A Look At Freeport’s Oil And Gas Division

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Freeport McMoRan Copper (NYSE:FCX) is one of the largest copper mining companies in the world. It has become a diversified natural resources company with the acquisition of oil and gas assets in 2013, in addition to the company’s gold and molybdenum mining operations. Though copper mining generates a majority of Freeport’s revenues, the oil and gas business is an extremely important division for the company.

In this article we will take a look at Freeport’s oil and gas division, and why it is so important for the company.

See our complete analysis for Freeport McMoran Copper here

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The Oil And Gas Division

Freeport acquired its oil and gas operations in Q2 2013 by acquiring Plains Exploration and Production (PXP) and McMoran Exploration (MMR). The oil and gas division is referred to as Freeport McMoran Oil And Gas (FM O&G). It had proved reserves of 464 million barrels of oil equivalent (MMBOE) at the end of 2013. All of the company’s proved oil and natural gas reserves are located in the U.S., with 80% comprising of oil (including natural gas liquids, or NGLs) and 66% represented by proved developed reserves. ((Freeport’s 2013 10-K, SEC))

At the end of 2013, the company’s oil and gas assets comprised of oil production facilities and growth potential in the Deepwater Gulf of Mexico (GOM), oil production from the onshore Eagle Ford shale play in Texas, onshore and offshore oil production facilities in California, onshore natural gas resources in the Haynesville shale play in Louisiana, natural gas production from the Madden area in central Wyoming, and assets in the emerging shallow-water, Inboard Lower Tertiary/Cretaceous natural gas trend on the Shelf of the GOM and onshore in South Louisiana. ((Freeport’s 2013 10-K, SEC))

The company sells oil and gas throughout the U.S. Oil produced is primarily sold under contracts with prices based upon regional benchmarks.  Prices generally reflect the global balance of supply and demand. Approximately 50% of the company’s gas sales are priced based on published index pricing, with the remainder priced daily on the spot market. Oil and gas sales stood at 38.1 MMBOE in 2013. ((Freeport’s 2013 10-K, SEC))

The oil and gas division accounted for about 11% of the company’s consolidated revenues in 2013. ((Freeport’s 2013 10-K, SEC)) However, this only takes the seven-month period since the acquisition of these oil and gas properties into account. Going forward, the oil and gas operations are likely to constitute a greater proportion of Freeport’s revenues.

Freeport recently announced the sale of its Eagle Ford Shale assets and the simultaneous purchase of interests in the Deepwater GOM. The Eagle Ford assets had estimated net proved reserves totaling 59 MMBOE and estimated net proved and probable reserves of 69 MMBOE at year-end 2013. ((Freeport-McMoRan Announces Agreement to Sell Eagle Ford Interests for $3.1 Billion, Freeport News Release)) The Deepwater GOM assets which are being acquired, including Apache’s working interests in the Lucius (11.7%) and Heidelberg (12.5%) oil production development projects, have estimated proved, probable and possible reserves of 55 MMBOE. [1] This move was primarily aimed at bringing down the company’s debt, in addition to acquiring promising oil and gas assets. [2]

Business Diversification

The rationale behind the purchase of the oil and gas assets in Q2 2013 was twofold – diversification and acquiring an exposure to energy markets, which have strong margins and positive fundamentals. [3]

Business diversification was an important consideration for Freeport, considering the bleak near term prospects of its copper mining operations. Sales of copper accounted for 69% of Freeport’s consolidated revenues in 2013. Copper prices have fallen over the past few years due to weak demand and an increase in supply by global mining companies, resulting in an oversupply situation. China, which accounts for 40% of the world’s consumption of copper, has seen falling demand for copper in the wake of an economic slowdown. ((China Premier Warns On Economic Slowdown As Data Fans Stimulus Talk, Reuters)) Fears over the unwinding of financing deals, which use copper as collateral, have further added to the uncertainty surrounding the demand for the metal. ((China Fears Trigger Dramatic Drop In Copper, Financial Times)) The expansion in copper production by major copper mining companies has created an oversupply situation, which is expected to persist in the near term and keep prices subdued. [4] Lower prices and increasing mining costs have negatively impacted margins in Freeport’s copper mining business. The company has gone ahead with plans to significantly boost copper production, in order to reap the benefits of economies of scale and lower unit costs. You can read more about this strategy in one of our recent articles. [5] In view of the bleak near term prospects of its copper mining business, diversification into the oil and gas business was a logical step for the company, especially considering its strong growth potential.

Strong Growth Prospects

Global energy demand is expected to grow by 36% between 2011 and 2030, or around 1.6% annually, driven by emerging economies.((BP Energy Outlook 2030, BP Website)) Gas consumption is expected to grow at 2% per annum between 2011 and 2030, with oil consumption expected to grow at 0.8% per annum during the same period. ((BP Energy Outlook 2030, BP Website)) Gas will steadily gain market share amongst fossil fuels over the same period. Energy demand growth will be matched by growth in supply. Shale gas supply is expected to treble between 2011-2030, and shale oil supply is expected to increase six-fold over the same period. ((BP Energy Outlook 2030, BP Website)) Most of the growth in shale gas and oil production is expected to come from North American producers. This is good news for the company’s various shale assets. Despite all the growth in shale oil and gas production, renewable energy and other sources, conventional fossil fuel supplies will still account for almost half the growth in energy supply between 2011 and 2030. ((BP Energy Outlook 2030, BP Website)) Thus, demand for the Freeport’s oil and gas production is expected to be robust over the long term and there is great potential for an increase in production.

The oil and gas business is a high-margin business for the company when compared to its copper mining business. For 2013, Freeport’s average realized copper prices and unit net cash costs stood at $3.30 and $1.49 respectively. [6] This translates into a margin of around 55%. In comparison, for the oil and gas division, realized revenues per barrel of oil equivalent (BOE) and cash production costs per BOE stood at $76.87 and $17.14 respectively. [6] This translates into a margin of around 77%. With a weak demand and pricing environment for copper expected to persist in the near term, and a  robust demand and pricing environment for oil and gas expected in the near and long term, the oil and gas division may play an important role in margin growth for the company as a whole.

The Road Ahead

In view of the foregoing discussion, the importance of the oil and gas division is evident for Freeport. Oil and gas sales are expected to rise to 81 MMBOE in 2016 from 38.1 MMBOE in 2013. The company has projected that around 42%, 48% and 61% of capital expenditure in 2014, 2015 and 2016 respectively, will be dedicated to the oil and gas division. ((Freeport’s Q4 2013 Earnings Presentation, Freeport Website)) This is disproportionately high, when considering that it accounted for only around 11% of the company’s revenues in 2013, though that figure reflects only seven months of operation of the oil and gas division. However, this reflects the importance that the company has assigned to the oil and gas division in driving its business prospects going forward.

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Notes:
  1. Freeport-McMoRan Announces Agreement to Acquire Deepwater GOM Interests for $1.4 Billion, Freeport News Release []
  2. Freeport Restructures Oil And Gas Portfolio Primarily To Reduce Debt, Trefis []
  3. Freeport’s Q2 2013 Earnings Call Transcript, Seeking Alpha []
  4. Copper Miners Forecast Years Of Surplus, The Financial Times []
  5. Freeport Bets Big On Copper Volumes, Trefis []
  6. Freeport’s Q4 2013 Earnings Presentation, Freeport Website [] []