a year. This prospect in i t s e l f , poses new problems for Japan the most serious of which i s how to avoid too high a growth in the nation's reserves which would tend to bring about increased i n f l a t -ionary pressures at home as well as increased pressure from abroad for a revaluation of the yen or voluntary export controls. Such prospects would not be looked upon happily by the Japanese, and one possibility now being actively considered i s the loosening of capital export "Japan: The Yen For Growth," op. c i t . 2 "Holding Down the Yen," The Economist. (London), November 8, 1969. p.81. - 6 0 -controls i n order to encourage overseas investment. Foreign Exchange Control After the end of the Second World War and the return of economic and p o l i t i c a l control to Japanese Governmental hands, i t was thought necessary by the Government to impose s t r i c t Foreign Exchange and Foreign Trade Control laws to protect the s t a b i l i t y , and to f o s t e r the r e b i r t h of the economy. The r e s u l t of the passage of these laws was to give the Government consid-erable control over matters of foreign trade and invest-ment, and to require a licence f o r a l l foreign exchange transactions. Under A r t i c l e 2 2 of the Cabinet Order governing Foreign Exchange Control, the competent Minister (deemed to be either the Minister of Finance or the Minister of International Trade and Industry, depending on the nature of the transaction) was directed not to grant licence i f actions or transactions concerned came under any of the following i terns t 1 . Where deemed to influence, d i r e c t l y or i n -d i r e c t l y bad e ffects upon the balance of payments; 2. Where deemed to )have an adverse e f f e c t on the r e h a b i l i t a t i o n of the national economy; 3. Where deemed to have the purpose of c a p i t a l f l i g h t or otherwise evading r e s t r i c t i o n s under laws and orders; •'•"Highlights of the Month," The Oriental  Economist. (Tokyo), May, 1 9 6 9 . p.2. - 6 1 -4. Where deemed to be improper i n view of the foreign exchange position.1 Up u n t i l 1 9 6 8 , Government approval was required f o r a l l overseas investment, however, i n that year as the r e s u l t of a continuing strong balance of payments s i t u a t i o n the Government decided on a minor relaxation of exchange controls. The Ministry of Finance (MOF) announced that i t would give automatic approval to a l l investments under 2 $50,000. With Japan's increasingly favourable balance of trade, such l i b e r a t i o n i s expected to be speeded up. However, any easing which does take place w i l l be con-t r o l l e d by the Government so as to f i t i n with i t s o v e r a l l economic p o l i c y . Such p o l i c y has recently been p a r t i c u l -a r l y directed to encouraging projects and aid to the developing nations; p a r t i c u l a r l y those i n South-east Asia 3 and those bordering on the P a c i f i c Rim. The p o l i c y aims of the Government are carried out by i t s m i n i s t r i e s and are r e f l e c t e d i n t h e i r announced p o l i c i e s , goals and objectives. The most important m i n i s t r i e s i n terms of the Provisions of A r t i c l e 22 were kindly provided to me by the Japanese Consul i n Vancouver. The Oriental Economist. May, 1 9 6 9 . p .3« ^"Highlight's of the Month;1 The Oriental  Economist. May, June, Sept. 1 9 6 9 . - 62 -foreign investment decision are the Ministry of Inter-national Trade and Industry (MITI) and the Ministry of Finance (MOF). Up u n t i l the l a s t several years, the major p o l i c y of MITI was geared to encouraging production expansion by fostering the growth of big industries and by o f f e r i n g trade protection to these industries during t h e i r development period. With the strong development of Japan's economy i n recent years, t h i s p o l i c y has been streamlined and modified to give increased emphasis to the aspects surrounding s o c i a l r e s p o n s i b i l i t y by giving greater attention to consumer protection and the prevent-ion of public nuisances. However, the ministry i s not planning to abandon i t s t r a d i t i o n a l p o l i c y of protecting Japan's modern ind u s t r i e s . In J u l y of 1969 i t issued a report, "the Basic D i r e c t i o n of the New Trade and Industry Policies." One of i t s major goals was announced to be the "deployment of economic i n t e r n a t i o n a l i z a t i o n , " by which i t means to encourage new projects f o r the development and import-ation of overseas natural resources and also, to encourage the advance of Japanese enterprises overseas* The F i n a n c i a l Post reported l a s t January that t h i s ministry "I n d u s t r i a l Roundup," The Oriental Economist. September, 1969. pp.50-51* - 6 3 -was advocating that # 5 0 0 m i l l i o n of Japan's $ 3 , 5 0 0 1 m i l l i o n foreign exchange reserves should be used to secure foreign sources of raw materials, p a r t i c u l a r l y 2 o i l , coal, copper and n i c k e l . The Ministry of Finance i s also understood to be encouraging such developments as a r e s u l t of the rapid build-up of foreign exchange reserves. Last year, there was a basic surplus of U.S. $2.4 b i l l i o n and i n the l a s t two months Japan's reserves have increased by over 3 $400 m i l l i o n d o l l a r s . Thus, while foreign c a p i t a l has up u n t i l now been the mainspring of Japanese expansion, i n 1 9 6 9 Japan turned an important corner i n her economic development when she became for the f i r s t time since the war a net c a p i t a l exporter. While the t o t a l of net Investment abroad i s s t i l l snail, t o t a l l i n g less than $2 b i l l i o n , i t i s expected 5 to grow to $ 1 0 b i l l i o n by 1980., Of the t o t a l overseas investment, 6 5 percent has taken place i n the l a s t three ^These reserves have increased by $400 m i l l i o n i n the months of February, March, 1 9 7 0 . 2 "Yen to revalue?," F i n a n c i a l Post. January 1 7 , 1 9 7 0 , p.40. 3 "Japant The Yen For Growth," Monthly Review. (The Bank of Nova Scotia, Toronto) March, 1 9 7 0 . 4 "Japan's Drive to Outstrip U.S.," U.S. News  & World Report. A p r i l 6, 1 9 7 0 , p . 2 ? . 5 I b i d . p . 2 7 . - 64 -1 years. With the easing of restrictions, and the new Governmental policies encouragingeconomic internation-alization, the amount of new overseas investment i s expected to rise sharply over the next several years. Already, the amount said to be determined for the mining of copper alone, over the next five years i s $440 million, and this represents just those mines which so far have 2 been slated for financial or development assistance. Thus i t can be seen that a fundamental change in Japanese policy has come about in the last several years. Whereas up un t i l that time, s t r i c t Governmental control had been the chief obstacle to Japanese investment 3 abroad, this investment i s now actually being encouraged by the Government as one method of developing the economy further while at the same time dealing with the trouble-some balance of payments problem. In terms of the theoret-i c a l model the relaxation of governmental control eases one of the restrictions hindering the Japanese copper 1The Oriental Economist. May, 1969, p.3. 2 T. Iwasaki, "Japanese Metal Industry And The Change of Their Raw Material Securing Measures," (Unpublish-ed paper - the author was formerly with the Resources Devel-opment Office of Ataka & Co., Ltd. in Toronto) 3 This opinion was expressed by the National Industrial Conference Board, see - Obstacles and Incentives  to Private Foreign Investment, 1967-1968 Business Policy  Study No. 130.. National Industrial Conference Board (1969). Volume 1, p.l40. - 65 -industry from achieving i t s "desirable" level of investment. However, i t neither assures that the Government w i l l be willing to lend funds to the mining companies to carry out their investment acti v i t i e s or that i t w i l l not intervene in proposed ventures (which s t i l l must be approved by the Japanese Government). Government Aid. Regulation and  Incentives to Japanese Foreign Investment The Government offers two important forms of aid to Japanese industry which may be investing overseas. Because of the Government's announced intention to give 1 top priority to the support of the developing nations, particularly in Southeast Asia, many of these incentives are directed to encouragingprojects in the developing nat-ions. Some indication of the Government's interest in aiding investment i n the developing nations i s a tax de-ferr a l incentive introduced in 1964. Under this system, a company was allowed to place up to one half of i t s investment in a developing country into a special loss reserve, and to deduct this amount as an expense i n com-puting i t s taxable income in Japan. Sums placed in this loss reserve, could be held there for five years, and The Oriental Economist. May, 1969, p.2. - 6 6 -were then to be transferred back to taxable income in equal instalments over the next five years. This system was to cover investments made between April 1, 1 9 6 4 and March 3 1 , I969I Given that the mining industry requires very high capital costs, this incentive could be particularly important to the Japanese mining firms and may account to some extent for their participation i n opening new mines in Papua - New Guinea, the Phillipines, the Congo, and other developing nations. While i t i s impossible to determine to what extent this form of incentive may have played a role in determining investment decisions to date; i t i s certain that i f this incentive i s maintained and the Japanese continue to invest abroad in copper they w i l l make increasing usage of these incentives. A further incentive offered by the Japanese Government i s insurance against the p o l i t i c a l risks of confiscation, war, revolution, rebellion, riots, c i v i l disturbances, or other infringements on the rights of ownership. The Japanese program offers blanket coverage only. It i s not, as are most national insurance programs, limited to developing countries. Under separate arrange-1 Obstacles and Incentives to Private Foreign  Investment, op. c i t . p . l 4 0 . ( I am not aware whether or not this legislation has been renewed. In view of the Governments announced policy to increase aid and devel-opment in Southeast Asia, I would Imagine that i t has.) - 67 -ments the government may'.insure against inconvertibility •with contracts generally running 15 years for capital and 10 years for earnings. Coverage i s for 75 percent of the actual loss and premiums are just under 0 .5 per-i cent. Specific contracts are kept confidential. Japan has signed treaties of friendship and commerce with some of the developing nations which include clauses protecting Japanese investment in these 2 countries. These provisions combined with the tax de-ferral incentives, already mentioned, would appear to offer a Japanese concern adequate protection at reason-able cost, when considering the possibility of an invest-ment in a developing nation. Turning now to an examination of specific government aid provided to the copper mining industry, i t may be seen that this Is provided chiefly through the auspices of the Metallic Minerals Exploration Agency of Japan. Control i s enacted in the Mining Act, which i s similar to the Mineral Act in effect in the Province of British Columbia. ^Obstacles and Incentives to Private Foreign  Investment. 1967-1968 (Volume II) - Incentives. Assurances  and Guarantees| National Industrial Conference Board, Inc. p.70. 2 Ibid, (Volume I) p.140. S 68 -The Metallic Minerals Exploration Agency of Japan Further evidence of the Government's support of overseas mining exploration and development, i s the new policy of this Agency* Originally, i t was established i n May of 1963 as the "Metallic Minerals Exploration Finance Agency" for the purpose of loaning funds to "help the mining industry build i t s basic and constit-utional strength through speedy exploration for metallic 2 minerals." The agency reports that "In view of the ever-increasing demands for metallic minerals, i t i s now deemed necessary to promote exploration for new deposits overseas, not only for the purpose of securing stabilized supplies and meeting international competition but also for meeting the international demands for economic and technical assistance of developing nations." The tasks which were assigned to the Agency for the promotion of overseas mineral resources are outlined ass "An Outline of Metallic Minerals Exploration Agency of Japan," Metallic Minerals Exploration Agency of Japan, .(January, 1969) Tokyo. This document contains an outline of the Agency's activities and exploration efforts since i t s inception. 2 Ibid, p . l . - 69 -1. Collection and Dissemination of Materials and Information With subsidies granted by the Japanese Gov-ernment, the Agency w i l l collect and f i l e materials and information extensively on geology, exploration for ore deposits, mining laws, p o l i t i c a l , economic and labour situation and various other matters in countries prom-ising bountiful ore resources. After analyzing these materials and information, the Agency w i l l prepare reports for extensive distribution to private enterprises and for use by the Agency as reference materials for making basic surveys. 2. Basic Survey The Agency w i l l undertake basic surveys, sim-i l a r to the regional and detailed geological surveys now conducted in Japan, in undeveloped areas of promising countries with subsidies from the Japanese Government. Areas ascertained from such surveys to have f a i r prospects are to be assigned to private mining companies (including Overseas Mineral Resources Development Corporation) for intensive exploration. 3« Loans for Exploration The Agency w i l l make long-term, low-interest loans to private Japanese enterprises exploring for ore deposits overseas. For those undertaking such projects  in developing countries, loans are available from the - 70 -Overseas Economic Co-operation Fund of the Japanese Government. k. Guaranteeing of Loans for Development The Agency "will guarantee loans obtainable from the Export-Import Bank of Japan and other monetary organizations for funds required for developing metal mines overseas. 1 From the foregoing, i t may be seen that the Agency i s moving actively into the promotion of explor-ation efforts abroad, and that i t i s providing special incentives for projects in the developing nations. Once a project has been submitted for consid-eration to the government a joint meeting of the designated directors of the bureaus of the; Ministry of Finance Ministry of International Trade & Industry Ministry of Foreign Affairs Ministry of Agriculture & Forestry Economic Planning Agency and observers from; The Bank' of Japan The Japan Import Export Bank i s held in order to make a decision on the proposed Ibid, p.10. - 71 -overseas investment. If the investment i s approved, then a loan may be extended by the Japanese Import Export Bank in order to cover part of the cost of exploration. General loan provisions arei* 1. Maximum ratio of loan against the cost of exploration . . . 70$ 2, Rate of interest . . . 5.5-7$ per annum 3» Term of deferment . . . not in excess of 3 years. 