Freeport-McMoRan Copper & Gold (NYSE:FCX) recently completed the sale of its Eagle Ford shale assets for a total of $3.1 billion to a subsidiary of Encana (NYSE:ECA). What were the main reasons behind selling this asset? And were these the right assets to sell?
Eagle Ford -- growing fast
The Eagle Ford shale, which produces oil, natural gas, and NGLs, is rapidly growing with oil and gas producers such as Chesapeake Energy (NYSE:CHK) and Devon Energy (NYSE:DVN), expanding their production in this shale. This region produces roughly 1.4 million bbl per day, and by 2020, analysts project the Eagle Ford's output will reach 2 million bbl per day -- an over 40% increase within six years.
Freeport-McMoRan's recently sold stake in the Eagle Ford included net proven reserves of 59 million barrels of oil equivalent and probable reserves of 10 million barrels of oil equivalent as of the end of 2013. This region accounted for 13% of the company's oil output last year.
The price tag the company received for this project seems reasonable: With the current price of oil at $100 per barrel, the expected revenue from this asset will be between $5.9 billion and $6.9 billion (not discounted) in the coming years. This asset, however, will require investments, and the production costs will also cut this stream down closer to the price Freeport-McMoRan received for it.
As a back-of-the-envelope calculation, under certain assumptions (a 70% profit margin, a discount rate of 10%, and extracting within five years only proven reserves), the present value of this asset comes to $3.1 billion before the additional investments needed or the probable reserves -- in line with the price Encana paid for this asset.
Keep in mind, the current high prices of oil, natural gas, and NGL (compared to last year) may have increased the price tag Freeport-McMoRan received for selling the Eagle Ford assets. Moreover, the high production pace in this region may have also played a role in driving the price of these assets higher.
Moreover, the operational uncertainty in this region is low, and the operating margin of the company's oil and gas operations is very high -- at 76%. So, the company may have benefited from keeping these assets.
But even if Freeport-McMoRan received a good price, was it the right move for the company to sell?
Debt and capex
One of the problems the company has been facing in recent years is its high level of debt. Freeport-McMoRan's debt-to-equity ratio is close to 1. This is considered high even in Freeport-McMoRan's sector. Because of this high debt level, management plans to cut it from $20.8 billion to $12 billion by 2016. One of the ways the company plans to reach this goal is by selling assets such as the Eagle Ford assets.
Besides reducing the level of debt, part of the payment from this sale is likely to go toward capex, which is budgeted at $7.3 billion in 2014.
Even though this sale was needed, the company should have considered other assets such as its copper mines in Indonesia, which are causing problems; Indonesia's high imposed exports taxes have reduced the company's profit margin from its operations in this country. The political climate and the added taxes may eventually lead the company to sell some of its mines in Indonesia in order to reduce its operational risk.
Foolish bottom line
The company's decision to sell assets was the right play, but it might not have sold the right assets. Some of Freeport-McMoRan's other assets could have been a better fit and also could have reduced its operational risk. Nonetheless, the current high energy prices and rising production in this region have enabled the company to sell at a good price. Finally, this sale will reduce the company's debt and allow Freeport-McMoRan to allocate some of these funds toward its existing projects.
Lior Cohen has no position in any stocks mentioned. The Motley Fool owns shares of Devon Energy and Freeport-McMoRan Copper & Gold. 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.