Case 035Macro and commodity sensitivityHard

Tamravat Copper mines 200,000 tonnes a year at a cash cost of USD 6,500 a tonne. The copper price falls from USD 9,000 to USD 8,000. What happens to EBITDA, and how does a 30% hedge at USD 8,800 change it?

The situation

Tamravat Copper runs an open-pit copper mine and concentrator and sells 200,000 tonnes of copper a year. Its all-in cash cost, mining, processing, freight and overheads, is USD 6,500 a tonne and barely moves with the copper price. The copper price has fallen from USD 9,000 to USD 8,000 a tonne.

At the start of the year Tamravat sold forward 30% of its output, 60,000 tonnes, at USD 8,800 a tonne. The rest is sold at the market price.

Your task

What happens to EBITDA with and without the hedge, why does profit move so much more than the price, and what would you check next?

Quick check

Without the hedge, how far does EBITDA fall when copper drops 11%, from 9,000 to 8,000?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Unhedged, EBITDA falls from USD 500 million to USD 300 million, a 40% drop on an 11% price fall, because the margin is a thin slice on top of a cost that does not move. Every USD 100 a tonne is worth USD 20 million. With 60,000 tonnes sold at 8,800, EBITDA is USD 348 million, down 28.7% from 488 million: the hedge cuts the sensitivity by 30% but does not change the direction.

Step 1Why does profit fall four times faster than the price?

A vegetable seller buys onions at Rs 65 a kilo and sells at Rs 90. If the market price drops to Rs 80, her buying price does not change, so her margin falls from Rs 25 to Rs 15: an 11% price fall has taken 40% of her profit. A commodity producer's profit is a thin slice sitting on top of a large cost that does not move with the price, so every change in price lands entirely on the slice. The ratio of price to margin, 9,000 over 2,500, is 3.6: each 1% move in copper moves Tamravat's EBITDA about 3.6%. This is operating leverageThe way a business with mostly fixed costs turns a small change in revenue into a larger percentage change in profit. in its purest form.

The price falls 11%, the margin falls 40%: cost does not moveCost 6,5002,500Price USD 9,000Cost 6,5001,500Price USD 8,000-11% price-40% marginEBITDA, USD millionUnhedged500 at 9,000300 at 8,000change -40.0%30% hedged at 8,800488 at 9,000348 at 8,000change -28.7%
At USD 9,000 Tamravat keeps USD 2,500 a tonne above its USD 6,500 cost and at USD 8,000 only USD 1,500, so an 11% price fall cuts margin and EBITDA 40%, from USD 500 million to 300 million; with 30% hedged the fall is 28.7%.
The relationship
EBITDA=Q×(P−C)=200,000×(8,000−6,500)=USD 300mΔEBITDAΔP=Q=USD 20m per USD 100\text{EBITDA} = Q \times (P - C) = 200{,}000 \times (8{,}000 - 6{,}500) = \text{USD }300\text{m} \qquad \frac{\Delta \text{EBITDA}}{\Delta P} = Q = \text{USD }20\text{m per USD }100
Qtonnes sold a year, 200,000
Pcopper price, USD a tonne
Ccash cost, USD 6,500 a tonne
What it says in wordsEBITDA is volume times the margin per tonne, so every USD 100 on the price moves EBITDA by volume times 100.
Step 2What does the hedge change?

On 60,000 tonnes Tamravat receives USD 8,800 whatever the market does, a margin of 2,300. The other 140,000 tonnes earn 1,500. With the hedge EBITDA is USD 348 million at 8,000 against 300 million without it; at 9,000 the hedge would have cost USD 12 million, giving 488 million instead of 500. The hedge does not make copper less important to Tamravat. It removes 30% of the exposure for one year, so EBITDA now moves USD 14 million per USD 100 instead of 20.

The hedge flattens the line: EBITDA against the copper price, USD million100300500700hedge price 8,800hedged 348unhedged 300Unhedged: +20 per +100Hedged: +14 per +1007,0008,0009,00010,000Copper price, USD a tonne
Unhedged, Tamravat's EBITDA moves USD 20 million for every USD 100 on copper; with 30% sold at USD 8,800 it moves USD 14 million, so at USD 8,000 hedged EBITDA is USD 348 million against 300 million.
Copper, USD a tonneUnhedged EBITDA, USD mHedged EBITDA, USD mHedge adds, USD m
7,500200278+78
8,000300348+48
8,800460460+0
9,000500488-12
9,500600558-42
The hedge adds EBITDA when copper is below USD 8,800 and gives some up above it; it narrows the range of outcomes for one year without changing Tamravat's long-run exposure to the copper price.
Step 3What would you check before trusting the numbers?

Three things can make the real sensitivity smaller or larger. Royalties are often charged as a share of the metal price, so part of cost does fall with copper. By-products such as gold or molybdenum earn credits that move with their own prices. And if costs are in rupees while copper is priced in dollars, a weaker rupee in a falling market cushions the margin. For valuation, the hedge matters for one year; the long-run copper price you assume decides the value.

Where candidates lose it

The usual loss is scaling EBITDA with the price: an 11% fall becomes an 11% cut. That ignores the fixed cost underneath and understates the hit almost fourfold.

The second is treating the hedge as making the company safer for good. It protects 30% of one year's output; the following year Tamravat is fully exposed again unless it hedges at whatever the forward price then is.

What the interviewer asks next

  • At what copper price does Tamravat's unhedged EBITDA reach zero, and what does the mine do then?
  • Would you rather value Tamravat on spot copper or a long-run price deck, and why?
  • How would you show the hedge in a sum of the parts?

Company names and figures are illustrative.