4. Term of redemption . . . Up to 20 years. The Government's move to provide aid to the 2 mining industry appears a natural step in order to assist the industry in meeting the growing international competition for new sources of raw material supplies. It appears that the Japanese copper Industry has come to notice that there i s a limit in obtaining through the use of financial development funds alone, new sources of raw materials which have already been discovered and prospected. This information supplied by the Japanese Consul in Vancouver. 2 On account of i t s interest in planning the economy and assuring that a l l necessary resources for the country's growth and prosperity w i l l be available. - 72 -This thus accounts for the copper industry's interest in 1 participating in mining exploration and development ventures i n order to secure new sources of supply, to meet i t s expected needs. Reportedly, the Japanese are increasingly interested in starting f i n a l purchase negot-iations (with potential supplying mines) while f i n a l mine 2 prospecting i s underway. This could be interpreted as a move to increase the Japanese bargaining power by comp-leting a deal before other interests would be prepared to move in . Copper Consumption in Japan Over the last five years copper consumption in Japan has been increasing at the rate of 14 percent per 3 annum or three times the world average. This growth rate has been slightly higher than the actual growth rate of the GNP (13 percent) a sign that copper has been in the forefront of industry growth. Over the next five years, the copper industry projects that growth of consumption within the industry w i l l f a l l to a rate of 10-12 percent per annum, equal to 1 This opinion i s expressed by T. Iwasakl, op. c i t . p.3« 2 "Why Japan searches a l l the world for copper; more copper," World Mining. (Oct. 1969) p.52. 3 "Copper, Aluminum & Nickel in Japan," Non-Perrous Metals Division, Sumitomo Shoji Kalsha Ltd., (April 1969), Tokyo p.8. ^Ibid. - 73 -the projected growth rate of the GNP. On the basis of these projections, i t i s expected that the demand for copper* w i l l rise to 1.4-1.5 million tons per annum by 2 1975* This would be equal to about 18 percent of est-3 imated world production. A comparatively high correlation appears to exist between Japan's index of industrial production (IIP) and the growth in copper demand. 4 GROWTH RATE OF IIP AND COPPER DEMAND Year 1963 1-964 1965 1966 1967 1968 Growth Rate of Copper Demand 13.1 -2.9 16.9 13.1 28.2 19.2 IIP 12.6 3.2 17.1 17.1 18.6 17.3 This suggests that the demand for copper i s highly dependent upon the growth of the economy (which i s what one would expect, since copper i s primarily associated with the capital goods sector of the economy.) The demand for copper may be defined as net consumption by fabricators + change in stocks 4 exports. 2 T. Iwasaki, op.cit. p.2. 3 "Copper, Aluminum & Nickel in Japan," op.cit. p.8. j. 1963-65 data: "Japanese Metal Industry and the change in their raw material securing measures," op. c i t . p.6. 1966-68 data: "Copper, Aluminum & Nickel in Japan," op.cit. p.6. - 74 -Thus, i f Japan 1s high rate of growth continues to increase at i t ' s projected l e v e l s , i t can be expected that copper 1 demand w i l l continue to approximate t h i s growth. Sources of Supply Data on t o t a l production and various projected sources of supply vary with each source checked, but not 2 to a s i g n i f i c a n t extent. A table prepared by World Mining. appears to contain a good summary on sources of supply for the 1 9 6 5 - 6 8 period with projections to 1 9 7 5 ' These projections are more conservative than those projected by 3 other sources, so I have adjusted the table to r e f l e c t the growth rate projected by Sumitomo Shoji Kaisha, Ltd. 4 of 1 0 percent per annum. This rate i s the minimum rate of growth being projected f o r the economy by government planners through to 1 9 7 5 * In adJBting the table, I have assumed that projections of future production from native ores and xSupport for t h i s assumption comes also from a paper prepared by J.L. Johnston, "An econometric model of the world copper market," Unpublished paper, A p r i l , 1 9 6 9 , University of B r i t i s h Columbia. In the demand equation of h i s Study 7 Mr. Johnston found that world trade figures, which he used as a proxy f o r disposable income had a c o e f f i c i e n t which, s t a t i s t i c a l l y speaking, was highly s i g n i f i c a n t . 2 Variances were under 5 percent. 3 "Copper, Aluminum & Nickel i n Japan," op.cit. pp. 1 - 9 . , also T. Iwasaki, op.c i t . pp 1 - 5 * 4 "Copper, Aluminum & Nickel i n Japan," p.9« JAPANESE SOURCES OF COPPER FROM 1 9 6 5 THROUGH 1968 AND PROJECTIONS FOR I969 THROUGH 1 9 7 5 (IN METRIC TONS) FISCAL YEAR a DOMESTIC SUPPLY "b SCRAPS, ETC. c IMPORTED METAL d IMPORTED CONCENTRATES e TOTAL (a+b*c4d) TOTAL IF 1 0 # GROWTH ASSUMED 1 9 6 5 1 1 2 , 0 0 0 7 3 , 0 0 0 64,000 1 9 2 , 0 0 0 441,000 1 9 6 6 114,000 9 1 , 0 0 0 8 7 , 0 0 0 2 1 2 , 0 0 0 5 0 4 , 0 0 0 1 9 6 7 1 1 0 , 0 0 0 7 3 , 0 0 0 1 7 4 , 0 0 0 3 0 9 , 0 0 0 6 6 6 , 0 0 0 1 9 6 8 1 1 7 , 0 0 0 80,000 180,000 3 7 6 , 0 0 0 7 5 3 , 0 0 0 1 9 6 9 1 2 0 , 0 0 0 7 8 , 0 0 0 1 6 2 , 0 0 0 4 5 0 , 0 0 0 812,000 840,000 1 9 7 0 129,000 8 3 , 0 0 0 1 7 0 , 0 0 0 468,000 8 5 0 , 0 0 0 9 3 0 , 0 0 0 1 9 7 1 1 3 6 , 0 0 0 8 8 , 0 0 0 1 7 9 , 0 0 0 4 9 4 , 0 0 0 8 9 7 , 0 0 0 1 , 0 3 0 , 0 0 0 1 9 7 2 143,000 9 3 , 0 0 0 1 6 1 , 0 0 0 5 7 4 , 0 0 0 9 7 1 , 0 0 0 1,140,000 1 9 7 3 1 5 0 , 0 0 0 9 8 , 0 0 0 143,000 6 5 9 , 0 0 0 1 , 0 5 5 , 0 0 0 1 , 2 6 0 , 0 0 0 1 9 7 4 1 5 7 , 0 0 0 104,000 1 2 6 , 0 0 0 743,000 1 , 1 3 0 , 0 0 0 1 , 3 9 0 , 0 0 0 1 9 7 5 1 6 5 , 0 0 0 1 1 0 , 0 0 0 1 1 0 , 0 0 0 828,000 1 , 2 1 3 , 0 0 0 1 , 5 3 0 , 0 0 0 Note 1 « (a to e) Source "Japan in the World of Mining," World Mining. October, 1 9 6 9 , p.53. - 76 -scrap are r e l i a b l e and because of assumptions made e a r l -i e r (concerning long range planning of production from the Japanese mines) are not subject to adjustment. Thus the gap between anticipated consumption and supply w i l l have to be closed by the importation of additional quantities of concentrates or imported metal. Prom an analysis of the table, one can see that the Japanese have had to r e l y on the importation of refined copper f o r between 20-25 percent of t h e i r copper needs within the past several years. Through i t i s pro-jected that they w i l l s t i l l require the importation of refined copper at l e a s t up u n t i l 1975» th i s need Is projected to decline both as a percentage of t o t a l con-sumption and i n absolute terms. This adds support to the hypothesis that Japanese policy, at present, i s geared to the importation of concentrates. Since these concentrates must then be smelted and refined i n Japan, the projected imports of concentrates must also be a projection of the minimum amount of planned smelting capacity to be available i n Japan during each year. In terms of the t o t a l imports of concentrates, the minimum projected increase i s over kOO percent i n the ten year period from 1965 to 1975. Looking at the years 1970 to 1975. the t o t a l of (c +• d) indicates the minimum expected planning gap to be f i l l e d , while the t o t a l of (c+d+f - e) represents - 77 -the maximum expected gap to be f i l l e d , While provision 1 has already been made to f i l l part of this gap, i t was estimated last f a l l that unless new sources of supply are found and commitments made the estimated shortfall of copper to Japan in 1975 could range from 400,000 to 2 600,000 tons. 3 It has been estimated by one source that in the past several years, Japan has accounted for over half of the copper ore moving in world trade and that by 1972, i t w i l l account for between 80-90 percent. At the same time, i t has been estimated that Japan w i l l require almost a quarter of the new copper which i s to be brought into production in the next five years in order to meet her expected needs. Previously, i t was cited that the average cost per milling ton to bring a new mine into production, had risen to $3,000 in the United States (based on. large open-pit operations and low grade ore.) Thus i f we were to assume that the Japanese would be willing, and able, to put up the total financing required to bring in the new production which they require over the next five years *See selected case examples cited in chapter V. 2 "Why Japan searches a l l the world for copper; more copper," op.cit. p.50. 3 "Copper, Aluminum & Nickel in Japan," op.cit. P.7. 4 , T. Iwasaki, op.cit. pp.5-6. - 78 -(say 600,000 tons) then this might require financing in the neighbourhood of 1.5-2.0 b i l l i o n dollars! To see how they have gone about obtaining their required supplies, I now turn to an examination of the organization and profit a b i l i t y of the Japanese copper industry. Industry Organization The following data are figures on smelting capacity, ore self sufficiency, and percentage dependency on copper sales of the major producers taken from figures compiled by the Oriental Economist in Ap r i l , 1969. Earl-ier, I Identified the firms within the industry as Nippon Mining, Mitsubishi Metal Mining, Sumitomo Metal Mining, Mitsui Mining & Smelting, Dowa Mining, Furukawa Mining, 2 Toho Zinc and Nittetsu Mining. This section i s designed The chief variable determining the amount of funds required would appear to be the grade of ore and the recovery ratio during benefication. An ore grading 2 per-cent copper, a l l other things being equal, would yield 4 times as much copper as an ore grading 0.5 percent copper; while in terms of capital costs per milling ton the invest-ments would be almost equal. Thus, with only limited funds for investment purposes, i t would appear much more profit-able to mine only high grade ore provided such bodies could be found. 2 Nittetsu Mining has no smelting capacity of i t s own, but sells i t s entire mine output to Mitsui Mining & Smelting. ELECTROLYTIC COPPER PRODUCTION BY THE MAJOR SMELTERS (INCREASE 1965-1968) Annual Smelting Capacity in Ore se l f - Ratio of Copper Metric Tons Percentage sufficiency to total sales increase Company at Sept. 68 ($) at Sept. 68 Sept. 65 Sept. 68 1965-68. Nippon Mining 17.8$ 35.0$ 105,500 144,000 36$ Mitsubishi M.M. 17.2$ 54 $ 73,800 133,778 81$ Sumitomo M.M. 9.9$ 44 $ 69,600 110,800 60$ Mitsui M.S. 0.0$ 43 $ 46,800 72,000 54$ Dowa 41.2$ 65. % 31,320 78,480 150$ Furukawa Mining 24.3$ 38 $ 32,000 33,000 3$ Toho Zinc 5.0$ 16 $ 8,400 14,400 71$ Total Capacity 367,420 586,458 Percentage increase 1965-68 60$ "Reorganization of Copper Industry," The Oriental Economist. July. 1969 p.44. - 80 -t o show how t h e s e f i r m s have worked t o g e t h e r and how, f o r purposes o f i n d u s t r y a n a l y s i s , t hey may be t r e a t e d as a u n i t . From an a n a l y s i s o f d a t a i t can be seen t h a t the o r e s e l f - s u f f i c i e n c y o f the m i n i n g f i r m s i n S e p t . 68 as a p e r c e n t a g e o f t o t a l o u t p u t was r a t h e r low, and w i t h the e x c e p t i o n o f Dowa M i n i n g Co. was f o r the most p a r t below 20 p e r c e n t o f p r o d u c t i o n . A s u b s t a n t i a l i n c r e a s e has t a k e n p l a c e I n t h e e x p a n s i o n o f d o m e s t i c s m e l t i n g c a p a c i t y w h i c h i s p r e d i c t e d by t h e model, i f the Japanese a r e t o c o n t i n u e t o r e l y on c o n c e n t r a t e s . However, t h i s e x p a n s i o n has j u s t k e p t pace w i t h the i n c r e a s e d i m p o r t -a t i o n o f c o n c e n t r a t e s and mine p r o d u c t i o n i n Japan. Thus a f u r t h e r e x p a n s i o n o f d o m e s t i c s m e l t i n g c a p a c i t y w i l l be n e c e s s a r y o v e r th e n e x t s e v e r a l y e a r s as demand f o r copper c o n t i n u e s t o i n c r e a s e . The p e r c e n t a g e o f t o t a l i n d u s t r y s a l e s h e l d by each company can be e s t i m a t e d by t a k i n g t h e r a t e d s m e l t i n g c a p a c i t y o f each f i r m as a p e r c e n t a g e of t o t a l c a p a c i t y . Thus Nippon would appear t o have had about 28$ o f r e p o r t e d s a l e s i n 1965 and a p p r o x i m a t e l y 25$ i n 1968. T h i s a g r e e s 1 w i t h f i g u r e s r e p o r t e d by t h a t company. •"••'Nippon M i n i n g Co. L t d . - i n p i c t u r e s " 1966 by Nippon M i n i n g Co. L t d . p . l . - 81 -An analysis of the reported p r o f i t a b i l i t y of several Japanese and major overseas copper producers appears on the following page. While the data i s restrict ed to an analysis of the 1967 f i s c a l year results, these appear to be indicative of the general trends. The large American and European integrated producers have averaged a minimum 10% return of net income to sales over the last 1 five years, while the Japanese have only managed to 2 obtain a return of J-kfo on sales over the same period. The question then arises as to what should account for this considerable differential in reported profitability? Can i t , i n fact, be attributed solely to the fact that the American and European producers are almost f u l l y integrated at the mining and smelting stage, while the Japanese are not? Or i s i t due to the reported lower level of efficiency of operations of the Japanese smelters as a result of less advanced technology and more antiquated equipment than that being used in the United States? "Dark Cloud with a Copper Lining," Forbes. March 1, 1970. p.33 - this a r t i c l e contains a s t a t i s t i c a l profile on the pro f i t a b i l i t y of the major world copper producers over the past five years. 2 For corporate data on the Japanese mining companies and their financial condition seei Japan  Company Directory 1969. published by the Oriental Economist (Tokyo) pp. 118-122. see alsoi T. Iwasaki, op.cit. p.4. - 82 -Ma.ior Copper Smelters in Japan and Overseas (In ¥ 100 mm) Total Profits Ordinary Profits Firm Sales Ordinary Net as a $ of Sales Anaconda 3,773 796 340 21.0$ Kennecott Copper 1,760 267 400 15.0$ Phelps Dodge 1,836 275 183 15.0$ Rio Tinto-Zinc 2,219 425 372 19.0$ Cerro Corp. 1,315 206 120 15.6$ Misubishi M.M. 889 28 14 3.0$ Dowa Mining 436 40 16 10.9$ Mitsui M.S. 770 18 14 2.3$ Japan's 0 "Big 6" Total 4,701 182 85 3.9$ For f i s c a l 1967, consolidated results for overseas firms. Ordinary profits before tax, net profits after tax. - Source* "Reorganization of Copper Industry," op.cit.p.4l. b The relatively high p r o f i t a b i l i t y for Dowa is accounted for by i t s relatively high self-sufficiency of ore, 35-40$ and i t s concentration in copper - see "Dowa Mining Co. Ltd." The Oriental Economist. Sept. 1969, p.55. Mitsui, with no ore supplies of i t s own, has the lowest reported profit. This appears to add support to the hypothesis concerning the p r o f i t a b i l i t y of mining. c excludes, Toho Zinc and Nittetsu Mining. -the latter has no smelting capacity of i t s own, but sells i t s entire mine output to Mitsui M.S. - 83 -In part, i t may be due to the higher financial charges involved, necessary to finance the shipments 6f concentrates from foreign ports to the point of eventual smelting and resale* Possibly too, higher shipping costs for concentrates (3 times the bulk of refined copper) may 2 add slightly to the costs of operations. A further reduction in.profits may have occurred as a result of the long term sales contracts signed between Japanese copper producers and fabricators, and as a result of competition 3 within the industry. While adequate data on these possibilities i s not available, they may each account to some small extent for the lower reported p r o f i t a b i l i t y of Japanese operations. However, I think myself, that i t i s the lack of integration which has been the most important factor in reducing profits. (Witness the difference in reported p r o f i t a b i l i t y between Dowa and Mitsui Mining and Smelting.) The difference here between the integrated producer and the independent smelter, i s that the prod-ucer must pay only his variable operating costs required to bring the copper concentrate to "his smelter, whereas the independent producer must pay the f u l l market price less t o l l s for shipping, smelting, refining and marketing, in order to obtain his copper needs. Thus the independent smelter may have to carry a higher working capital over i t s operating cycle. p But this should be covered in contract prov-isions, and w i l l depend on the bargaining power of the selling and purchasing parties. 