PT.

International Nickel Indonesia

Mine Department (19) -  2800

MEMORANDUM
To: Date:
FILE FEB. 16, 2005
Copy:
H. ASMAR; D. KROLL; A. HENDARMAN; Y. SWAMIDHARMA
From: Our Ref. No.:
W. AHMAD 0199/LITERATURE/EX-MEMO/MGX-SPA
Subject:
DOCUMENTATION  CUT-OFF GRADE DETERMINATION

The following documentation has been prepared as a requirement for AMEC audit.
The documentation provides the general philosophy of cut-off grade determination
for the Sorowako Project and gives an example using 2005 Budget costs (used for
the 2004 MRMR estimation).

General Philosophy

Cut-off grades for the Sorowako Project are based on a break-even grade analysis.
Break-even grades are such that at these levels the mining and processing of ore
incurs neither a profit nor a loss when all applicable project costs are included (cash
as well as non-cash).

Cut-off grades based on break-even analysis are used for MRMR estimation that
cover a long period of time. Such cut-off grades that are based on break-even
analysis may differ from actual operating cut-off grades that are more sensitive to
current metal prices and short-term corporate objectives of profitability and rate of
return.

Cut-off grades based on break-even analysis offer several advantages:

 There is an underlying element of economic viability in the cut-offs

used
 There is an element of objectivity since all operators will derive the
same break-even grade based on a given set of parameters
 Several companies making an estimate for the same deposit will arrive
at the same break-even grade based on project economics rather than
determining a cut-off grade with their own rate of return in mind

Application of break-even grades as cut-off grades still leaves a natural margin of

profitability for the project since averages are always higher than the cut-offs used.

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The actual difference between cut-off grades and average orebody grades varies
from hill to hill and depends on the relationship of cut-off grade to grade population.

Break-even grade determination

The table below describes the process of determining break-even grades in detail.
An example is given using 2005 Budget costs (used for 2004 MRMR estimation).

Methodology Calculation example

Nickel price and cost data for the project:
A. Long term LME nickel price, in US$/lb 3.50
B. PT Inco realised price of nickel, in US$/lb 2.73 (78% of LME price)
C. Project cash costs, $M 331.0
D. Project Non-cash costs, $M 105.0
E. SG&A expenses, $M 2.3
F. ETAC (Expenses Treated as Cost), $M 6.0
G. Grand Total Budget Plan, $M 444.3
Any cost reductions for Break-even analysis
Any one-time costs or costs that are temporarily out of
line may be adjusted to reflect a long-term cost
scenario. For the 2004 MRMR, PT Inco used the
following cost reductions:
 Extra drilling (one-time cost), $M 1.0
 Oil price adjustment, for future low price, $M 23.0
 Maintenance and management costs, $M 7.3
 Bahodopi exploration/test mining, $M 5.3
H. Total reduction from Budget Plan 36.6
Cost adjustments due to ore types
PT Inco recognises three ore types: West Block, East
Block, and Petea. To tailor the break-even grade to
specific ore type, any variable costs that depend on ore
type need to be known and factored in the break-even
grade analysis. PT Inco recognises two cost areas
dependent on ore types: mining cost and drying cost.
Cost adjustments for the three ore types were made as
follows to the 2004 MRMR estimation:
W.B. E.B. Petea
Mining cost adjustment to overall Budget costs, $M: +2.6 +1.3 -7.1
Drying cost adjustment to overall Budget costs, $M: +2.3 -2.6 -2.6
J. Total adjustment to Budget Plan, $M +4.9 -1.3 -9.7
K. Final cost used for Break-even analysis (G+H+J) 412.7 406.4 398.0
Note: For the example of Break-even calculation below,
only West Block case is shown. Break-even grades for
East Block and Petea can be determined in a similar
manner using their individual costs.
L. Total cost that must be recovered to break even, $M 412.7 (using the WB case)
M. Pounds nickel required as product (L/B), M lbs 412.7 / 2.73 = 151.1722
N. Process plant recovery 0.90 (per 2005 Budget)
P. Pounds nickel required in DKP (M/N), M lbs 151.17 / 0.90 = 167.9691
Q. Total DKP planned for 2005, M dmt 4.752 (per 2005 Budget)

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R. Grade required in DKP (P/Q), %Ni 1.603%
(Note that prior to dividing P by Q, P must b converted
to equivalent tonnes since Q is given in tonnes)
Thus final break-even grade for West Block ore type is: 1.60% Ni

Some considerations for break-even analysis

The following need to be considered for break-even grade analysis:

 The break-even analysis is based on total project costs, both cash and non-
cash. Also included in the cash costs are royalty fees and land rental costs.

