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Why This Oil Shift Is Likely to Be a Profitable One

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Resource diversification has allowed BHP Billiton  (NYSE: BHP  ) to remain profitable despite generally weak mining markets. Looking to further diversify, BHP recently pushed deeper into oil and natural gas because of relatively high oil prices.

Freeport-McMoRan Copper & Gold (NYSE: FCX  ) followed suit this year. The problem is that drilling for oil is outside of their comfort zones. That's why Canada's Teck Resources (NYSE: TCK  ) moving into the oil sands makes more sense.

Similar but different
Drilling and mining are similar businesses but are different enough that a company can't easily transfer base knowledge between operations. And machinery and equipment can't really be shared, either. So, in some important ways, they are wildly different businesses.

That's one of the reasons why Freeport bought Plains Exploration & Production and McMoRan Exploration, for a total cost of around $19 billion, earlier this year. By purchasing a driller, it didn't need to learn new skills. Oil and gas now comprises about a quarter of Freeport's business.

And although the move is still relatively recent, in the third quarter the company noted that an "impressive and significant contribution from" oil and gas was a big support to the top and bottom lines. Clearly, management is happy with the move, particularly since copper and gold prices fell 9% and 16%, respectively, through the first three quarters, year over year, while oil prices remain strong.

BHP Billiton made a similar push in 2011 when it bought Petrohawk Energy for around $15 billion. In fiscal 2013, which ended in June, BHP saw similar weakness to Freeport in its mined materials, including iron ore, copper, and coal, that led to a bottom-line decline of about 30%. However, oil prices only dipped 4% and natural gas prices were up 17%. All in, BHP's likely been just as happy as Freeport to own a drilling business.

Change can be risky
That said, drilling for oil isn't the same as mining for copper and iron ore. BP is the poster child for drilling disasters, but ExxonMobil and Shell aren't strangers to such issues. That's why the oil move Teck Resources is making is so logical. Teck isn't trying to learn new skills or taking on new risks like BHP and Freeport did; it's just going to mine the stuff in the Canadian oil sands.

Teck, which mines for coal and other resources, has partnered with Suncor and Total on the Fort Hills Oil Sands project. Both are experienced oil companies, with Suncor holding a key position in the oil sands. Each brings something important to the table.

And Teck believes Fort Hills has an expected life of greater than 50 years versus most oil operations, which face "very steep depletion curve[s]." But, the best part is that it "will be large truck and shovel operations and... [will] allow us to leverage what is our core competency in this business and that is large scale bulk mining." In other words, Teck just has to be Teck to make this work.

The miner expects that it will eventually get about 13 million barrels of oil a year for its 20% stake in the operation after it starts up in late 2017. That gives Teck plenty of time to get ready for selling oil, which is the only "new" task it really needs to learn.

A different approach
So while BHP and Freeport have benefited from taking on the risks of oil drilling, Teck has gone down a different path. Although that doesn't guarantee success, mining for oil reduces the business risk that Teck must face as it, too, incorporates a new resource into its portfolio. That could make the miner an interesting contrarian play for those seeking a diversified miner -- and nothing else.

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Related Tickers

9/26/2016 4:02 PM
BHP $32.63 Up +0.09 +0.28%
BHP Billiton CAPS Rating: ***
FCX $10.51 Down -0.12 -1.13%
Freeport-McMoRan C… CAPS Rating: ****
TCK $18.49 Up +0.31 +1.71%
Teck Resources CAPS Rating: ***