3 see - fabricating operations - chapter II. - 84 -Assuming average sales of refined copper by the industry average one m i l l i o n tons of copper over the next f i v e years (excluding imports of refined metal) and further assuming an average sales price of 50 cents a pound and a gross return of 5$ on sales, t h i s suggests that the maximum funds which the industry w i l l be able to generate f o r reinvestment purposes over the next f i v e 1 years w i l l be between $200 - $300 m i l l i o n . This pool of c a p i t a l must serve not only f o r expansion into overseas investments, but also f o r the expansion of existing smelting and f a b r i c a t i n g f a c i l i t i e s i n Japan. Thus the amount of funds to be generated i n t e r n a l l y by the indust-ry w i l l f a l l f a r short of that necessary to secure th e i r 2 e x i s t i n g f i n a n c i a l commitments fo r overseas mine devel-opment, l e t alone allow for the achievement of f u l l scale v e r t i c a l integration. This thus accounts to a great ex-tent f o r the co-operation which has been necessary both amongst firms within the industry, and also between the 1 This figure must be regarded as a proxy meas-ure, i t ignores the presence of funds generated as a re s u l t of allowances made f o r depreciation and also the necessity of meeting taxation expenses. Assuming a 50$ tax rate i n Japan, actual funds available f o r reinvestment i n each year would be approximately one-half t h i s figure, plus a l l non-cash expenses incurred i n that year. 2 The minimum estimate of funds required by the Japanese to secure an adequate supply of copper over the next f i v e years was estimated by the MITI to be $500 m i l l i o n . - see "Why Japan searches a l l the world f o r copper; more copper," op.cit.p.52. - however, th i s projection which was made i n 1968, i s already considered to be too low, -see T. Iwasaki, op.cit.p.5* - 85 -the industry and outside industry and government groups, i n order to secure financing and. to reduce the l e v e l of f i n a n c i a l and business r i s k , faced by the copper industry. 1 I t has been estimated by one source, that the Japanese copper firms w i l l be able to r a i s e no more than 30$ of the funds required to secure an adsquate supply of copper resources f o r Japan over the next f i v e years. The rest w i l l have to come from governmental financing, and the trading firms. Already, (as has been shown) some financing i s available from special agencies such as the Japan Export Import Bank, the Overseas Economic Co-oper-ation Fund, and the M e t a l l i c Minerals Exploration Agency of Japan (MMEAJ). However, t h i s financing has been li m i t e d to date, and i s designated f o r special purposes usually associated with projects i n the developing countries. It i s .thus imperative that t h i s f i n a n c i a l aid be expanded, i f Japan i s to secure her anticipated copper needs. As has been ci t e d , the Government's attitude i n t h i s regard appears favourable, and the Ministry of International Trade and Industry i s now advocating that up to $500 m i l l i o n of Japan's foreign exchange reserves be used to help secure overseas sources of raw materials. The industry i s not currently i n a strong f i n a n c i a l p o s i t i o n . To meet i t s expansion needs i t has had to borrow heavily i n the l a s t several years. Now the 1 "Why Japan searches a l l the world for copper; more copper," op.cit.p.52. - 86 -industry i s almost f u l l y loaned up, and cannot offer collateral good enough to obtain additional loans through normal channels in Japan! One possibility i s to obtain foreign loans from overseas commercial banks backed by 2 the guarantees of Japanese commercial banks. With the tight money situation now existing in most parts of the world, i t i s unlikely that the Japanese copper firms would be able to secure the additional financing that they require through these channels. Another possibility being considered, i s the issuance of bonds in foreign 3 markets. This too, i s l i k e l y to face the same problems of a tight money market, and high interest charges. The sale of further capital stock would also appear to be limited on account of the low level of profit a b i l i t y currently being obtained by the industry. For these reasons, the industry appears temporarily restricted in an expansion of i t s capital structure except through the channels of normal growth. The capital which i t i s able to generate as a result of i t s own operations must be carefully employed not only to increase the pro f i t -a b i l i t y of overall operations but also to secure i t s necessary raw material supplies. p.43. "Reorganization of Copper Industry,"op.cit. 2 I b i d p.43. •^ The Oriental Economist. May, 1969 p.83. - 87 -In part, the industry's f i n a n c i a l d i f f i c u l t -i e s are due to i t s remarkable growth. Its s i t u a t i o n i s analogous i n many ways to that of a junior i n d u s t r i a l which possessing a product much i n demand has been forced to expand i t s production faster than i t would have l i k e d , thereby st r a i n i n g i t s f i n a n c i a l resources, i n order to protect i t s market pos i t i o n . During t h i s transformation period from the status of junior to senior companies i n the mining f i e l d ; the Japanese copper firms have had to accept a lower p r o f i t a b i l i t y than would otherwise have been obtainable, i n order to achieve faster growth. By achieving this growth they have f i l l e d the market need and thereby protected t h e i r long run market po s i t i o n . Actually, this process i s a continuing one and w i l l take some years to achieve. I t cannot be expected that the Japanese copper firms w i l l achieve the status of senior mining firms, comparable i n size to the large American and European producers, u n t i l the l a t e 1970*s. In the meantime, while they continue t h e i r rapid expansion, they w i l l have to r e l y primarily on outside c a p i t a l financing f o r t h e i r growth. Furthermore, because of t h e i r high leverage and t i g h t f i n a n c i a l p o s i t i o n , they w i l l be un-able to accept a high l e v e l of r i s k , on t h e i r own account (but w i l l be able to do so i f they have the f i n a n c i a l aid and support of the government agencies.) - 8 8 -Current Developments within..the Industry In view of the need to strengthen t h e i r f i n -a n c i a l resources and to reduce the l e v e l of r i s k faced by in d i v i d u a l firms within the industry; the industry has for a long time co.--operated together on the purchase of copper concentrates. In recent years, t h i s co-operation has been strengthen by the construction of j o i n t smelters, by the j o i n t development of overseas resources, and by exchanges of technical information* In 1969 three of the copper mining firms reached agreement on an ov e r a l l business tie-up arrange-2 ment through the mutual in t e r l o c k i n g of stocks. This arrangement may be preliminary to a much closer arrange-ment amongst these three companies which could eventually lead to t h e i r merger. (Already, these firms have co-op-erated to bu i l d the Onahama smeltery, the largest smelter i n Japan, f o r th e i r j o i n t use.) Should a merger event-u a l l y take place, i t might strengthen the f i n a n c i a l power of these firms s u b s t a n t i a l l y by providing a greatly i n -creased asset base and also by eliminating duplication of personnel and f a c i l i t i e s , such as exis t i n t h e i r overseas o f f i c e s . "^"Reorganization of Copper Industry," op. c i t . p.40. 2 I b i d . p.40. - Dowa acquired 1 m i l l i o n shares of Mitsubishi M.M. and of Mitsui M.S. and each of the l a t t e r received 500,000 shares of Dowa, while interchanging 350,000 shares of th e i r own. - 89 -In co-operating together on large-scale development projects, the Japanese are able to pool t h e i r resources and technical know-how and to undertake projects which i n d i v i d u a l l y would be too c o s t l y and extensive i n scale f o r any of them to undertake i n d i v i d -u a l l y . Moreover, through t h e i r j o i n t purchasing agree-ments, they are able to share the r i s k of an interruption of supply from any one mine seriously c r i p p l i n g operations for an i n d i v i d u a l smelter. The aid and f i n a n c i a l support of the trading firms has also been a necessary and important part of the Japanese copper firms* expansion plans. (This role i s analyzed i n chapter V.) CHAPTER V RECENT JAPANESE OVERSEAS PARTICIPATIONS IN COPPER - SOME CASE EXAMPLES To date, i t has been concluded that the Japan-ese copper producers must move overseas in order to secure their needed sources of supply, and to improve the pr o f i t -a b i l i t y of their overall operations. It has also been concluded that on their own, with very limited financial resources (relative to their capital needs), they cannot afford to take high levels of financial risk without the support of outside financial aid. Because the industry i s committed to expanding i t s production capacity to f i l l i t s country's anticipated copper needs, i t finds i t s e l f caught in a dilemma of i t s own creation. It has been shownthat the Japanese mining industry lacks the resources to achieve f u l l scale vert-i c a l integration, at this time. Thus i t must encourage outside production from foreign mining firms, while at the same time obtaining commitments of supplies for the Japanese marketplace. Because the mining end of operations has been traditionally more risky than smelting, refining, or fabricating operations; this suggests that the Japanese copper industry must bear some of the risk in-order to encourage new mine production. On the other hand, i t has already been postulated that the industry's limited finan-c i a l resources restricts the level of risk which the - 90 -- 91 -Japanese copper industry would willingly wish to under-take. Having identified from the theoretical model the specific situation which the industry now faces, a normative definition of the industry's present strategy might be stated as» The industry w i l l attempt to secure the maximum amount of production possible (in the form desired) up to the limit of the industry's anticipated needsi by employ-ing the industry's scarce resources in their most profit-able way, consistent with the constraints allowed by industry and government policy as to the level of risk and the amount of investment which the industry i s able to afford. Accepting for a moment, this definition of the industry's strategy; this chapter focuses on an examin-ation of the background and nature of selected Japanese participations in the development of new overseas sources of copper supply. Selected case examples, particularly of major contract and loan agreements signed or under negotiation in the last year are used as illustrations in testing the hypotheses of the theoretical models which have been developed. Attention i s placed on the nature of risk sharing by the Japanese in outside mine development and on the - 92 -negotiation and signing of long term sales contracts. While actual delails of most contracts are kept confid-ential, the information which i s available i s sufficient I believe, to lend support to the hypotheses which I have developed. Purchase Contracts for Concentrates Conceptually, there are two types of agreements made by the Japanese in purchasing contracts. One is a straight purchase agreement, where the independent mine i s already in production or has been able to secure i t s own financing. The other i s where the purchase contract i s negotiated at the same time as provisions are being made to provide financial support for new mine develop-ment. Most of the recent contracts negotiated have been in the latter category. This section focuses on a discussion of the general terms which must be settled between two negot-iating parties, in signing a sales (purchase) contract. This discussion i s based on interviews with Canadian and Japanese mining o f f i c i a l s and contains what I believe to be the typical background terms to contract negotiations. For the moment, the assumption i s made that no financial aid i s involved in the agreements, (later this restriction is relaxed). The assumption i s also made that the contract negotiations w i l l be for the purchase of concentrates and that the Japanese copper interests are dealing at arms - 93 -length with independent mining companies. Under these assumptions, the most important terms which appear to be involved i n contract negotiations are theset 1. Quantity - minimum and maximum amounts of concentrate to be delivered per annum. 2. Length of contract, provisions for renewal i f any, at whose option. 3» Tolerances - the minimum grade of concentrate without penalty, the maximum tolerances of impurities without penalties, maximum moisture content without penalty. 4. Penalty provisions f o r exceeding tolerances. 5 . Price basis - determination of what metals to be paid for, reference guide f o r price quotations and p r i c i n g dates. 6. Assaying, weighing - provisions f o r . 7. Delivery basis - passage of t i t l e , r e s p o n s i b i l i t y f o r loading. 8. Payment provisions - when and how to be made. 9» Dues - payment of port and dock fees. 1 0 . T o l l s f o r - smelting - r e f i n i n g - ocean f r e i g h t - marketing - 94 -- including provisions for copper loss in smelting and refining operations, as well as loss in recoveries of other contained metals. - provisions for renegotiating t o l l s during l i f e of contract. 