Here’s Why We’re Revising Down Our Price Estimate For Freeport-McMoRan to $8

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Brent crude oil prices have fallen close to their 2015 lows and are currently trading at around $43 per barrel. [1] The latest meeting of the Organization of the Petroleum Exporting Countries (OPEC) concluded last week without any agreements on production cuts. OPEC’s persistence in maintaining high levels of crude oil output despite weak demand, has dashed hopes of a rapid recovery in oil prices. This has prompted us to revise downward our pricing forecasts for Freeport-McMoRan’s Oil and Gas division, and consequently, our price estimate for the company’s stock.

Supply Glut

The following chart illustrates the decline in oil prices over the course of the past few months.

Brent Crude Oil Spot Prices, Source: Y Charts

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A sharp increase in crude oil output from the U.S., enabled by hydraulic fracturing techniques, boosted global oil supply over the course of the last few years. Though U.S. oil production has declined over the course of the last twelve months in response to falling prices, it still remains at fairly high levels. A number of small, indebted U.S. producers have continued to pump oil in order to generate cash flows for servicing debt, while several other producers with hedged positions have also maintained production levels, resulting in a lesser than expected decline in U.S. output in response to the fall in prices. [2] Moreover, OPEC has not lowered its output in response to falling prices, in order to preserve the market shares of its member countries. In addition, with the signing of the Iranian nuclear deal, oil and gas production from the region is expected to rise, once Western sanctions on the country are lifted.

On the demand side, China, the world’s largest importer of crude oil, is witnessing slowing economic growth, with economic conditions in Europe subdued as well. With OPEC continuing to keep oil prices under pressure with near-record production levels, we are likely to see greater declines in U.S. crude oil output next year. However, with the recovery in demand for crude oil remaining sluggish, oil prices are likely to recover at a more gradual pace than currently factored into our model. In order to align our estimates with the current market realities, we have revised downward our forecasts of realized prices for Freeport’s Oil and Gas division. As a result, our new price estimate for the company stands at $8.10, lower than our previous estimate of $11,  and  close to the current market price of around $7.50.

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Notes:
  1. Oil falls towards 2015 low on OPEC inaction, strong dollar, Reuters []
  2. As Oil Keeps Falling, Nobody Is Blinking, Wall Street Journal []