CASE "AMAX Corporation"

In early 1980, management at AMAX Corporation (formerly American Metal Climax) had to decide whether or not to proceed to a massive investment in expanding production capacity at several of its molybdenum (pronounced mol-IB-de-num) mining operations. Widespread concern over both inflation and the potential exhaustion of natural resources like as molybdenum had lead to a rapid recent increases in all metals prices, including molybdenum. In early 1980, molybdenum was selling on world commodity exchanges for just over $9 per pound, up from $6,05 per pound in 1979 and only $2,47 per pound as recently as 1975. The amount of capital involved, however, was substantial even by the standards of a company like AMAX with $2.865 million in 1979 sales. The proposal being put forward by the managers of the molybdenum operations would involve the expenditure of roughly $200 million per each year from 1980 to 1982 ($600 million in total) before the new molybdenum production capacity would come on stream in late 1982.

I. The Company

AMAX, founded in 1957 with the merger of the American Metal Company and the Climax Molybdenum Company, began life as American Metal Climax, Inc., before changing its name to AMAX in 1974. The bulk of its 1979 revenues were produced by molybdenum (38 percent) and base metal (39 percent) sales, primarily copper, zinc and lead. Sales of energy (oil, gas and coal) accounted for an additional 17 percent of revenues, with the remainder being iron (4 percent) and chemicals (2 percent). Molybdenum by itself accounted for 60 percent of operating income with base metals supplying 22 percent and energy 11 percent. AMAX was a largely undiversified producer of raw materials - mainly metals and metal ores. In the past, limited attempts to diversify beyond this base of expertise had been largely unsuccessful and were fairly rapidly abandoned. Total sales in 1979 of $2.865 million generated net income of $365 million, up from $1,727 million and $160 million respectively in 1978 (see Exhibit 1). Total assets at the end of 1979 were $3,937 million, of which $2,133 million represented stockholders equity. At that time, AMAX had about $1,100 million in outstanding debt (see Exhibit 2).

II. AMAX Molybdenum Operations

At the beginning of 1980, AMAX was producing molybdenum concentrate - a raw material consisting of 60 percent molybdenum that underwent final processing at plants near potential customer around the world at two locations in central Colorado. The Climax mine, which had been operating continuously since 1918, produced 49 million pounds of molybdenum (i.e. 81 million pounds of concentrate) in 1979. At this production rate, the Climax mine had a thirty-years supply of proven high quality molybdenum ore. In practice, however, the potential supply was almost inexhaustible since proven reserves at the mine tended to increase over time and were higher at the end of 1979 than at any previous time in its 61 year history. The Henderson, also in Colorado, produced 43 million pounds of molybdenum in 1979; at this rate of production, the mine had 20 years of proven reserves, although like the Climax mines reserves, these tended to grow over time rather than shrink. The Henderson mine was generally less profitable than Climax since the concentration of molybdenum in the ore was lower (i.e. 0,130% versus 0,419%). Variable costs per pound of molybdenum produced in 1979 were $4.50 per pound at Henderson compared $4 per pound at Climax. These costs did not change with the level of output. Beyond overall inflation, these costs were not expected to increase over time. A third, higher cost mine at Kitault in British Columbia (Canada) had been shut down several years before because its costs were too high to allow for profitable operations at then-prevailing molybdenum prices. If reopened, Kitault would yield about 10 million pounds of molybdenum per year from the end of 1982 forward at a variable (marginal) cost $6 per pound in current terms (1979). The ore concentration at the mine was 0.192%. At this rate of production, the Kitault mine had sufficient reserves to operate indefinitely.

III. The Molybdenum Market

Molybdenum products - such as molybdenum metal, fermolybdenum and molybdic oxide - are used almost entirely as alloy additives to steel. As a result, demand for molybdenum is determined almost entirely by the demand for high performance steel. Since the cost of molybdenum is a very small fraction of the overall cost of the final steel product and since the amount of molybdenum required is determined inflexibly by metallurgical requirements, molybdenum demand as an input to production is almost completely insensitive to the molybdenum price. In addition, after slow but significant growth in the late 1960s and early 1970s, the overall demand for steel, particularly high quality steel, has largely stabilized. Consequently worldwide consumption of molybdenum stabilized in the late 1970s at about 200 million pounds per year (see exhibits). Future increases in demand would depend on the new uses for high performance steel. These uses had lately been limited as lighter aluminum alloys (which did not require molybdenum) and were increasingly displacing high performance steel in many applications.

In late 1979, there were three sources of molybdenum. First, there were mines that produce molybdenum concentrate and Climax and Henderson. In 1979, these mines operated at full capacity and produced about 150 million pounds of molybdenum (i.e., 250 million pounds of 60% concentrate). AMAX, with an output of 92 million pounds, accounted for just over 60 percent of this direct production. Other United States mines produced about 20 million pounds, Canadian mines produced about 20 million pounds for its own use. Variable costs at the competing mines were roughly comparable to those at AMAXs Henderson mine. Furthermore, since the open pit technology was already highly developed, continuing cost improvements at AMAX and other mines were expected to be slight.