11. Disputes - provisions for arbitration, deter-mination of which parties w i l l bear cost of arbitration. This l i s t appears to contain the most important contract provisions which must be negotiated between the two parties (the firm or firms representing the Japanese copper industry, and the independent mining firm), Under the given assumption, the relative terms agreed upon in the f i n a l contract w i l l be governed by the bargaining power of the two parties as covered by hypotheses 1-3 discussed in chapter I. Some of the contract provisions are more content-ious than others, and some are easily settled on the basis of historical settlement patterns, in other contracts. In general, the quantity of concentrates to be available from any one mine i s based largely on i t s plan-ned capacity and the policy decisions of the independent mine operators, as to how much they are willing to s e l l to any single customer. (The mine operators Independence and bargaining position may be protected by selling to two or mae customers rather than being tied to one.) - 95 -The length of contract w i l l depend largely on the mine operators desire to secure a sales contract in order to raise financial capital and to secure a guaran-tee of a sales outlet for the mine's production until i t s capital cost can be recovered. It w i l l also depend on the Japanese desire to secure a source of concentrate over a given -period. Both parties appear generally interested in a longer contract usually running five to ten years. Tight contract specifications covering allowable content tolerances for concentrates usually lead to higher benefication costs for the supplying mine while they tend to lower the actual smelting and refining costs for the Japanese smelters, as the latter are geared to handling material f a l l i n g into certain predefined specifications. Thus the Japanese attempt to negotiate for tight specif-ications and high penalty charges in order to reduce their operating costs, while the independent suppliers are generally interested in looser specifications and smaller penalty costs for the same reasons. There i s always the risk of a change i n the price of copper between the time of purchase of con-centrates from a supplying mine and their eventual smelt-ing, refining and resale in Japan. Since neither party alone may wish to bear the burden of this risk (and i t has already been postulated that the Japanese won't) the usual method of dealing with this problem i s to agree on - 96 -some form of price averaging over the time between pur-chase and resale. Prices for the contained copper content are usually based upon the export refinery price for electro-l y t i c copper wire bar as published in the Engineering  Mining Journal, although a trend to the use of the LME price i s developing. Since'concentrates often contain other metals, including gold and silver, agreement must be reached as to what other contained materials w i l l be paid for, and on what price basis. As some material w i l l be lost in smelting and refining operations, agreement must be reached on allowances for this. In the case of copper, I believe that the allowances usually run from 3-4$ of the contained copper content. Reaching agreement on these allowances can again be a contentious issue since they have a direct effect on the p r o f i t a b i l i t y of operations for both parties. As i t i s impossible to verify what the actual losses are in any smelting operation, the outside independent mines must attempt to verify what other firms are offering i n the way of allowances, i n order to find some basis for neg-otiations with the Japanese. The assaying and weighing steps are necessary in order to determine the amount of materials to be paid for. Usually provision i s made to have this operation performed twicei once by the seller prior to shipment, and again by - 97 -the purchasing party upon arrival in Japan. In case of disputes covering the assay, provision must be made for independent arbitration. Agreement on a delivery basis i s not normally d i f f i c u l t to resolve. The usual basis i s f.o.b., or f.a.s., a given port. Disagreements which may arise here cover the question of who w i l l pay for port and dock fees including loading operations. In the case of copper concentrates, the normal basis of payment i s 90 percent of the preliminary assay value at the time of shipment upon presentation of f u l l documents with the balance being settled after subsequent arri v a l , weighing and assaying In Japan. This 90 percent value i s arrived at both to cover possible price changes and also to allow for differences which may have to be settled as a result of disputes over the weighing and assaying of the concentrates. Probably the most contentious issues to be resolved are those covering t o l l s for smelting, refining, ocean freight and marketing. These items provide* the margin in which the Japanese copper firms must cover a l l their smelting and refining costs including a margin of profit. The higher are these t o l l s , the greater i s the margin of freedom for the Japanese to recover a l l their costs and to make a profit on operations. At the same time, the higher the tolls, the less w i l l be the reported - 98 -p r o f i t a b i l i t y of mining operations. A r r i v i n g at an agreement on these t o l l s can therefore require a lengthy period of negotiations l a s t i n g many months. The eventual outcome of th i s agreement w i l l depend on the bargaining power of the two par t i e s . Purchase Contracts with F i n a n c i a l Aid With the t r a d i t i o n a l r i s k i n e s s of mining oper-1 ations, most new copper mining projects appear either unable or unwilling to s t a r t up without some form of Japanese f i n a n c i a l a id and/or price support. The reasons f o r this may be many. In most instances about 80 percent of mine financing i s raised i n the form of debt.capital, usually from commercial banks and other large f i n a n c i a l i n s t i t u t i o n s . While these i n s t i t u t i o n s have been w i l l i n g to lend a ce r t a i n amount of c a p i t a l on the basis of sales 2 contracts negotiated with the Japanese, i t appears that t h i s financing has been f a c i l i a t e d when subordinated debt c a p i t a l has been contributed by the Japanese. A noteable exception i s the Island Copper pro-j e c t at Port Hardy, Vancouver Island, B r i t i s h Columbia which announced i n June of 19^9 that i t would go into production i n the f a l l of 1971. I t was not t i l l October of that year that Utah Construction & Mining Company announced that i t had signed a sales contract with Mitsui Mining & Smelting Co. covering the sale of 60% of the mines expected output over a 10 year period. This was followed by an announcement i n December that a second contract had been signed between the company and two Japanese firms, Mitsubishi and Dowa, for about 30% of the mines expected output over a 5 year period.-see the Journal of Commerce June 16, 1969. the Northern Miner, June 19,1969. the Vancouver Sun, Oct.21,1959, and the F i n a n c i a l Post Dec.20,69. 2"Japan's Drive to Outstrip U.S." op.cit.p.27. - 99 -While impossible to v e r i f y , i t i s my b e l i e f that independent mining o f f i c i a l s and the senior o f f i c e r s of f i n a n c i a l lending i n s t i t u t i o n s have been somewhat dubious concerning the projections of growth for copper demand i n Japan. Although possibly more true i n the early 1960*s than today, th i s explanation could well account f o r t h e i r caution i n supporting or going ahead with new mining developments without the.support of Japanese f i n a n c i a l aid and contractual' commitments. If this assumption i s true, then sich a f i n a n c i a l commitment may be viewed by t h i r d party lenders and mining o f f i c i a l s a l i k e , as a form of f i n a n c i a l guarantee that the Japanese w i l l hold to t h e i r contractual commitments, p a r t i c u l a r l y should the demand for copper i n Japan not continue to grow to meet Japanese expectations. Aside from, and i n conjunction with, d i r e c t f i n a n c i a l aidj guarantees of price supports have been important factors i n securing new mine production. By agreeing to support a f l o o r price i n t h e i r purchase of concentrates, the Japanese have reduced the l e v e l of business and f i n a n c i a l r i s k faced by independent mine operators to a l e v e l where they are w i l l i n g to go ahead with new mine production. These f l o o r price guarantees are one of the most in t e r e s t i n g phenomena associated with the Japanese purchase contracts. In a sense, they provide a form of - 100 -f i n a n c i a l leverage for the Japanese firms by serving as a substitute f o r the additional amounts of c a p i t a l which the Japanese copper industry might otherwise be required to provide to encourage the development of new mining projects. While these price support agreements do e n t a i l a f i n a n c i a l r i s k f o r the Japanese copper producers, t h i s r i s k i n t h e i r opinion may be more apparent than r e a l (based ontfreir projections of future copper prices.) Moreover, these price support agreements may o f f e r a r e a l opportunity f o r p r o f i t to the Japanese copper i n t e r e s t s . Wherever the Japanese have agreed to support a f l o o r price, they have usually extracted a si m i l a r concession to provide a c e i l i n g p r i ce, or a p r o f i t sharing agreemant should the price exceed a cer-t a i n l e v e l . Again, although i t i s impossible to v e r i f y I believe that the Japanese copper i n t e r e s t s may attach a much higher subjective p r o b a b i l i t y to the event that prices w i l l tend to exceed the c e i l i n g l e v e l than that 1 they w i l l f a l l below the f l o o r price support l e v e l . Whether or not t h i s i s true, however, the Japanese w i l l have achieved one goal which i s the postponement of 1 For example, the contracts signed between Utah Construction and Mining representing Island Copper, and Mitsubishi Shoji Kaisha Ltd. and Dowa Mining Co. of Japan c a l l f o r the purchase of approximately 70,000 tons of concentrate per annum with a contained copper content of about 17,000 tons. - 101 -immediate cash outlays, thereby stretching their existing financial resources. If in future, they have to make good on their guarantees they may be in a better financial position to do so. It i s also probable that the Japan-ese producers being integrated at the smelting, refining and primary fabricating operations would, in the event of a sharp price decline to or below the floor support price level, be able to resist lowering the prices of their semi-fabricated products to the same extent and would therefore be able to pass on some, or a l l , of the cost of their price support agreements to the secondary fabricators and consumers of copper. The introduction of financial aid and/or price support introduces a new element into contract negot-iations and alters the bargaining strength of the neg-otiating parties. While the contractual terms and agree-This copper i s to be sold at prices based on the  LME quotaHon, with an agreed floor price of 36& per pound, less normal industry charges for smelting and refining. Utah i s to bear insurance and freight costs, see; "Utah Construction sells more copper to Japanese firms," the Northern Miner, December 4, 19&9* (emphasis mine) Assuming, Mitsui Mining & Smelting signed a similar contract agreement, providing for a floor price of 36^ per lb. - i t i s known that Mitsui, when announcing the signing of the agreement placed an estimated sales value of $400 million on their contract over a 10 year period - equivalent to an average purchase price of 57$ a pound over this period, based on their projection of prices. A spokesman for Utah i s said to have expressed the opinion that he would consxer such a high average price as optimistic. This i s suggestive of a differential in the future outlook on prices held by the two negot-iating parties; see the Vancouver Sun. October 21, 1969. - 102 -ments which must be set t l e d remain the same, Japanese in t e r e s t s may play a greater r o l e i n determining some of these terms than they would under the assumption of no f i n a n c i a l a i d . This may be p a r t i c u l a r l y true i n deciding on the planned capacity of a p a r t i c u l a r new mine develop-ment, where Japanese f i n a n c i a l p a r t i c i p a t i o n may provide the basis f o r expanding planned production. Selected Case Examples Very l i t t l e information i s p u b l i c l y available on contract s p e c i f i c a t i o n s , price guarantees, and the terms and provisions surrounding f i n a n c i a l a i d agreements. From that information which i s available, I have selected c e r t a i n data to i l l u s t r a t e various aspects of the d i s -cussion which has already been presented. Bouganville This mine w i l l be the single largest source of copper concentrates f o r the Japanese market when i t i s brought into production i n mid-1972. Start-up costs f o r the mine, located on Bouganville Island i n the T e r r i t o r y of Papua and New Guinea, are estimated at $350 m i l l i o n . With i n i t i a l start-up capacity of 150,000 tpy of contained copper, th i s mine represents one of the large s t f i n a n c i a l commitments ever made by private c a p i t a l i n t e r e s t f o r a project of t h i s type. As such, i t provides a good i l l u s t -r a t i o n of the f i n a n c i a l arrangements necessary to bring a mine of thi s size into production. - 103 -Bouganville Copper i s two thirds owned by Conzinc Riotinto of A u s t r a l i a Ltd. and one t h i r d owned by New Broken H i l l Consolidated Ltd. Conzinc i s a member of the Rio-Tinto Zinc Group which appears to have engineered most of the f i n a n c i a l negotiations surrounding the bring-ing of t h i s new mine into production. In February of 1969, i t was announced that a l e t t e r of intent had been signed with Japanese copper in t e r e s t s for the sale of 950,000 tons of contained copper over a f i f t e e n year period. On the strength of thi s l e t t e r of intent, Rio Tinto was able to approach other groups to secure outside f i n a n c i a l assistance i n the form of medium and long term loans to enable the project to go ahead. In J u l y of 1969, i t was announced that a c r e d i t agreement fo r $246.4 m i l l i o n i n Eurodollars had been signed by the development company, two syndicates of banks repre-sented by the Bank of America, and the Commonwealth Trading Bank of A u s t r a l i a . The:* agreements with the banks c a l l f o r short-term loans of $15^ m i l l i o n to be repaid through 1973-1976. These loans are to be arranged by the Bank of America through a syndicate of banks and f i n a n c i a l i n s t i t -utions i n North American and Europe. The second consortium of banks, also being brought together by the Bank of America, w i l l make available up to $92.4 m i l l i o n i n long-term loans to be deposited with the Commonwealth Trading Bank i n A u s t r a l i a . The a v a i l a b i l i t y of these loans was - 104 -to be conditional upon the acceptance by the Bank of America of the project f e a s i b i l i t y report and the con-clusion of sales contracts for a minimum of 135.000 tons of contained copper per annum for a period of 10 years. By September of that year, the company had signed letters of intent with the German company Norddeut-sche Affinerie for the sale of 52,500 tpy of contained copper, and with the Spanish company of Rio Tinto Patino for 15,000 tpy. In late November, i t was announced that sales agreements had been signed between the company and seven Japanese copper producers ( a l l but Nittetsu) and two trading companies, Mitsubishi Shoji Kaisha and Mitsui & Co. The two trading companies, Mitsui and Mitsubishi, have signed an agreement with Bouganville to loan the latter $30 million, to be repaid by 1979, and have