## Management’s Discussion and Analysis 

These estimates involve assumptions regarding future copper and gold prices, the geology of our mines, the mining methods we use and the related costs we incur to develop and mine our reserves. Changes in these assump- tions could result in material adjustments to our reserve estimates, which could result in changes to unit-of-produc- tion depreciation and amortization expense in future periods, with corresponding adjustments to net income. If aggregate estimated copper reserves were 10 percent higher or lower at December 31, 2004, we estimate that our annual depreciation expense for 2005 would change by approximately $14 million, changing net income by approx- imately $7 million. Although some degree of variability is expected, we believe the extent of our technical data and operating experience – specifically as it relates to our Grasberg open-pit mine, which we have been mining for 15 years – mitigates the potential for significant changes in reserve estimates, especially as compared with mines that are undeveloped or newly developed. 

As discussed in Note 1 of “Notes to Consolidated Financial Statements,” we review and evaluate our long- lived assets for impairment when events or changes in circumstances indicate that the related carrying amounts may not be recoverable. Changes to our estimates of proven and probable recoverable copper and gold reserves could have an impact on our assessment of asset impair- ment. However, we believe it is unlikely that revisions to our estimates of proven and probable recoverable copper and gold reserves would give rise to an impairment of our assets because of the significant size of our reserves in relation to our asset carrying values. 

• Deferred Mining Costs –  Mining costs are charged to operations as incurred. However, because of the configu- ration and location of the Grasberg ore body and the location and extent of surrounding overburden, the ratio of overburden to ore is much higher in the initial mining of the pit than in later years. As a result, surface mining costs associated with overburden removal at PT Freeport Indonesia’s Grasberg open-pit mine that are estimated to relate to future production are initially deferred when the ratio of actual overburden removed to ore mined exceeds the estimated average ratio of overburden to ore over the life of the Grasberg open-pit mine. Those deferred costs are subsequently charged to operating costs when the ratio of actual overburden removed to ore mined falls below the estimated average ratio of overburden removed to ore mined over the life of the Grasberg open-pit mine. We use the proven and probable ore reserves for the Grasberg open pit disclosed in the notes to our consolidated financial 

statements to calculate the estimated average ratio of over- burden to ore over the life of the mine. 

The deferred mining cost method is used by some companies in the metals mining industry; however, industry practice varies. The Emerging Issues Task Force of the Financial Accounting Standards Board (FASB) currently is evaluating this issue. The deferred mining cost method matches the cost of production with the sale of the related metal from the open pit by assigning each metric ton of ore removed an equivalent amount of overburden tonnage, thereby averaging overburden removal costs over the life of the mine. The mining cost capitalized in inventory and the amounts charged to cost of goods sold do not represent the actual costs incurred to mine the ore in any given period. If we were to charge all mining costs to expense when incurred, including all overburden removal costs, as some mining companies do, there would be greater volatility in our period-to-period results of operations. 

The application of the deferred mining cost method has resulted in an asset on our balance sheets (“Deferred Mining Costs”), which based on current mine plans, is estimated to continue to increase through about 2010. Subsequently, these costs are expected to begin to amortize as a charge to production and delivery costs until they are fully amortized at the end of the open pit’s life, which is estimated to be in approximately 2015. This is because PT Freeport Indonesia expects to mine higher than average amounts of overburden through 2010 and less than average thereafter. Deferred mining costs totaled $220.4 million at December 31, 2004, and $142.6 million at December 31, 2003. Additions to deferred mining costs are classified as increases in deferred mining costs in operating activities in our consolidated statements of cash flows and totaled $77.8 million in 2004, $64.4 million in 2003 and $30.6 million in 2002. We evaluate the recoverability of our deferred mining costs in conjunction with our evaluation of the recover- ability of our mining assets. The Grasberg mine is currently our only producing open-pit mine. 

The estimated average ratio of overburden to ore over the life of the Grasberg open pit used in our deferred mining costs calculation is a critical accounting estimate because (1) it is susceptible to change from period to period because it requires management to make assump- tions about future mining activities and (2) changes could materially affect net income. Our mine plan is derived from a model that takes into consideration available geological data and determines the most efficient and cost-effective method of accessing the economic reserves. Significant assumptions underlying our mine plan include the amount of total overburden and ore we expect to move in a given 

