Is Oil Too Cheap for This Materials Company to Go it Alone?

By Markets

Freeport-McMoRan Inc spent heavily to get into the oil business in 2013. But falling oil prices have taken a toll on this new business. Now Freeport is looking for partners so it can keep the drill bits turning in a key oil region. Is this good or bad for shareholders?

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$20 billion
In 2013, Freeport purchased McMoRan Exploration Co. and Plains Exploration for $20 billion, including debt. With oil prices down roughly 50% since mid-2014, however, that price tag now looks a little rich. In fact, Freeport has already written off roughly $1.7 billion in goodwill related to the transaction and reduced the carrying value of its oil business by $3.7 billion -- both because of the steep drop in oil prices. And it's warned that more write offs are likely this year if oil prices don't rebound sharply.

(Source: Gengiskanhg, via Wikimedia Commons)

On the operational side of things, the company has openly stated that it's pulling back on the exploration front in oil because it wants to "preserve resource value for the future." The plan is to trim the E&P budget by over 33%. In other words, it wants to wait until oil prices are higher before it drills for more black gold. Not a bad idea, but at the same time Freeport is looking for partners in the Gulf of Mexico to keep some activity happening. Those two facts seem at odds with each other.

Giving it away
To be fair, partnering up in the oil business isn't new. Companies sell minority stakes and team up in development projects all the time to help offset costs. Freeport did exactly this at the Lucius project, where it holds a 25% stake in the project today. Partners on this oil play includeAnadarko Petroleum Corporation, Apache Corporation, and ExxonMobil, among others. Togetherthis partnership helped to fund roughly four years worth of costs before any oil was brought out of the ground.

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That time lag is exactly why companies look for partners. Any one of them might have struggled to come up with the cash, but together the bill isn't as onerous. And, assuming everything works as planned, all of the partners get to benefit.

The interesting thing is that Freeport owns 100% of the operating rights for itsHolstein Deep, Marlin, Dorado, King, and Horn Mountain Gulf of Mexico projects. These are all at various stages of development, but Freeport can maintain control of them and still gain valuable access to the money it needs to keep drilling by selling minority stakes. And based on the partners it has at Lucius, it's got a deep Rolodex to pick from.

There's notable value there, too, since Freeport's average cash cost to produce a barrel of oil in the Gulf of Mexico was roughly $16 last year. In other words, would-be partners can still potentially make money even at today's low oil prices, if costs at its in-development plays track to its existing production. In an industry that's seen major players struggle to replace reserves, linking up with Freeport would seem an awfully enticing option.

Freeport is still discussing its options with potential partners, but it can use the help.As noted, development costs can be a material drag on a company's finances and can last for years something that Freeport can ill afford since the swift drop in the price of oil just added to the price weakness the company has been suffering through in other core businesses in recent years, notably copper and gold.

(An offshore oil platform in the Gulf of Mexico. Source: U.S. Coast Guard photo by Petty Officer 3rd Class Barry Bena, via Wikimedia Commons)

Doing what it takes
So Freeport is really doing what it takes to keep advancing its best opportunities. And if that means giving away some upside to keep drilling then so be it. In fact, it would probably be worse for the company to simply stop drilling since big projects can take years to get up and running. Indeed, there's no way to predict where the oil markets will be in a few years, let alone six months, but you can guarantee that Freeport's production won't grow if it stops developing new projects.

With the company's finances crimped by low commodity prices in its mining business as well as oil, taking on partners is probably the best course of action. And it's been rough for Freeport of late. So far it's pulled back from previously stated debt reduction goals, trimmed spending drastically, and cut its dividend by over 80%. These are aggressive measures to keep the business going today so it can survive this commodity rough patch. In fact, taking on a partner to keep key oil projects moving doesn't seem as grave an issue when compared to that massive dividend cut.

At the end of the day, the drop in oil has Freeport McMoRan retrenching. Looking for partners in the Gulf of Mexico is part of this. However, it should be viewed as a long-term positive even though it means giving away some upside from the company's best projects. The other option, not drilling at all, would probably lead to worse outcomes for shareholders.

The article Is Oil Too Cheap for This Materials Company to Go it Alone? originally appeared on

Reuben Brewer has no position in any stocks mentioned. The Motley Fool owns shares of ExxonMobil and Freeport-McMoRan Copper & Gold, Inc.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.