also arranged credit arrangements for Bouganville to purchase equipment worth up to $30 million from Japanese suppliers with pay-ments to be spread over a ten-year period. During the f i r s t five years of operation, the Japanese firms have agreed to purchase 95,000 tons of contained copper per annum. During the 6th-10th years they have agreed to purchase 80,000 tons per year, with a further 15,000 tons per year at the sellers option. In the 11th-15th year of the agreement they: have agreed to purchase 30,000 tons per annum. - 105 -The copper w i l l be sold at the world price (LME) with a guaranteed f l o o r s p r i c e of 30^ f o r most of i t . The recoverable gold contained i n the concentrate w i l l be paid for at the free gold price, l e s s cost of recovery. In return for i t s f i n a n c i a l assistance, the Bank of America w i l l receive a 1% equity i n t e r e s t i n the company, with a 2% i n t e r e s t being offered to the banks providing the long-term financing. In return f o r $A25 m i l l i o n , the company has offered to s e l l a 20 percent equity i n t e r e s t i n the Bouganville project to the Govern-ment of the T e r r i t o r y , which has accepted the o f f e r . In my opinion, there are several i n t e r e s t i n g and s i g n i f i c a n t developments i n t h i s financing arrange-ment. While the Japanese are to contribute up to $60 m i l l i o n i n cash and equipment, th i s i s being supplied by the trading companies rather than the copper producers (thereby conserving t h e i r l i m i t e d c a p i t a l ) . The p r i c i n g system adopted i s s i g n i f i c a n t as i t r e f l e c t s a movement towards adopting the world price, as opposed to the EMJ price, i n new contract negotiations. (It has already been pointed out that Utah's contract i s based on the LME price.) The f l o o r support price of 30^ a pound seems low by comparison with other support l e v e l s now being negotiated. This r e f l e c t s the lower expected mining costs for t h i s mine and i s i n keeping with bargaining theory. As a general rule i t i s expected - 106 -that a party w i l l only bargain for the minimum f l o o r support price i t requires i n order to meet i t s target rate of return. In order to obtain t h i s support price the Rio Tinto Group presumably made the minimum con-cessions possible. If they had bargained for a higher support price they would presumably have had to make much higher concessions. The movement to a free gold price, also appears to be a movement by Rio Tinto to a greater measure of r i s k taking, with the p o s s i b i l i t y of a higher price f o r gold, and therefore a greater return to the mine. The fact that the Japanese loans are sub-ordinated to the other debt c a p i t a l also i s i n keeping with the assumptions which have been made concerning f i n a n c i a l relationships, and Japanese p a r t i c i p a t i o n i n mine financing. No information i s available as to whether or not, Japanese i n t e r e s t w i l l receive some form of equity p a r t i c i p a t i o n f o r the i r f i n a n c i a l support. I t i s also s i g n i f i c a n t i n mf opinion that the other major customer for the mine's output i s a German firm, suggesting that the European customers are attempting to expand the i r sources of supply outside of t h e i r dependence on the CIPEC countries. The fac t that a l l the Japanese producers are involved i n the contract i s i n keeping with the hypothesis made e a r l i e r that they w i l l a l l share j o i n t l y the r i s k of r e l y i n g on any one source of supply. Because Japanese government approval was required f o r the invest-- 1 0 7 -merit, t h i s suggests that the government exercised some 1 measure of control over the investment decision. Freeport Indonesia Another agreement of i n t e r e s t was signed i n January of t h i s year. Freeport Indonesia i s a j o i n t venture of Freeport Sulphur Co. and Indonesian i n t e r e s t s . It holds a copper project, the Ertsberg deposit i n West Iria n , Indonesia which i t i s currently planning to bring into production commencing i n early 1 9 7 3 • The mine which i s estimated to cost $ 1 2 0 m i l l i o n w i l l produce 2 5 0 , 0 0 0 tons of concentrate per annum with a contained copper content of approximately 6 5 , 0 0 0 tons. The preliminary year end report of Freeport Sulphur Co., (released January 28, 1 9 7 0 ) contained an Information on the Bouganville project, was obtained from the following sourcesi "Bouganville Secures Contracts," Mining Journal. Nov. 2 1 , 1 9 6 9 . p . 4 5 7 "Rio Tinto-Zinc gets financing to exploit Copper i n Solomons," Wall Street Journal. Nov. 1 9 , 1 9 6 9 "Bouganville," The Engineering Mining Journal, Sept. 1 9 6 9 . p . 3 9 4 . "Huge Loan Extended to Bouganville Copper," American  Metal Market. July 3 0 , 1 9 6 9 . "Copper Producers to Finance Development of Bugenbill Mine," Japan Metal B u l l e t i n , Nov.22, 1 9 6 9 . "To contract t h i s week to buy Bouganville Copper Ore," Japan Metal Daily, , Nov. 18, 1 9 6 9 . - 108 -i n t e r e s t i n g account on the f i n a n c i a l "backing f o r t h i s project. Our subsidiary, Freeport Indonesia, Incorp-orated, obtained loan commitments during the past 30 days from a group of American insurance comp-anies and banks for $58,000,000 and from Japanese and West German sources for $42,000,000, the f u l l amount of the loans required f o r Freeport Indon-esia's $120,000,000 copper project f o r the development of the Ertsberg deposit i n West Irian, Indonesia. The loan agreements, as well as the sales agreements which have been made with Japan-ese and West German customers, are subject to the f u l f i l l m e n t of various conditions, including Japan-ese Government approval of the Japanese financing; these conditions are expected to be s a t i s f i e d with-i n the next few months. The balance of $20,000,000 of the project cost w i l l be provided as equity funds. Freeport Sulphur expects to obtain from the Agency fo r International Development (AID) s p e c i f i c - r i s k  guarantees to protect i t s equity investment i n Freeport Indonesia against loss due to war, exprop-r i a t i o n and currency i n c o n v e r t i b i l i t y . The American insurance companies w i l l provide $40,000,000 of senior debt financing, which w i l l be guaranteed by the United States Government through AID under the extended-risk guarantee program. The American banks w i l l provide $18,000,000 of senior debt financing, which w i l l be guaranteed by the  Export-Import Bank of the United States. The foreign financing consists of a $22,000,000 loan by Kredit-anstalt fur Wiederaufbau, the West German development bank, and a $20,000,000 subordinated loan by Japan-ese smelting and trading companies. The Japanese companies have contracted to buy about two thirds of the annual output of copper con-centrates to be produced from the Ertsberg deposit, and Norddeutsche A f f l n e r i e , Hamburg, has contracted to buy about one t h i r d . Sales prices under the long-term sales contracts w i l l be world prices f o r copper, les s allowances f o r smelting and r e f i n i n g charges.1 emphasis mine. - 109 -The contracts which were signed by the Japanese c a l l f o r d e l i v e r y of concentrates f o r a 13 year period from the commencement of production. Thirteen Japanese firms are involved i n the contract and f i n a n c i a l arrange-ments. Besides the eight member firms of the copper industry, f i v e trading firms - Mitsui & Co., Mitsubishi Shoji Kaisha, Sumitomo Shoji Kaisha, C. Itoh & Co., and Nissho-Iwai Co., are involved i n the f i n a n c i a l arrange-1 ments• While the actual terms of t h i s contract are unknown, Mitsui Mining & Smelting and Dowa Mining have described the terms of the contract to be the most favourable of a l l such development finance and copper ore purchase contracts so f a r signed by Japanese smelting and 2 r e f i n i n g firms. While these f i n a n c i a l arrangements appear sim-i l a r to those negotiated i n the Bouganville contract, they are in t e r e s t i n g i n that they show the d i r e c t involve-ment of American and German, as well as Japanese govern-ment agencies i n the f i n a l outcome of f i n a n c i a l negotiat-"Mitsui, Dowa Sign Development Loan, Copper Ore Purchase Deal with Freeport," Japan Metal Daily. Aigist 13. 1969.p.4. 2 Ibid, p.4. - see also; "Freeport Sulphur Unit Progesses on I r i a n Project," the Wall Street Journal, January 13, 1970. - 110 -ions. The trend i n t h i s contract i s again to the use of world prices f o r copper, and i s noted that thirteen member firms formed the Japanese purchasing and financing consortium i n negotiating contract arrangements. Mamut Both the Bouganville and the Freeport Indonesia projects were representative of developments i n which Japanese i n t e r e s t had no opportunity to secure a najor equity i n t e r e s t . If the model which I have constructed i s correct however, i t would suggest that the.Japanese w i l l attempt to develop new mining projects where they, themselves, can secure a major equity i n t e r e s t . Such a case i s that of the Mamut and Musoshi projects. In 1967, the Overseas Mineral Resources Devel-opment Co. Ltd! was the successful bidder on mining r i g h t s at Mamut, Sabah, Malaysia i n a tender c a l l e d by the j o i n t discoverers - the Malaysian government and the United Nations development fund* Since having been awarded the prospecting r i g h t s , the Japanese have outlined a deposit of 80 m i l l i o n tons of ore grading 0.6 percent copper. A development company, OMRD Sabah, Ltd. was set up as a j o i n t venture *The Overseas Mineral Resources Development Co. Ltd., i s a ¥2,000 m i l l i o n enterprise j o i n t l y financed by the Overseas Economic Development Fund and 23 non-ferrous metal companies. - see; the Oriental Economist, September 1969, p.57. - I l l -by the s e m i - o f f i c i a l Japanese Overseas Mineral Resources Development Co. (51$ interest) and by l o c a l i n t e r e s t s (49$) i n the Sabah State. This company now intends to ask the Malaysian Government to grant the company the mining and development r i g h t s to the project. Under present plans, the operation would produce about 40,000 tons of contained copper per annum i n the form of copper concentrates, and the estimated start-up cost i s $60 m i l l i o n . In December of 19&9, the Japanese copper producers came together to form the Mamut Mine Develop-ment Corporation with a paid-up c a p i t a l of ¥1,000 m i l l i o n . Mil of the copper companies are involved i n the formation of t h i s company which w i l l take over control of the development of the Mamut1 deposit, once permission from the Government of Malaysia i s obtained. The t o t a l devel-opment costs are estimated at ¥22,000 m i l l i o n , part of which w i l l be borrowed from the Japanese Government and the balance from Japanese private banks and other sources. This project i s s i g n i f i c a n t because of the large equity interest to be obtained by the Japanese copper prod-ucers, and also because of the Government's active support and p a r t i c i p a t i o n i n th i s project through i t s agencies. i see"Mamut Copper Mine Development to be Inaug-urated," Japan Metal Daily. Nov. 17, 1969, p.4. "Mamut Copper Mine Development Company Created," Japan Metal Daily. Dec. 2, 1969, P«3»6. Musoshi In December of 1 9 & 7 , Nippon Mining Co. arrived at an agreement with the Congolese Government f o r the exploration and development r i g h t s covering nearly 3 7 , 0 0 0 square kilometers i n the Province of Katanga, and subsequent exploration of the property has revealed 1 the existence of two potential mines. - Musoshi and Kinseda. The Musoshi mine has proven ore reserves of 1 1 0 , 0 0 0 , 0 0 0 tons of 2 . 1 1 copper with a core containing 3 3 , 0 0 0 , 0 0 0 tons grading 3 « 6 o percent ore. The Kinsenda ore body contains 2 0 , 0 0 0 , 0 0 0 tons of 5 « 0 percent ore. The estimated cost of bringing each of these mines into production i s $ 7 5 , 0 0 0 , 0 0 0 . In 1 9 6 8 , a j o i n t venture with Nippon as the senior partner was formed to bring 2 Musoshi into production by the f a l l of 1 9 7 2 . The Congo Government has subscribed f o r 1 5 $ of the c a p i t a l of the If an a r t i c l e i n Newsweek i s true, i t i s doubt-f u l that the Japanese i n t e r e s t s had to take as much r i s k as i s normally the case i n mining exploration to locate these deposits. Newsweek reports that a Japanese mine company o f f i c i a l , f i n ding himself i n Leopoldville during Katanga's secessionist war with the Congo i n 1 9 6 l , f i g -ured that i f Katanga l o s t the war, Union Miniere.(the giant Belgian mining firm and Katanga's principal backer) would lose some of i t s mineral rig h t s i n the province. This man, Shoroku Kato, therefore made of f with a set of Union Miniere's maps i n the midst of the f i g h t i n g and managed to get safely outside the country. Kato's company with others, i s now developing a mine (Musoshi) to be opened on a s i t e selected from these maps. - (emphasis mine) see; "Japan Salesman to the World" o p . c i t . p . 6 5 . 2"Why Japan searches a l l the world f o r copper; more copper," o p . c i t . p . 5 3 • • see also; "Copper, Aluminum & Nickel i n Japan," o p . c i t . p . 1 0 . - 113 -development organization (the Congo Mining Development Committee) and has an option to acquire an additional 35$ i n t e r e s t . Of the Japanese i n t e r e s t , 57$ of the c a p i t a l has been supplied by Nippon, 10$ by each of M i t s u i , Sumitomo & Toho Zinc, 8$ by Furukawa and 5$ by Nishoi Iwao. The i n i t i a l production i s estimated at 50,000 tons of contained copper annually i n the form of concentrates, and t h i s could be expanded subs t a n t i a l l y i f financing i s available and world market prices warrant. In my opinion, the s i g n i f i c a n t aspects of the Japanese p a r t i c i p a t i o n i n t h i s mine are that they went 1 into an area where they faced a known r i s k and where they had an opportunity to secure a najor equity i n t e r e s t . I do not have the information as to how the Japanese copper producers secured the financing f o r t h i s project. However, i t i s almost certain that the financing was arranged with Japanese Government support including r i s k guarantees. Bethlehem Copper Bethlehem Copper i s one of the most in t e r e s t i n g mines to study as i t was the f i r s t mine i n which Japanese inte r e s t s secured an equity p a r t i c i p a t i o n and one i n which They would already appear to have a good idea of the area's mineral p o t e n t i a l from Union Miniere*s maps. The r i s k they faced was therefore a p o l i t i c a l one, the p o s s i b i l i t y of l a t e r expropriation by the Congolese. - 114 -they (the Japanese interests) would appear to have had a relatively strong bargaining position. I make this inference from the contract and financial provisions which appear to have been negotiated in the original contract, and on the basis of the history of this mine prior to the signing of agreements with the Sumitomo Group of companies. Bethlehem was the f i r s t low grade, open-pit copper mine to be developed in the Highland Valley area of British Columbia. The company was incorporated in 1955 "to carry out further exploration on claims staked a year earlier by Herman Heustis, a prospector. American Smelting & Refining Company agreed to a joint venture by which i t could earn a 55$ interest in the property by providing exploration and development funds. Four years later, after spending $1,250,000 Asarco terminated i t s agreement, thereby relinquishing its interest i n the property. At this stage, the company, s t i l l unable to raise i t s own funds sought other backers but could find none in North America. (With a low grade ore in a new unproven mining area and after Asarco*s withdrawal, their searches for new financial backing were made extremely d i f f i c u l t . ) Forced to look outside of North America, the company turned to the Sumitomo Group of companies which agreed to undertake further exploration and development - 115 -financing. Details of this are given in a prospectus covering the issuance of $ 4 , 0 0 0 , 0 0 0 in 6 $ convertible sinking fund debentures, Series A underwritten by-James Richardson & Sons, in September 1 9 6 5 » At the recommendation of the company's consult-ant an underground development and bulk sampling program was undertaken and completed in late i 9 6 0 . The ultimate cost was approximately $ 1 , 3 0 0 , 0 0 0 . Of this sum certain of the Sumitomo Group of Companies of Japan ("Sumitomo") provided $350.000 for which  they received 3 0 0 , 0 0 0 shares of the Company. Following the preparation of a f e a s i b i l i t y study, the Company, in February 1 9 6 1 , concluded an agreement with Sumitomo whereby Sumitomo provided  the financing to bring the property into production. The financing involved the purchase by Sumitomo of 400,000 shares of the Company for ! 