The second major source of molybdenum was as a by-product in the mining and refining of base metals, chiefly copper. Potential output of molybdenum from this source was widely dispersed among many companies. In 1979, about 75 million pounds of by-product molybdenum was produced, a figure that had increased rapidly as molybdenum prices has risen and more copper companies had adapted their refining processes to recover molybdenum. Once a copper or other base metal producer had converted his refining processes to molybdenum recovery, the marginal cost of extracting the molybdenum was negligible (about $0.50 per pound) since refining costs were driven by base metal production. In contrast, gearing up for molybdenum recovery was relatively expensive, about $7 per year per pound of installed production capacity (annualized cost taken over the expected life of the equipment), whether used or not. Since the by-product recovery was a new one, however, this initial installation cost was falling relatively rapidly (i.e., about 10 percent per year).

The third and final potential source of molybdenum was high quality steel scrap metal. Since the cost was high of recovering molybdenum from scrap steel was high, about $12 per equivalent molybdenum pound, little molybdenum was produced by this method in 1979. The total molybdenum production shown in Exhibit 4 came, therefore, almost entirely from mining and base metal by-product recovery.

Molybdenum prices were determined on world commodity exchanges by established sellers, major steel producers, governments and speculators. In early 1980, fears of natural resource exhaustion, chronic inflation, and political interruption of supply (as had happened to oil from Iran after the fall of the Shah in 1979) had driven molybdenum prices - along with those of natural resources to unprecedented highs (see Exhibit 3). At the beginning of 1980, molybdenum prices had reached $9.02 per pound and their rate of increase showed little or no sign of abating.

IV. AMAX Investment Opportunities

AMAX management was considering investing $600 million between 1980 and 1982 inorder to bring major new molybdenum capacity on line. An expenditure of $300 million at the Climax mine would increase its capacity (post-1982) by 15 million pounds of molybdenum per year (i.e., 25 million pounds of concentrate). An investment of $200 million at Henderson would increase its capacity (post-1982) by 13 million pounds per year. Reopening Kitault mine would cost $100 million and would yield an additional 10 million pounds each year after 1982. AMAX financial officers estimated that the annualized cost of each $100 million invested was $17 million per year for each year of these projects 10 years lives (that is, each $100 million of investment in the 1980-1982 period would require a cash outlay of $17 million per year for each of the 10 years starting in 1982). The potential benefits over variable costs for each project at various molybdenum prices are presented in Exhibit 5.

IV. Tasks:

What would the price prediction if we focus to the market data?

At what prices would be profitable each of mine? Are likely to occur?

What is your forecast for the evolution of the market price for the next decade?

Should AMAX proceed with these investments? If so, in which mines?

Exhibit 1: AMAX Corporation Income Statement

($ Millions)

	1977	1978	1979
Revenues	1,320	1,727	2,865
Cost of Goods Sold	1.012	1,301	2.119
General research	88	105	06R
Research & Exploration	56	57	103
Operating Earnings	164	264	480
Net interest	98	61	41
Income Taxes	0	43	71
Net Income	60	160	365

Exhibit 2: Balance Sheet

($ Millions)

	1978	1979
Fixed assets	2380	2542
Inventories	384	394
Accounts Reveivable	247	354
Cash	121	149
Other assets	320	498
TOTAL ASSETS	3452	3937
Shareholders Equity	1874	2133
Reserves	51	95
Debt Outstanding	994	1002
Accrued Liabilities	305	463
Other liabilities	228	244
TOTAL LIABILITIES	3452	3937

Exhibit 3: Molybdenum Demand Price

Year	Worldwide Steel production (million Tons)	Estimated molybdenum consumption (million Lbs)	Molybdenum Price ($)	Molybdenum price * (1980 $)
1970	220	180	1.73	3.87
1975	202	183	3.13	4.47
1976	212	191	3.73	3.13
1977	211	190	4.08	5.43
1978	224	197	4.64	5.83
1979	234	204	6.05	6.84

* This is the price level adjusted for inflation to be compared to that of January 1980.

Exhibit 4: Molybdenum Production

(million Lbs)

Year	United States	Canada	Chile	USSR	Worldwide Total*
1970	112	34	13	1	181
1975	106	29	20	1	180
1976	113	32	21	1	195
1977	122	37	21	2	210
1978	132	31	22	4	220
1979	144	25	22	8	231

* Includes other countries

Exhibit 5: Annualized AMAX Investment Return* at different Levels of molybdenum price

($ millions)

Project	Cost			Molybdenum Price
		5	7	9	11	13
Climax	300	15	45	75	105	135
Henderson	200	7	33	59	85	111
Kitault	100	0 **	10	30	50	70

* not including cost of capital invested

** Mine would shut down