Freeport-McMoRan Continues Battle On Two Fronts With Latest Revisions To Operating Plans

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Freeport-McMoRan Inc. (NYSE:FCX) recently announced revised operating plans and spending cuts pertaining to its copper mining business. [1] The revised operating plans envision lower production levels and capital spending in the company’s copper mining business, a move which more closely aligns the company’s operations with the realities of the prevailing pricing environment for the metal. The move to reduce spending pertaining to the copper mining business closely follows another recent round of spending cuts pertaining to the company’s oil and gas business. [2] Thus, Freeport is fighting a battle on two fronts, as it strives to operate competitively in challenging market conditions impacting both copper and crude oil — the two major commodities sold by the company.

A Battle on Two Fronts

Weakening Chinese economic growth is the major reason for the woes facing Freeport-McMoRan. Most of the recent downturn in copper prices is lower due to the slowing of economic growth in China, which accounts for over 40% of the global demand for copper and is the world’s largest consumer of the metal. [3] Whereas the weakness in oil prices is mostly down to a global supply glut, concerns over weakening demand from China, the world’s largest importer of crude oil, are exacerbating the situation.

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Copper is a metal which has extensive industrial applications, particularly in the manufacturing, power, and infrastructure sectors.  Chinese demand for copper has weakened due to weak prospects of the Chinese manufacturing sector, as illustrated by the Manufacturing Purchasing Managers Index (PMI) data. The Manufacturing PMI captures business conditions in the manufacturing sector of the concerned economy. A value above 50 indicates growth in the manufacturing sector, compared to the previous month, whereas a value below 50 indicates a contraction. The following chart illustrates the weakening state of the Chinese manufacturing sector.

China Manufacturing PMI, Source: Trading Economics

The weakness in the Chinese manufacturing sector has translated into weakness in demand for copper. Chinese copper imports stood at 2.94 million tons in the first eight months of 2015, which represents an 8.1% year-over-year decline. [4] Demand-side weakness has resulted in tumbling copper prices, which was reflected in Freeport’s Q2 results. Freeport’s average realized copper price for Q2 2015 stood at $2.71 per pound, around 14% lower year-over-year. [5] The following chart illustrates the trajectory of copper prices over the last twelve months. 

Copper Prices, Source:LME

Compounding the effect of weak copper prices on Freeport, is the prevailing weakness in crude oil prices. Oil prices have tumbled over the last twelve months in the midst of oversupplied global markets. Over the course of the last few years, rising oil and gas output from the U.S., where hydraulic fracturing techniques have helped boost output, has boosted global oil and gas output. Though production levels in the U.S. have declined lately in response to falling prices, they still remain at fairly high levels. Moreover, major oil producers of the Organization of the Petroleum Exporting Countries (OPEC) have not lowered output in response to falling prices, in order to preserve their market shares. With the signing of the Iranian nuclear deal, oil and gas production from the region is expected to rise. In the backdrop of a global supply glut, concerns over weakening demand from China, due to sluggish economic growth, have negatively impacted oil prices. The average realized revenues of Freeport’s oil and gas division declined around 36% year-over-year to $50.04 per barrel of oil equivalent in Q2 2015. [6]

Freeport’s Response

In the latest move to counter the twin threat of low copper and oil prices, Freeport lowered its copper production guidance for 2016 by 150 million pounds to 5.25 billion pounds. [1] The company has also slashed mining capital expenditure in 2016 by $700 million to $2 billion. [1] This announcement follows closely on the heels of a $0.9 billion reduction in oil and gas capital spending in both 2016 and 2017 to $2 billion. [2]

With adverse business conditions impacting both the major commodities produced by Freeport, the company has little choice but to cut capital spending and reduce production levels. Whereas recent steps taken by the management will certainly better position the company to deal with current market conditions, a significant improvement in the company’s business prospects will only come about with a recovery in copper and oil prices. However, given the current market conditions for these commodities, that looks unlikely in the near term.

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Notes:
  1. Freeport-McMoRan Announces Further Spending Cuts in Response to Market Conditions, Freeport-McMoRan News Release [] [] []
  2. Freeport-McMoRan Announces Significant Reduction in Oil & Gas Capital Budget & Continuing Review of Mining Operations, Freeport-McMoRan Website [] []
  3. Copper hits 6-year low as China equities drop, Financial Times []
  4. China monthly copper imports flat in August, Reuters []
  5. Freeport-McMoRan Inc. Q2 2015 Earnings Release, SEC []
  6. Freeport-McMoRan Inc. Q2 2015 Earnings Release, SEC []