1 5 0 0 , 0 0 0 U.S. and a loan in the amount of ! • 5 . 0 0 0 , 0 0 0 .US The agreement further provided for the conversion by Sumitomo of  $600,000 U.S. of the said loan to shares at $1.50~  U.S. per share. In November 1964, Sumitomo exercised  i t s option to so convert. As a term of this agree- ment, the Company under certain conditions undertook  to expand i t s m i l l capacity before April 1965« J  Sumitomo exercised an option to participate in  financing the expansion by purchasing 500,000 shares of Bethlehem for a total consideration of $800.000. As a result of these various transactions Sumitomo t  purchased a total of 1 , 6 0 0 . 0 0 0 shares of the company. Further reference to the prospectus shows that these agreements were signed between Bethlehem and Sumitomo Shoji New York, Inc., Sumitomo Metal Mining Co. Ltd. and 2 Sumitomo Shoji Kaisha Ltd. Prospectus, Bethlehem Copper, op.cit. pp.2-3. (note that at Feb. 28, 1 9 6 5 , capital stock authorized was 6 , 0 0 0 , 0 0 0 shares. Of the 5 , 2 0 1 , 0 0 0 outstanding at that date, Sumitomo owned 1 , 6 0 0 , 0 0 0 or 3 2 . 5 $ - seet "Bethlehem Copper Corporation Limited," The Financial Post Corporation  Service, (revised information sheet July 311 1 9 6 9 ) 2Ibid. p.3. - 116 -The prospectus includes this information con-cerning the sales contracts On February 26, 196l the Company entered into an agreement with Sumitomo Shoji Mew lork, Inc. and subject to the terms and conditions thereof, Sumitomo Shoji New York, Inc. agreed to purchase a l l the copper, gold and silver concentrates produced at the Highland Valley properties up u n t i l March 1, 1973* The pricing formula for copper used in the said agreement i s based upon the export refinery price for Electrolytic Copper published weekly in the Engineering and Mining Journal. A provision of the  contract i s that i f such export refinery quotation  exceeds 33.50 U.S. funds per pound of copper, the  quotation shall be deemed to be 33*50 U.S. funds  per pound, plus one-half the amount by which the  export refinery quotation exceeds 33«50« The c a l - culation shall be on a weighted average basis over  a l l shipments each year up u n t i l March IT 1967* The contract provides that before March 1,1967 Sumitomo Shoji New York, Inc. and the Company shall negotiate a new pricing formula, such negot-iations to be on a reasonable basis, keeping in mind pricing formulae prevailing at the time. The contract provides that a provisional pay- ment shall be made to the company on presentation of  i t s sight draft, immediately following the loading  ana trimming or concentrates aboard ship in the Port  of Vancouver, equal to 90% of the net estimated"  selling price. The balance shall be paid to the  Company after the arrival of the cargo at i t s des- tination. The contract with Sumitomo Shoji New York, Inc. was assigned to Sumitomo Shoji Canada Ltd. in Vanc-ouver, on August 29, 196l. This participation agreement negotiated by Sumitomo seems to verify many of the hypotheses put forth in the model. In a strong bargaining position, the Japan-ese w i l l try to minimize the level of risk they face while seeking out ways to enhance the p r o f i t a b i l i t y of their operations. At the same time they w i l l balance these f i r s t - 117 -two objectives by a t h i r d and primary objective, which i s to.achieve a maximum amount of concentrates for each d o l l a r of f i n a n c i a l aid put f o r t h . In the case of the Bethlehem venture, i t can be c l e a r l y seen that the Jap-anese have t r i e d to accomplish a l l these objectives. The option clauses of the f i n a n c i a l contract are of great i n t e r e s t , i n that they show how the Japanese in t e r e s t s have attempted to reduce t h e i r r i s k through the holding of debt, while at the same time reserving f o r themselves the r i g h t to convert part of t h i s debt; into equity, should i t appear p r o f i t a b l e for them to do so. The more important clause In the contract i n my opinion was the one requiring Bethlehem to expand i t s production under cert a i n circumstances, and providing the Japanese int e r e s t s with the option to p a r t i c i p a t e i n t h i s financing. This clause c l e a r l y achieved the Japanese objective of increasing i t s supplies of concent-rates, at no cost to i t s e l f . (Presumably, since a l l concentrates must be sold to Sumitomo u n t i l 1973t Sumitomo could have forced Bethlehem to expand i t s prod-uction without contributing any further equity c a p i t a l . The f a c t that i t did so, appears only to indicate that Sumitomo believed t h i s to be p r o f i t a b l e f o r i t s own inter e s t s . ) The very f a c t that Sumitomo was able to acquire a 3 2 . 5 $ i n t e r e s t i n the company i s suggestive that the Japanese int e r e s t s were i n a po s i t i o n of - 118 -superior bargaining power. The pricing formula i s also indicative of this strong bargaining position and illustrates how these sales contracts can offer the Japanese an opportunity to enhance the p r o f i t a b i l i t y of their operations. This concession from Bethlehem was secured in return for a floor price guarantee on the original contract. No information i s publicly available on the contract prov-isions which were negotiated in 196?, as no outside financing, other than the private placement of one million treasury shares, has been carried out since that date. However, i t may be inferred from the company's 1969 annual report (which shows the average price per pound of copper in U.S. cents received each year) that the company i s faced with a ceiling price on i t s copper sales to Sumitomo! The price averaging basis appears extremely favourable to the Japanese interests, being based on a weighted average basis of a l l shipments during the year. By doing so, i t avoids violent price fluctuations and also allows more time for prices to be adjusted by the Japanese interests at their consumer level. *The average price per pound of copper sold in the f i s c a l years ended February 28, 1968 and 1969, was reported to be 49.150 per pound u.s. The lack of any change in the average price during these two years which were marked by high and fluctuating prices for copper in world markets suggests that this ceiling price prevailed during these years. - 14th Annual Report, Bethlehem Copper Corp. - 119 -As appears to be the usual Japanese copper producer's policy when making an equity investment, the Sumitomo interests have secured 3 seats on a 9 man board of directors to oversee their interests i n the operation of the company. At today's prices, Sumitomo's original investment of $2,320,000 in equity funds has a market value of $25-30 million. In dividends, i t i s returning over $800,000 per annum. Brenda Mines This property bears a similarity in many respects to the history of the development of Bethlehem Copper. Like Bethlehem, Brenda was a low grade ore body in the Peachland area of the Okanagan area of British Columbia. The ore body was f i r s t explored by Noranda and Kennecott in the early 1950's before being abandoned by them in early 1957• The ore body was found to contain very low grades of copper ore, and molybdenite for which no major market had been developed at that time. In the early 1960's several developments in the mining industry encouraged further exploration in the area. These were the development of a market for molybdenite, the successful exploration and development of two low grade copper-molybdenum properties (Endako and Boss Mountain) in B.C., and the development of new mining equipment and technology which greatly changed the economics of open-pit mining. - 120 -In the summer of 1964, the principals of the firm, Bern Brynelsen and Morris Menzies (then manager and assistant manager of Noranda's office in Vancouver) f e l t that these developments warranted further examin-ation of the Brenda property and together they sought support f,6r their project. Noranda declined further involvement, but agreed to allow Brynelsen and Menzies to proceed on their own. During that summer they appro-ached every major Canadian, American and Japanese mining company resident in Vancouver, but with the exception of Nippon Mining Company, they expressed no interest in the venture! Nippon apparently was willing and anxious to take a l l the action but the principal's policy required Canadian control and imposed a limit on the Japanese 2 participation. In early 1965, the Brenda Mining Syndicate was formed to raise a total of $140,000. Seven units were issued at $20,000 each, with Nippon picking up 2 of the units. At this stage the group gave Nippon Mining Co. Ltd. the right of f i r s t refusal to purchase any copper concentrates being sold without the Province of Morris M. Menzies, "The Brenda Project," Canadian Mining Journal, April, 1969 pp.120-124. 2 I b i d . p.122. - 121 -B r i t i s h Columbia provided that the price was equal to or better than prices offered by other outside smelters* On the basis of further exploration, a f u l l scale f e a s i b i l i t y study was recommended. By June 1966, with more information at hand and prospects for a sus-tained demand fo r copper and molybdenite, Noranda again agreed to enter the picture, loaning both c a p i t a l to complete the f e a s i b i l i t y study and the services of some of i t s top mining, m i l l i n g and assaying s p e c i a l i s t s . In return for i t s p a r t i c i p a t i o n , Noranda was given the r i g h t of f i r s t r e f u s a l on development financing 2 upon receipt of the f i n a l f e a s i b i l i t y report. Noranda delayed i t s f i n a l decision u n t i l release of the Federal Government's statement on the continuation of the three-3 year tax exemption period. With the release of t h i s statement i n May 1967, by the Minister of Finance, the go ahead was given f o r arranging production financing and mine development. In December 1965» the Brenda Syndicate was con-verted into a public company Brenda Mines Ltd. As a r e s u l t Prospectus, Brenda Mines Ltd. dated Jan. 1966 -paragraph (x)-(b). 2 "Brenda MinesiLtd." - an investment study pre-pared by G. Tower Ferguson Ltd. of Toronto, March 28, 1968. p.6. 3 Department of Finance, Ottawa, News Release #67, May 11, 1967. - 1 2 2 -o f i t s p a r t i c i p a t i o n i n t h e o r i g i n a l s y n d i c a t e , N i p p o n r e c e i v e d 3 ^ 0 , 6 1 7 s h a r e s r e p r e s e n t i n g a 1 5 p e r c e n t i n t e r e s t i n B r e n d a . A t t h i s t i m e , i t w a s f e l t t h a t t h e a p p r o x i -m a t e c o s t o f p r o d u c t i o n d e v e l o p m e n t w o u l d b e $ 5 0 m i l l i o n . I n o r d e r t o m a i n t a i n i t s i n t e r e s t N i p p o n w a s a s k e d t o s u p p l y 1 5 $ o f t h e r e q u i r e d f i n a n c i n g o r $ 7 . 5 m i l l i o n . I n o r d e r t o d o t h i s , N i p p o n t o o k o n M i t s u i & C o . t o a c t a s i t s a g e n t f o r h a n d l i n g t h e e x p o r t o f t h e B r e n d a c o n -c e n t r a t e s . N i p p o n a r r a n g e d t o p u t u p $ 4.5 m i l l i o n a n d M i t s u i p u t u p $ 3 « 0 m i l l i o n i n s e c o n d m o r t g a g e d e b e n t u r e s . I n r e t u r n f o r t h i s , N i p p o n w a s t o r e c e i v e 2 4 , 0 0 0 b o n u s s h a r e s a n d M i t s u i 1 6 , 0 0 0 ; e q u i v a l e n t t o 5 - 1 / 3 s h a r e s p e r $ 1 , 0 0 0 o f f i n a n c i n g . T h e s e f u n d s w e r e a p p a r e n t l y r a i s e d t h r o u g h J a p a n e s e b a n k s , i n c l u d i n g t h e J a p a n E x p o r t I m p o r t B a n k , t h e J a p a n I n d u s t r i a l B a n k , a n d t h e M i t s u i B a n k a s w e l l a s t h e c o m p a n i e s own r e s o u r c e s ! N i p p o n M i n i n g L t d . h a s t h e e x c l u s i v e r i g h t t o p u r c h a s e a l l c o p p e r c o n c e n t r a t e s f o r t h e f i r s t f i v e y e a r s o f p r o d u c t i o n . T h e a p p r o x i m a t e t e r m s o f t h e c o n t r a c t a r e j ' ' ' '••Brenda M i n e s L t d . " The F i n a n c i a l P o s t S u r v e y  o f M i n e s 1 9 7 0 . p . 2 0 5 . 2 G . T o w e r X F e r g u s o n L t d . , o p . c i t . p p . 6 - 7 « - 1 2 3 -Grade of concentrate: 2 7 . 5 $ T o l l s f o r smelting r e f i n i n g ) ocean freight) marketing ) 8^/lb. pay metal (Cdn.) or $42.40 per ton of concent-rate shipped. Moisture content 7% Copper price "basis: EMJ export r e f i n e r y price f o r e l e c t -r o l y t i c copper. In terms of the model developed, i t would appear that the s i g n i f i c a n t aspects of t h i s p a r t i c i p a t i o n are that the Japanese i n t e r e s t s desired to pa r t i c i p a t e i n t h i s development to a much greater extent than they were act u a l l y able to do so. In t h i s case because of th e i r experience, knowledge and contacts within the mining i n -dustry, the p r i n c i p a l s were able to take steps to protect the i r bargaining power. This was accomplished by r e s t r i c t -ing the Japanese to a small minority equity p a r t i c i p a t i o n , and l a t e r by bringing i n Noranda to manage the mine devel-opment program. With Noranda*s and th e i r own experience behind them, the p r i n c i p a l s were able to negotiate a con-t r a c t with the Japanese which appears r e l a t i v e l y favour-able to Canadian Interests. The provision of bonus shares i n the debt financing arrangements appears to be a f a i r l y common practice i n mine development financing. A shiilar arrange-1 Ibid. p.7. - subject to change a f t e r 2 years. - 124 -ment i s known to exist in the case of the proposed Lornex 1 contract currently under renegotiation as a result of the B. C. Copper Smelter Act. The specifications of the purchase contract are the most detailed that I have seen publicly available. Davis-Keays This company i s another example of Japanese interests entering British Columbia at the exploration and development stage of a new mining project. Unlike the other mines discussed this one i s s t i l l in the exploration stage. 