## Management’s Discussion and Analysis 

year, the ultimate configuration of the pit and the level of ore contributed by our underground mines. All other variables being equal, increases in the life of mine over- burden removed to ore mined ratio would result in more of the overburden removal costs being matched with current period production and therefore charged to expense rather than deferred. Decreases in the life of mine overburden removed to ore mined ratio would result in more of the overburden removal costs being deferred and matched with production in future periods. 

In the fourth quarter of 2004, PT Freeport Indonesia changed its life-of-mine overburden-to-ore ratio to 2.4 to 1 based on a recently completed annual assessment. PT Freeport Indonesia’s estimated life-of-mine overburden- to-ore ratio averaged 2.3 to 1 in 2004, 2.0 to 1 in 2003 and 1.8 to 1 in 2002. PT Freeport Indonesia’s geologists and engineers reassess the overburden-to-ore ratio and the remaining life of the Grasberg open-pit mine at least annually, and we reflect any changes in our estimates prospectively beginning in the quarter of change. We expect the estimated life-of-mine overburden-to-ore ratio to average 2.4 to 1 for 2005. The increases in the ratio over the last several years primarily relate to changes in the cutoff grade at the open pit caused by a reassessment of the optimal milling rate at our mill facilities including a greater proportional contribution to our total ore processed from our underground Deep Ore Zone mine. 

If the life-of-mine overburden-to-ore ratio was 2.4 to 1, as in the fourth quarter of 2004, instead of the 2.2 to 1 ratio used through September 30, 2004, we estimate our deferral of mining costs for 2004 would have been $11.0 million lower and net income would have been $5.6 million ($0.03 per share) lower. 

• Reclamation and Closure Costs – Our mining opera- tions involve activities that have a significant effect on the surrounding area. Our reclamation and closure costs primarily involve treatment of acidic water (also known as acid rock drainage) created by overburden, reclama- tion and revegetation of a large area in the lowlands of Papua where mill tailings are deposited, reclamation of overburden stockpiles and decommissioning of operating assets. Through December 31, 2002, we had accrued $29.2 million for estimated closure and reclamation costs on a unit-of-production basis over our total estimated proven and probable recoverable copper reserves. For a discus- sion of the assumptions that we make to estimate proven and probable recoverable reserves, see “Depreciation and Amortization” above. 

Effective January 1, 2003, we adopted Statement of Financial Accounting Standards (SFAS) No. 143, 

“Accounting for Asset Retirement Obligations” (see Note 1 of “Notes to Consolidated Financial Statements”). SFAS No. 143 requires that we record the fair value of our estimated asset retirement obligations in the period incurred, with the cumulative effect of adopting SFAS No. 143 as of January 1, 2003, for all existing asset retirement obligations, asset retirement costs and related accumulated depreciation required to be reflected in earnings as a separate line item. The accounting estimates related to reclamation and closure costs are critical accounting estimates because (1) we will not incur most of these costs for a number of years, requiring us to make estimates over a long period; (2) reclamation and closure laws and regulations could change in the future or circumstances affecting our operations could change, either of which could result in significant changes to our current plans; (3) calculating the fair value of our asset retirement obligations in accordance with SFAS No. 143 requires management to assign probabilities to projected cash flows, to make long-term assumptions about inflation rates, to determine our credit-adjusted, risk- free interest rates and to determine market risk premiums that are appropriate for our operations; and (4) given the magnitude of our estimated reclamation and closure costs, changes in any or all of these estimates could have a material impact on net income. 

In 2002, we engaged an independent environmental consulting and auditing firm to assist in estimating PT Freeport Indonesia’s aggregate asset retirement obliga- tions, and worked with other consultants in estimating Atlantic Copper’s asset retirement obligations. We estimated these obligations using an expected cash flow approach, in which multiple cash flow scenarios were used to reflect a range of possible outcomes. We estimated these aggregate obligations to be approximately $120 million for PT Freeport Indonesia and $17 million for Atlantic Copper. To calculate the fair value of these obliga- tions, we applied an estimated long-term inflation rate of 2.5 percent, except for Indonesian rupiah-denominated labor costs with respect to PT Freeport Indonesia’s obliga- tions, for which an estimated inflation rate of 9.0 percent was applied. The projected cash flows were discounted at our estimated credit-adjusted, risk-free interest rates which ranged from 9.4 percent to 12.6 percent for the corresponding time periods over which these costs would be incurred. The inflation rates and discount rates we used to calculate the fair value of PT Freeport Indonesia’s asset retirement obligation are critical factors in the calcula- tion of future value and discounted present value costs. An increase of one percent in the inflation rates used results in an approximate 17 percent increase in the discounted 