 Reduction of costs due to one-time application or other reasons must be

defendable.

 Refinement of operating costs based on ore type needs to be looked at

carefully. An exercise carried out for the 2004 MRMR estimation indicated
that mining costs among the three areas (WB, EB, Petea) were quite different
due to different strip ratios, ore recoveries, and haul distances. Similarly,
drying costs in the process plant differed significantly among the three ore
types due to specific moisture contents and DKP recovery factors.

 PT Inco generates break-even grades for its three major ore types: West
Block, East Block, and Petea. While Petea ore is similar to Sorowako East
Block in its chemistry, it entails extra hauling costs. Thus, further separation
into ore types can be implemented if certain hills do not match the average
ore type model (very thin or thick overburden; extra hauling distance;
unusually low or high ore recovery; unusual chemistry; etc.)

 It is inherently implied in the above analysis that there is no discrepancy

between MRMR grades and actual production grades. If such a discrepancy
exists and has been recognised, then the break-even grade needs to be
adjusted accordingly. For example, if a 5% grade discrepancy exists between
West Block MRMR estimates and actual New DKP, then the break-even
grade determined above will be increased by 5% (1.603 / 0.95 = 1.687% Ni).
However, if appropriate dilution allowance has already been factored into
MRMR reported grades  and diluted grades then match actual production
grades  then no adjustment is required to the break-even grade.

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Use of Break-even grades as Cut-off grades for MRMR estimation

The break-even analysis does not automatically yield applicable cut-off grades.
Before break-even grades can be used as cut-off grades, it must be determined that
they do not have an adverse impact on:

 Resulting ore chemistry and ore blending options

 Total resource tonnage (Life of Mine considerations)

It is recommended that after the break-even grades have been calculated,

preliminary resource estimation should be carried out to see if chemistry is
appropriate and that the mine has an adequate life.

 If there is no impact on either the ore chemistry or the life of mine, then
break-even grades can be used as cut-off grades for MRMR reporting

 If, however, ore chemistry is affected or mineral tonnage is not

sufficient for the life of mine plan, then break-even grades should be
adjusted (up or down), until the concerns are adequately addressed.
For the 2004 MRMR estimation, computed break-even grade of 1.6%
Ni for West Block resulted in less limonite (Fe) being taken in the ore
layer. Thus, the resulting chemistry did not allow the use of Petea ore
that was already low in iron. At the same time, 1.6% Ni cut-off reduced
tonnages by 20-25% (relative to 1.5% cut-off). Thus, a decision was
made to lower the cut-off grade for West Block to 1.5% Ni. This still
resulted in average West Block grade of 1.92% in the MRMR that still
leaves a good margin of profitability.

Every effort should be made to use break-even grade as the cut-off grade for MRMR
estimation. This brings consistency and objectivity to establishing cut-off grades for
all projects within PT Inco concession. If the calculated break-even grade appears to
have an adverse impact on ore chemistry and ore tonnage, then efforts should be
made to see if such adverse impact can somehow be mitigated through blending
ingenuity (adding limonite from overburden to increase iron content, adding crushed
rock to lower iron content, or hauling say West Block type ore from a longer distance
such as Matano). Only if the adverse impact of the computed break-even grade
cannot be mitigated should the cut-off be adjusted up or down, as appropriate.

PT Inco moved to the use of break-even grades as cut-offs for MRMR estimation
beginning with 2001 MRMR. For 2001 to 2003 MRMR estimates, break-even grades
were used as cut-offs at the Sorowako Project. For 2004 MRMR estimates, the
calculated break-even grades were a little high for all ore types and downward
adjustments were made in the interest of ore chemistry and life of mine
considerations.