Cerro Verde’s US$850 million mine expansion financing excelled as it was the largest project financing for a mining project in Latin America in 2005. In closing the deal, it brought together Japanese export credit agency JBIC commercial banks and KfW – with a local bonds facility due to follow this year

Situated 20 miles south west of Peru’s second city Arequipa, Cerro Verde has been operating since the mid-19th Century, mining green copper oxide from rich seams that gave the mine its name – ‘Green Hill’ in English.

Its deposits were first exploited by Spanish prospectors who shipped the high-grade ore all the way to Wales. The then mining company - Anaconda - owned the property from 1916 until 1970 when the Peruvian government took it over.

Cyprus Amax then bought the mine in 1994 and made startling increases in productivity before the company as a whole was bought by US major Phelps Dodge in 1999.

The copper oxide seams that have been mined for so long will be exhausted by 2014 at current production levels, but a deeper resource of copper sulphide ore offered the chance to continue operating at Cerro Verde until 2040. 

Around two years ago Phelps Dodge approached its long-standing financial adviser Citigroup saying that it wanted to launch a new project to develop the deeper resource. Sumitomo Metal Mining and Sumitomo Corporation, existing partners in other projects, expressed an interest in joining as partners. So did Phelps Dodge’s nine per cent partner in the existing mine, Compañía de Minas Buenaventura.

Bob Dewing, managing director of Citigroup’s infrastructure and energy practice, says: ‘It was one of the interesting parts of the project – that you are building a new project in the middle of an existing mine.’

As a result, Dewing says, considerable confusion would have resulted on the ground if a separate financing package was drawn up to that funding the existing mine operations. Equipment belonging to one project consortium would be sitting among that of another - a recipe for chaos and inefficiency.

‘Eventually Phelps Dodge was persuaded not to bring Sumitomo into a new project, but to bring it into the project as a whole. That was a very early stage issue to decide’, Dewing says.

So what went ahead was a financing package covering both existing operations and the new project. The first stage was completed in October 2004, with Sumitomo committing to take a 20-25 per cent interest in the existing consortium and Buenaventura agreeing to raise its stake to around 20 per cent.

Altogether, Phelps Dodge estimated that it needed US$850 million to complete the mine expansion and set a target of getting around half of that in equity from Sumitomo and Buenaventura and the other half in project financing.

However, what is probably most interesting about the project financing is the way it was not really needed from a financing point of view at all.

After all, Phelps Dodge is the world’s second largest producer of copper and had around US$1.6 billion of cash on its balance sheet at the end of 2005. Sumitomo and Buenaventura also have strong financial profiles.

Dewing says: ‘Phelps Dodge believed that having local stakeholders brings diversity to the financing and also risk mitigation.’

So, in addition to bringing in Sumitomo and increasing the local company’s stake, the parties looked to widen the deal’s international profile by bringing in banks from Canada, Germany, the UK, Japan and France – while reserving a portion of their contributions to go into a local bond financing to Peruvian investors this year.

The Parties

Cerro Verde is managed by a consortium called Sociedad Minera Cerro Verde, led by Phelps Dodge. Before the deal was completed, Phelps Dodge owned 82.5 per cent of the mine, with Peruvian company Compañía de Minas Buenaventura holding 9.2 per cent and residual minority shareholders the remaining 8.3 per cent.

After the close of the deal, Buenaventura’s stake was raised to 18.2 per cent. Sumitomo Metal Mining and Sumitomo Corporation between them took a 21 per cent stake while the minority shareholders were diluted only slightly to 7.2 per cent.

Citigroup was financial adviser to Phelps Dodge as project leader with Debevoise & Plimpton handling its legal work. Leading Peruvian firm Rodrigo Elías & Medrano advised the Cerro Verde consortium in Peru while Sullivan & Cromwell represented the Sumitomo companies.

Much of that work involved dealing with the minority shareholders in the mine who wanted their rights protected as part of the deal.

Dewing says: ‘It was one of the big issues putting together a financing with such disparate shareholders – for example in defining the rights and capacities of the various parties. Normally you have one or two major customers.’