2 In January of 1 9 7 0 , i t was announced that Dowa Mining Co. of Tokyo would advance up to $ 1 . 3 million to finance further exploration and feasibility studies of the Davis-Keays Mining Company's property 1 2 0 miles west of Fort Nelson in northeastern British Columbia. The letters of intent covering the agreement must be approved by the Japanese government and the Vancouver Stock Exchange. Under the agreements arranged, Dowa may convert one-half of i t s exploration funds into shares of Davis-Keays at $ 4 . 5 0 . After completion of the f e a s i b i l i t y 1 The Japanese group of six copper smelters and three trading houses were to subscribe $ 2 6 , 5 0 0 , 0 0 0 U.S. .. through the purchase of units consisting of $1,000(U.S.) notes and 5 . 6 6 0 4 Lornex shares (under a reorganized capital structure) for each $ 1 , 0 0 0 U.S. contributed. 2 „ " $ 1 . 3 Million Development Pact Signed With Japanese," The Vancouver Sun, January 2 9 , 1 9 7 0 , p.30. - 1 2 5 -report, Dowa w i l l have the r i g h t to advance 5 0 percent of the cost of placing the Davis-Keays property into production (the estimated cost of which i s | 9 , 0 0 0 , 0 0 0 ) . In consideration of thi s financing, Dowa w i l l be granted an eight year contract covering a l l sales of concentrates from the mine. In addition, Dowa w i l l be granted the r i g h t to convert one-half of i t s senior production f i n -ancing into shares of Davis-Keays at $ 7 . 0 0 a share. Dowa w i l l have one representative on the board of d i r e c t o r s during the exploration stage and two repres-entatives, i f an when Dowa advances the necessary prod-uction financing. This case would also appear to confirm the trend of general development pointed out to date, i n the spe c i f i c a t i o n s of the model and the determination of Japanese objectives. CHAPTER VI OUTLOOK FOR THE FUTURE INVESTMENT POLICIES OF JAPANESE COPPER INTERESTS This study set out to explore trends and devel-opments i n the world copper industry and the Japanese economy which may influence the nature and extent of Japanese p a r t i c i p a t i o n s i n overseas copper mining, ex-ploration and development ventures. The study was devel-oped on the basis of l i b r a r y research and a series of unstructured interviews with various executives connected with the Canadian and Japanese copper mining industries. For purposes of an analysis ce r t a i n f a c t s , d e f i n i t i o n s and hypotheses were developed to explain the nature and extent of Japanese overseas p a r t i c i p a t i o n i n copper. These were developed and discussed i n d e t a i l i n subseq-uent chapters. Based on the analysis presented to date, the following trends may be predicted f o r the industry over the next decade. There w i l l be a backward integration by the Japanese copper industry to achieve a substantial equity p a r t i c i p a t i o n i n overseas mining ventures. This move w i l l be necessary i n order to maintain control over the form, and source of the industry's supplies and w i l l act to reduce the o v e r a l l business r i s k faced by t h e i r operations. - 126 -- 12? -The h i g h r a t e of growth p r e d i c t e d f o r the J^anese economy-over the next decade w i l l c o ntinue to f o r c e a r a p i d expansion of the I n d u s t r y and w i l l p l a c e a heavy burden on the copper i n d u s t r y ' s a b i l i t y to r a i s e s u f f i c i e n t funds f o r c a p i t a l expansion. Thus the movement to backward i n t e g r a t i o n w i l l be geared to the i n d u s t r y ' s a b i l i t y to o b t a i n adequate sources of c a p i t a l to meet i t s expansion needs both a t home and abroad. During the next decade the Japanese Government w i l l i n c r e a s e i t s i n c e n t i v e s to overseas investment as a p a r t i a l means of d e a l i n g w i t h a troublesome balance of payments problem c r e a t e d by a growing trade s u r p l u s . T h i s w i l l a l s o l e a d to a movement to reduce and e v e n t u a l l y e l i m i n a t e a l l Japanese c o n t r o l s o n . f o r e i g n exchange move-ments r e l a t e d to overseas investments. A movement w i t h i n most p r e s e n t copper producing c o u n t r i e s to encourage f u r t h e r p r o c e s s i n g of t h e i r ores p r i o r to export w i l l l e a d to more s m e l t i n g o p e r a t i o n s being e s t a b l i s h e d i n these c o u n t r i e s . In order to a s s u r e her s u p p l i e s , Japan may t h e r e f o r e be f o r c e d to move some of her s m e l t i n g o p e r a t i o n s overseas. The problem of a i r p o l l u t i o n w i t h i n Japan may a l s o add impetus to movements i n t h i s d i r e c t i o n as w i l l the d e c l i n e i n the importance of sulphur recovered from s m e l t i n g o p e r a t i o n s . Should new chemical, h y d r o l o g i c and b a c t e r i a l -o g i c a l methods of ore r e c o v e r y prove economically f e a s i b l e , - 128 -these could come into wide usage by the middle of the decade. This would substantially influence the economics of smelting operations by reducing the high cost of plant f a c i l i t i e s now required to esta b l i s h smelting operations. This would speed a movement to esta b l i s h smelters close to major sources of copper supply. The opinion was expressed thatcopper prices are l i k e l y to be much more stable i n future than they have been i n the past and that t h i s should act to reduce the perceived r i s k s of mining operations. This should act so as to increase the l e v e l of investment which the Japan-ese w i l l undertake i n overseas operations. It was suggested that the area i n which the Japanese in t e r e s t s would invest would be dependent upon the opportunities a v a i l a b l e to them; t h e i r assessment of the r i s k s involved; and the l e v e l of taxation and r e s t r i c t i o n s on the r e p a t r i a t i o n of c a p i t a l and dividends imposed by the host countries i n which the Japanese were contemplating investment i n t e r e s t s . As the scope of analysis was r e s t r i c t e d to a global viewpoint on operations, no detailed analysis was made of these factors. It was postulated that Japanese Government incent-ivesvto encourage investment i n the developing nations might lead to industry p a r t i c i p a t i o n i n these areas. This conclus-ion appears to be v e r i f i e d by a study of the case examples. These show that Japanese interests have made t h e i r heaviest commitments i n these areas and that they have secured t h e i r - 129 -g r e a t e s t e q u i t y p a r t i c i p a t i o n i n mines w h i c h have had the f i n a n c i a l s u p p o r t of t h e Japanese Government and i n d u s t r i a l g r o u p s . The s t u d y was l a r g e l y s u c c e s s f u l i n accomp-l i s h i n g its m a jor o b j e c t i v e s o f i d e n t i f y i n g the f a c t o r s w h i c h may i n f l u e n c e the n a t u r e and e x t e n t o f Japanese p a r t i c i p a t i o n s i n o v e r s e a s copper v e n t u r e s , and i n d i c a t i n g t h e t r e n d i n new c a p i t a l i n v e s t m e n t d e c i s i o n s w i t h i n the i n d u s t r y . A r e a s w h i c h may r e q u i r e f u r t h e r s t u d y i n v o l v e such q u e s t i o n s as the a t t i t u d e o f e x e c u t i v e s t o r i s k t a k i n g i n m i n i n g o p e r a t i o n s . I n v e s t i g a t i o n i s r e q u i r e d t o d e t e r -mine whether more s t a b l e p r i c e s w i t h i n the i n d u s t r y would i n c r e a s e o r d e c r e a s e th e i n c e n t i v e s t o m i n i n g o p e r a t i o n s , and whether the r a t e o f mine e x p a n s i o n would be speeded o r slowed by t h e i n t r o d u c t i o n o f p r i c e s based on the l o n g -r u n average c o s t o f mine p r o d u c t i o n ? S h o u l d a t r e n d t o more s t a b l e p r i c e s d e v e l o p w i t h i n the copper i n d u s t r y , t h e s e q u e s t i o n s would have I m p o r t a n t i m p l i c a t i o n s f o r Japanese d e c i s i o n makers. C o u l d c o p i e s o f c o n t r a c t s be o b t a i n e d and examined t h i s m ight l e a d f u r t h e r s u p p o r t t o the hypotheses d e v e l o p e d I n t h i s t h e s i s . SELECTED BIBLIOGRAPHY Books Commodity Research Bureau, Inc. Understanding the Comm-odity Futures Markets. New York: Commodity Research Publications Corp., 1969. Cordero, H.G. and Tarring, G.H. In a Metal Merchant's O f f i c e . 2nd.ed. London: Quin Press Ltd. 1958. The F i n a n c i a l Post. Survey of Mines (1966-1970). Toronto: MacLean-Hunter Ltd. Japan External Trade Organization. Foreign Trade of Japan 1969. Japan External Trade Organization, October 1969. K i l l i n , A.F. The Canadian Copper Industry i n 1966. Mineral Information B u l l e t i n MR.88, Mineral Resources Di v i s i o n , Department of Energy, Mines and Resources. Ottawa: Queen's Printer, 1967. National I n d u s t r i a l Conference Board. Obstacles and In- centives to Private Foreign Investment. 1967-1968. Business P o l i c y Study No. 130. Vol. 1 and I I , the National I n d u s t r i a l Conference Board, Inc. 1969. The Oriental Economist. Japan Company Directory 1969. Tokyo: The Oriental Economist, 1969. Journal and Magazine A r t i c l e s "Huge Loan Extended to Bouganville Copper." American  Metal Market. July 30, 1969. "Dealing From Strength.*' Barron's. Feb. 24, 1969, p.H "Copper's Future." Barron's. March 9, 1970, pp.1-3, 24-29. "A red-hot economy's quest for raw material." Business Week. January 24, 1970. pp.46-47. - 130 -- 131 -"Getting a handle on the copper market." Business Week. March 7. 1970, p.24. Menzies, M.M. "The Brenda Project," Canadian Mining  Journal, A p r i l 1969» "Holding down the Yen." The Economist. Londoni November 8, 1969, p.81. "Everyone*s happy." The. Economist. London: January 10, 1970, p.62. Cleaver G., "Copper." Engineering Mining Journal, March 1968, pp. 100-101. "Copper." Engineering Mining Journal. March 1 9 6 9 , pp. 103-104. "In L a t i n America the going gets bumpy for mining." Engineering Mining Journal. July 1969. pp.59-60. "Bouganville." Engineering Mining_Journal. September 1969, p.394. Grant-Suttie, R.I. "Copper Substitution." Finance &  Development. Vol. 2, 1969, pp.49-55. Olsen, John A. and Blaney, Terry A. "The Copper Industry-Forecasting by P r o b a b i l i t i e s . " F i n a n c i a l  Analysts Journal, March-April 1968, pp.36-40. "Dark Cloud with a Copper Linin g , " Forbes. March 1, 1970, pp.26-37. Harris, S.G. "Japan." Foreign Trade. Vol. 132 No. 8. October 11, 1969, pp.6-8. Cameron, Juan. "Threatening Weather i n South America." Fortune. October I969, pp.100-104. Charles, A.G. "Copper," Mining Annual Review. June 1969, p.31. " P o l i t i c s "Dictate." Mining Journal. London, May 2 3 , 1969. "Bouganville Secures Contracts." Mining Journal. November 21, 1969, p.457. Prain, S i r Ronald L. "Copper." Mining Congress Journal. Vol. 54. No. 2. February 1968, pp.58-62. - 132 -"Japan-Salesman to the World." Newsweek, March 9, 1970, pp.64-68. "Reorganization of Copper Industry." The Oriental  Economist. July 1969, pp.40-44. "Highlights of the Month." The Oriental Economist -April, May, June, September 1969^ "Industrial Roundup." The Oriental Economist, September 1969, pp.50-51. "Dowa Mining Co. Ltd." The Oriental Economist. September 1969, p.55. "Japan-Socialism on the Ropes." Time, January 12, 1970, p.31. "Toward the Japanese Century," Time. March 2, 1970, pp.28-46. "Japan's Drive to. Outstrip U.S." U.S. News and World  Report. April 6, 1970, pp.26-28. Argall, G.O. Jr. "Japan in the World of Mining." World Mining. Vol. 22, No. 11. October 1969 pp.37-76. Newspaper Articles "Yen to revalue?" Financial Post. January 17, 1970 p.40. "Copper Producers to Finance Development in Bouganville Mine." Japan Metal Bulletin. November 22, 1969. "To contract this week to buy Bouganville Copper Ore." Japan Metal Dally. November 18, 1969. "Mitsui, Dowa Sign Development Loan, Copper Ore Purchase Deal with Freeport." Japan Metal Daily. August 13, 1969, p.4. "Mamut Copper Mine Development to be Inaugurated." Japan  Metal Daily. November 17, 1969, p.4. "Mamut Copper Mine Development Company Created." Japan  Metal Daily. December 2, 1969, p.3,6 "Utah Construction sells more copper to Japanese firms." Northern Miner. December 4, 1969. - 133 -"How the U.S. i s handling i t s copper c r i s i s . " Northern  Miner. January 22, 1970, p.15. "Copper speculation i n center stage." Northern Miner. A p r i l 23, 1970, p.75-"$1.3 M i l l i o n Development Pact Signed with Japanese." Vancouver Sun, January 29, 1970, p.30. "Canada-Japan Trading Booms." Vancouver Sun, January 30, 1970, p.22. " B i l l i o n s at stake i n Bennett's resource development plan for B.C." The Globe and Mail. May 8, 1970, p.Bl. "Rio Tinto-Zinc gets financing to exploit Copper i n Solomons." Wall Street Journal. November 19, 1969. "Freeport Sulphur Unit Progresses on I r i a n Project." Wall Street Journal, January 13, 1970 Other Sources Information Card, "Bethlehem Copper Corporation Limited," The Financial Post Corporation Service, updated July 31, 1969. Prospectus, Bethlehem Copper Corporation Ltd. - $4,000,000 6% Convertible Sinking Fund Debentures Series A, underwritten by James Richardson & Sons, Sept. 1965. 1969 Annual Report, "Bethlehem Copper Corporation Ltd." "Brenda Mines Ltd." - an investment study prepared by G. Tower Ferguson Ltd., Toronto, March 28, 1968. Iwasaki, T. "Japanese Metal Industry and the Change of t h e i r Raw Material Securing Measures." - an unpublished paper - the author was formerly with the Resources Development Office of Ataka & Co. Ltd. i n Toronto, 1969. "Japani The Yen f o r Growth." The Bank of Nova Scotia, Monthly Review. March 1970. > - 1 3 4 -Johnston, J.L. "An Econometric Model of the World Copper Market," - an unpublished term paper prepared for professor Whatarangi Winiata of the Faculty of Commerce and Business Administration, University of British Columbia, April 1970. (20 pages) "An Outline of the Metallic Minerals Exploration Agency of Japan." Metallic Minerals Exploration Agency of Japan, Tokyoi January, 1970. (11 pages) "Copper, Aluminum & Nickel in Japan, - review of'68 out-look for *69." The Non-Ferrous Metals Division Sumitomo Shoji Kaisha, Ltd. Tokyo? April, 1969 pp.1-11. APPENDIX A A Note on the Copper Industry Copper, a key metal i n the world mining, be-cause of i t s v e r s a t i l e properties finds many uses i n industry. Like other metals, copper i s said to face a derived demand. I t i s dependent upon the growth of other industries; p a r t i c u l a r l y i n the areas of e l e c t r i c a l and electronic equipment, building construction, i n d u s t r i a l machinery and transportation. The rapid growth of these areas during the 1960's has had an important influence on the growth of the copper industry. T r a d i t i o n a l l y , the production of copper has been highly concentrated i n the hands of a small number of producers who, operating on an in t e r n a t i o n a l basis, have dominated the market. To summarize the exi s t i n g structure* three firms - Anaconda, Kennecott and Phelps Dodge - supply almost two-thirds of t o t a l U.S. mine out-put, with an additional 20 percent supplied by f i v e other large producers. These firms, i n turn, dominate prod-uction i n Chile and Peru. In Canada, Noranda, Falcon-bridge and INCO dominate the market exporting half t h e i r copper output to the United States. Three A f r i c a n concernsi Anglo-American Corp. of Sojfch A f r i c a Ltd., Generale Congo-l a i s e des Minerals, and Roan Selection Trust Ltd. have 1 , ,Dealing From Strength," Barron's. Feb. 24, 1969, p.11. - 1 3 5 -- 136 -dominated production i n A f r i c a , exporting primarily to the European market. The Japanese have r e l i e d t r a d i t i o n a l l y 1 on imports from Canada, the P h i l l i p p i n e s , and Zambia. In terms of production, the major producing countries arej the U.S., the U.S.S.R., Chile, Zambia, 2 Canada, the Congo and Peru. However, consumption i s concentrated i n the highly i n d u s t r i a l i z e d nations. Both the United States and the U.S.S.R. have been net import-ers of copper during the l a s t several years; with.the United States r e l y i n g on imports f o r about 10 percent of 3 her consumption. This then leaves four nations, Chile, Zambia, the Congo and Peru i n control of 80 percent of 4 the world's copper exports. The economy of these count-r i e s has been b u i l t c h i e f l y by the development and export of copper, and the foreign exchange which th i s export brings i n . Thus these nations have a very high stake i n maintaining a high and stable price f o r copper ( i n order 1 A r g a l l , J r . , World Mining, op.c i t . p.52. 