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This Canadian copper giant is missing best of metal's surge

A port worker checks a shipment of copper in Valparaiso port, Chile.

Eliseo Fernandez/Reuters

As copper producers from Freeport-McMoRan Inc. to BHP Billiton Ltd. ponder what to do with the windfall from surging prices, First Quantum Minerals Ltd. has no such dilemma.

Unlike most of its peers, First Quantum's copper sales are fully hedged -- at an expected average price of $2.37 a pound for the second half of the year. That means it's largely watching from the sidelines as the metal surges above $2.90 for the first time in more than two years.

The Vancouver-based company began hedging in 2015 to lock in the value of its output so as to avoid breaching debt covenants while developing a project in Panama. But as copper has risen more than 30 percent in the past year, the trade has proven to be a liability: the company posted a net loss of $35 million in the second quarter as its hedge book lost $97 million.

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It plans to continue hedging next year, although to a lesser extent.

"FQM is not a strategic long-term hedger of the copper price as we believe really in the positive fundamentals of copper," President Clive Newall told analysts on a July 28 earnings call. "However, this program protects cash flows and covenants as we develop the Cobre Panama project."

For copper sales in the first half of 2018, First Quantum is only 30 percent hedged and plans to use mechanisms to secure a greater benefit if prices remain strong, Chief Financial Officer Hannes Otto Meyer said during the earnings call.

Currently the 2018 hedge book is structured so that the company will never get less than $2.59 a pound for its copper or more than $2.80. When copper trades between those two levels, it receives the market price.

First Quantum is the third-worst performer in the S&P/TSX Global Base Metals Index in the past six months, slumping 27 percent. The stock fell 4.6 percent on Wednesday when it announced plans to shutter a nickel mine in Australian because of persistently low prices.

The company declined to comment on hedging beyond what was disclosed in the earnings call and presentation.

"Most investors do not care for companies hedging," Richard Bourke, an analyst with Bloomberg Intelligence, said by phone from New York. "Most investors want full exposure to metals."

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Rivals BHP, Teck Resources Ltd. and Freeport don't hedge copper, Bourke said. He estimates First Quantum will lose $229 million on its hedge book in the second half of this year, assuming average copper prices remain close to July levels.

First Quantum's underperformance against its peers may make it a takeover target, according to Paul Gait, an analyst at Sanford C Bernstein.

"First Quantum is one of the few targets out there with the right commodities that isn't outrageously priced. The debt has been problematic for the company, but it wouldn't move the needle for the likes of Rio Tinto or Vale," he said by phone from London. "I was very surprised someone didn't make a move on it back in 2015."

It's not the first Canadian miner to be criticized for being stuck on the wrong side of this kind of trading strategy.

In the 1990s, Toronto-based Barrick Gold Corp. built up a large gold hedge as a way of locking in gains in a lackluster market. When prices began to rally in 2001, the world's largest gold producer found itself wrong-footed, running up hefty hedge book liabilities even as many of its competitors were able to benefit fully from the run-up in price. In 2009, Barrick used a massive equity issuance to retire its hedge book. The decision was largely responsible for the $5.7 billion impairment charge it took in the third quarter of 2009.

Similarly, producers including Chile's Codelco saw their hedge books turn south in the 2000s after prices soared on the back of a surge in Chinese demand.

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As with so much in business, hindsight is 20:20. In 2015, Goldman Sachs recommended producers increase their copper hedges, as it braced for prices to drop to about $2 a pound by the end of 2016. Copper finished the year at about $2.50 and has rallied a further 15 percent this year to hit its highest level in more than two years.

"With First Quantum, there's a case to be made that the hedges helped to secure the long-term future of the company, but in general, my advice would be: don't hedge," Gait said. "Don't listen to the guys who are trying to flog these hedging instruments at the bottom of the cycle, and focus instead on running a company with a conservative balance sheet and limited leverage."

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