Milbank Tweed Hadley & McCloy, Estudio Luis Echecopar Garcia and Morrison & Foerster represented the lenders.

Because the mine expansion is not defined as a new project per se, no EPC contract was awarded for the construction works – so Fluor remains as the principal contractor on the mine.

Phelps Dodge and the two Sumitomo companies are sharing the mine’s production as joint off-takers.

The Project

The project will enable Phelps Dodge and its partners to access and start production on a one billion tonne copper sulphide ore body with a 0.51 per cent copper content, situated underneath the oxide ore seams that are currently in production.

This will allow Cerro Verde to continue in operation until 2040, rather than 2014 as would have been the case without the sulphide resource being in place.

The development works will also increase initial copper production from 100,000 to 300,000 US tons per year from 2007, though initial production from the ore body is expected in the second half of 2006.

The mine will also use a new modern concentrator to process the sulphur ore with a copper recovery capaicty of 80 per cent - the first in the world with such capacity.

Phelps Dodge estimates the expansion will create 2,400 construction jobs at peak construction and 350 permanent new jobs at the mine, which currently employs about 660 employees. Around 1,000 indirect jobs will be created in the surrounding community as a result of the expansion.

Maurizio Levi-Minzi, a partner within Debevoise & Plimpton’s project finance practice, says: ‘If all goes according to plan, the cash flow generated by the current operations together with the cash flow from mining the sulphide ore will generate a healthy debt coverage.’ 

Financing

Citigroup’s Dewing emphasises the way the project sponsors did not need the US$450 million they raised in the project financing side of the deal. They were looking for financing that complemented its risk profile of the financing. The project should drive the financing rather than the financing drive the project.’

What this meant in practice was a deliberate effort to diversify sources as widely as possible, while keeping local Peruvian interests prominent. Luckily, the strength of the sponsoring companies and the project itself meant that the deal was substantially oversubscribed.

Japan has a particularly close relationship to Peru and its export credit agency JBIC took the biggest share of the project financing with a contribution of US$247.5 million. This faciliy included Sumitomo Mitsui Banking and Bank of Tokyo Mitsubishi.

Kreditanstalt fur Wiederaufbrau (KfW) put in US$22.5 million. The Bank of Nova Scotia, Royal Bank of Scotland, Calyon and Mizuho each put in US$45 million for a US$180 million total contribution from the commercial banks.

Dewing says: ‘The commercial banks bring in flexibility’, partly for agreeing to have half of their total debt contribution replaced this year with a prospective US$90 million bond issue to Peruvian institutions.

Citigroup has been mandated as sole arranger, book runner and placement agent for this facility, which should go on to the market this year.

But this flexibility extended further, for the deal also allows the sponsors to deviate from copper production quotas and reorganise production if they see fit. Since the deposit includes some spreads of highly-priced molybdenum, this could prove lucrative for all parties.

Levi-Minzi says: ‘The lenders were very comfortable with the project because of the strong track record of Phelps Dodge. This, together with the healthy cash flows meant that the lenders provided a fairly flexible covenant package and did not require hedging of copper prices.’

The financing structure includes a two-and-a-half year grace period and completion guarantees, with a debt buy-down mechanism from the sponsors on a pro-rata basis.

Conclusion

The Cerro Verde mine expansion financing was not just significant for the fact that it included the largest project financing in Latin America last year. It also showed the lengths to which sponsors and their advisers are looking to satisfy local concerns in their large-scale international financing deals.

This can be seen in the diverse range of nationalities of the sponsors and banks that participated in both equity and debt sides of the transaction.

Indeed, the fact that the project financiers selected included one bank each from Germany, the UK, Canada, Japan and France was more than a co-incidence. With the largest contribution - from JBIC - effectively coming from the Japanese government, it can be seen that political risk has been spread very widely.

If Peru's government should decide to intervene in any way - and it has a presidential election coming up this year - it will have to take on a whole host of vested interests from a wide range of countries, most pertinently Japan, a strong supporter of Peruvian development over the years.

Getting such a wide range of financiers on what are regarded as extremely attractive terms for the sponsors is down to the strength of those companies and of the project itself.

The project at a glance