2 A.G. Charles, "Copper," Mining Annual Review. June, 1969, p.31* 3 "Dark Cloud with a Copper Lining," Forbes. March 1, 1970, p.28. - note also, no r e l i a b l e data are published on the production and consumption of copper by the Communist nations. Both China and Russia have been net importers on a small scale over the l a s t several years, 4 "Copper's Future," Barron's. March 9, 1970, pp. 1-3, 24-27. - 137 -to maintain a balanced planned program of development for t h e i r economies.) Copper constitutes between 50-60 percent of the Congo's export earnings, between 70-80 percent f o r Chile, and over 90 percent for Zambia! With the increased e f f o r t s by a l l these count-r i e s i n the l a s t decade to assume greater control over t h e i r copper mining a c t i v i t i e s they have succeeded i n large measure i n obtaining t h e i r objectives; both of increased prices for copper and greater control over the 2 marketing and r e f i n i n g of thei r copper production. However, the risk of increasing interference and unrest i n the CIPEC nations has served to i n t e n s i f y exploration e f f o r t s i n other countries which appear to o f f e r a more congenial climate f o r investment. Thus exploration e f f o r t s have been stepped up i n such countries as Canada, A u s t r a l i a , Iran, South A f r i c a , Indonesia and the P h i l l i p p -ines. Major ore bodies which have been found i n these areas are scheduled to come into production i n the early 1970*s. This may have a very s i g n i f i c a n t a f f e c t on the world copper market, by reducing i t s dependence on the 3 t r a d i t i o n a l market areas. 1R.I. Grant-Suttie, "Copper Substitution," Finance & Development, #2, 196§« P'53« 2 Forbes, op.c i t . p.27. (this w i l l be explored i n further d e t a i l i n discussing the a c t i v i t i e s of the CIPEC countries as part of r i s k analysis.) ^This view, expressed by Simon Strauss, a v.p. of American Smelting & Refining Co. seems generally shared i n the industry. - see Barron's. March 9, 1970, p.24. - 138 -Aside from new mine production, another major source of supply to the copper industry i s scrap. For every 100 tons of primary copper produced in the Free World, there are between 70 and 72 tons of scrap copper coming back into use. Of this scrap intake, about 30 percent i s refined into new copper again, and the other 70 percent i s channeled into direct use in alloys or i s remelted. As a percentage of copper consumed, scrap has hi s t o r i c a l l y accounted for about 42 percent per annum, a percentage which has remained rather constant for many 1 years. No mention has yet been made" of costs of prod-uction. These vary widely, and are influenced by a number of factas. The more important of these are the type and grade of ore; size of mine; method of mining; location and transporation costs; capital construction costs; wage rates; and the value of by-products recovered from refining. Differing accounting practicesmay hinder efforts at making usable cost comparisons. Systems and rates of taxation amongst different countries also vary hindering comparisons of after tax profits available for reinvestment or d i s t r i b -ution. While an exact comparison of costs i s imposs-ible, i t has been estimated by leading industry sources x S i r Honald L. Prain, "Copper," - Mining Con-gress Journal, Feb. 1968, Vol.5^ No.2. p.ol (Prain has been chairman of Roan Selection Trust since 1950 and chief ex-ecutive officer since 19^3« He i s probably one of the most widely quoted experts on copper. - 139 -that approximately half the copper mined i n the United States costs l e s s than 25 cents a pound to produce. In Chile, the mines operated by U.S. copper i n t e r e s t s have a low cost averaging between 15-20 cents per pound. Average costs of the Zambian mines are 25-35 cents, being higher p a r t i a l l y because of the Rhodesian s i t u a t i o n which has forced the su b s t i t u t i o n of lower grade l o c a l coal f o r smelting purposes and the use of more expensive trans-portation routes; and also because of a system of variable royalty and bonus payments based not on cost, but on the London Metal Exchange (LME) s e l l i n g price f o r refined 1 copper. These approximate cost figures go f a r to 2 explain the apparent attractiveness of producing copper i n Chile; and also explain why the Roan Selection Trust (RST) and Anglo American groups were accused so often by President Kaunda and others of exploiting only Zambia's 3 high-grade deposits and neglecting the r e s t . •'•For the source of these cost estimates see -"Copper," Standard & Poor's Corporation, p m 105.(1969) 2 The copper companies are taxed at almost con-f i s c a t o r y l e v e l s , at one point as high as 90 percent i n Chile. Thus despite the apparent p r o f i t a b i l i t y of copper mining i n today's market the a f t e r tax return to the mining companies has been rather small. 3 Forbes, op.cit. - This i s a clear case where the e f f o r t s of the developing nations-in this case Zambia-to increase t h e i r earnings by.imeans of r o y a l t i e s based on s e l l i n g price rather than cost resulted i n a p o l i c y which has discriminated against lower-grade,higher cost mines. APPENDIX B RISK ANALYSIS AT VARIOUS OPERATING LEVELS OF THE INDUSTRY Febricating Operations At the f a b r i c a t i n g l e v e l of operations, the product i s i n i t i a l l y d i f f e r e n t i a t e d by primary f a b r i c -ating operations into r o l l e d copper sheet, wire bars and rods. From these operations i t i s processed p r i n c i p a l l y into wire and cable f o r the e l e c t r i c a l , e lectronic, transportation and building i n d u s t r i e s . Approximately one quarter of the copper output i s remelted fo r the making of brass and other a l l o y s used for f i x t u r e s and other applications. Operations at t h i s l e v e l would appear to have a r e l a t i v e l y low operating r i s k i n comparison to mining operations. The greatest uncertainties center around obtaining an adequate source of markets and a supply of refined copper to meet t h e i r operating needs. One of the chief r i s k s within t h i s segment of the industry would appear to be the p o s s i b i l i t y of a decline i n markets due to the p o s s i b i l i t y of the introduction of new technology or the substitution of other metals i n place of copper i n c e r t a i n industry applications. This might lead to the reduction of operating e f f i c i e n c y on c e r t a i n production l i n e s as a r e s u l t of under u t i l i z a t i o n of e x i s t i n g f a b r i c -ating capacity. - lkO -- 141 -Another risk i s the cost of carrying inventory, Most secondary fabricating operations and some primary operations are carried out by firms outside the copper industry. The Japanese copper producers s e l l copper to these goups on the basis of long term contracts. Occasionally, fabricators have refused to accept delivery on the basis that they were overstocked. On other occasions they have requested increased deliveries only to find that the producers were unable to supply their needs at that time! S t i l l another possible source of d i f f i c u l t y for the fabricating industry i s the increased amount of working capital required to carry inventories as a result of higher world copper prices. To the extent that the fabricators may have contracted their own production to buyer groups, they may have d i f f i c u l t y in passing on price increases. Refining and Smelting Operations The Japanese have relied on the import of copper concentrates for their smelting and refining oper-ations. Proper planning can remove much of the risk attendant at this level of operations. If demand can be *"Copper, Aluminum & Nickel in Japan,".- the Non-Ferrous Metals Division, Sumitomo Shoji Kaisha, Ltd. Kanda Mitosshiro-cho 1, Chiyoda-ku, Tokyo. (April 1969) - I do not have further information on these contracts but one would imagine that they have an important i n f l u -ence on the p r o f i t a b i l i t y of the fabricating and refining levels of the industry - the chief question would be who shares the burden of price fluctuations.. - 142 -forecasted with some degree of accuracy into the future, and adequate supplies of concentrates can be obtained; then smelting and r e f i n i n g operations can be planned to operate close to t h e i r long run most e f f i c i e n t operating l e v e l s , and the producers and the industry w i l l not be required to carry excess i d l e capacity. The chief uncertainties center around being able to obtain the necessary sources of raw materials and being able to achieve a good Hong run forecast of demand for planning purposes. By building i n a margin of f l e x -i b i l i t y i n t h e i r procurement operations, the Japanese can hedge against t h e i r uncertainties concerning the future l e v e l s of expected demand by purchasing t h e i r marginal requirements i n the form of refined copper on the open market. By d i v e r s i f y i n g the number of sources upon which they r e l y f o r raw materials, the Japanese producers can reduce the uncertainty of major supply interruptions (from any one source) forcing a temporary, substantial reduction i n t h e i r smelting and r e f i n i n g operations. This p o l i c y of r i s k sharing i s carried out i n practise by the producers when they form c a r t e l s to share In the purchase of output from large supplying mines. This p o l i c y of j o i n t p a r t i c i p a t i o n i n overseas mining developments can also be viewed as a form of mutual insurance p o l i c y to the extent that producers share a f i n a n c i a l i n t e r e s t i n - 143 -an overseas mining venture by way of either debt of equity. Another r i s k faced at t h i s l e v e l of the industry i s the r i s k of carrying inventory over the average three month operating cycle. (This i s the average time elapsed from when concentrates are f i r s t shipped and paid f o r u n t i l the time they a r r i v e i n Japan, are smelted and refined into copper and are sold to f a b r i c -ators.) During t h i s time the price of copper can fluctuate considerably. Mining Operations At the mining exploration and development l e v e l , a firm i s faced with i t s greatest uncertainties. An apt analogy could be drawn to the more publicized d i f f i c u l t i e s inherent i>n o i l exploration. Exploration and development expenditures are high i n both in d u s t r i e s . C a p i t a l once committed i s l a r g e l y a sunk cost. Thus, both the o i l and mining industries have devised p o l i c y controls and methods of exploration and development oper-ations which allow f o r progressive commitments of c a p i t a l to a given project depending upon the re s u l t s of a c t i v i t i e s achieved at various progress l e v e l s . While there are great uncertainties attached to e f f o r t s i n these f i e l d s , c e r t a i n potential benefits accrue to those who partake i n these a c t i v i t i e s . The - i44 -chief benefit inherent i n doing so i s the r i g h t to form a mining company and to bring the mine into production i f i t s thought economically viable to do so. Because venture c a p i t a l i s required at t h i s stage of operations, the largest equity p o s i t i o n usually accrues to those who have put f o r t h the greatest amount of r i s k c a p i t a l . Today, i t i s most often the larger mining companies who are part-i c i p a t i n g at t h i s l e v e l , because of the increased sop-h i s t i c a t i o n of these a c t i v i t i e s and the larger amounts of c a p i t a l required to carry out f e a s i b i l i t y studies on new pot e n t i a l mines. Once a new ore body has been found and suitable predevelopment a c t i v i t i e s have been c a r r i e d out, a decision must be made to bring the mine into production. This decision w i l l be subject to the securing of s u f f i c i e n t financing and sales contracts f o r the mine output, and w i l l be based on f e a s i b i l i t y studies prepared by a mine's consulting engineers. These f e a s i b i l i t y studies w i l l be based on projections of future costs and operating l e v e l s and w i l l include provisions f o r c e r t a i n losses i n the recovery of ore frommining and benefication operations as well as projections of future prices f o r metals expected to be recovered from operations. (At t h i s stage i t i s worth noting that copper i s often found i n conjunction with other metals. Thus the f e a s i b i l i t y of any mining operation w i l l be connected with the expected future price - 1 45 -l e v e l of a l l these metals.) Once a decision has been made to go ahead with a mining operation, the mine i s subject to the following r i s k s . If t o t a l preproduction expenditures exceed c a p i t a l cost projections, the firm may not achieve i t s expected return on c a p i t a l . If prices f a l l below i t s expectations, the expected p r o f i t may also be reduced, thereby endangering the f i n a n c i a l strength of the mine. (For these reasons, mine operations are generally funded on a short 4 - 7 year pay-back period on debt financing.) Should a mine have no d i r e c t connection with a smelter, i t i s subject to the r i s k that i t may not be able to s e l l i t s output i n i t s semi-processed form except at very unfavourable terms to i t s e l f , i n times when the industry i s i n an over supply p o s i t i o n . Further, i t i s subject to the p o s s i b i l i t y that market controls, taxation changes, or expropriation proceedings may be i n i t i a t e d by the governments of the country i n which the mine i s operating. 

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