Freeport-McMoRan’s Oil and Gas Transformation Isn’t Over Just Yet

Freeport-McMoRan (NYSE: FCX  ) spent much of last quarter repositioning the oil and gas business it bought last year. Not only did the company cash in its chips in the Eagle Ford Shale, but it took that money and increased its bet on the Gulf of Mexico. It did that by purchasing Apache's (NYSE: APA  ) interests in two projects headed by Anadarko Petroleum (NYSE: APC  ) as well as some exploration prospects. Despite all of the portfolio maneuvering last quarter, Freeport-McMoRan isn't done transforming its oil and gas business.

More sales to come
On the company's conference call with analysts, Jim Flores, the CEO of the company's energy unit, said that the company projects it will sell another $4 billion-$5 billion in onshore assets. Like the $3.1 billion sale of its Eagle Ford shale assets, future sales will be used to buy additional interests in deepwater properties in the Gulf of Mexico as well as pay down debt.

In looking over Freeport-McMoRan's portfolio, the company has two obvious candidates to sell. Take a look at the map below and note the two assets that really stick out.

Source: Freeport-McMoRan Investor Presentation

The company's natural gas rich positions in the Haynesville Shale as well as Madden are noted in red. In all likelihood these positions will be the first ones to exit the company's portfolio. One reason for this is because the two positions combined to contribute just 2% of the company's second quarter margin in its oil and gas business. Comparatively, the Eagle Ford assets that it sold in the quarter contributed 27% of its second quarter oil and gas margin.

That being said, given the size of the asset sales the company is targeting, these won't be the company's only sales. In order to generate that much cash it's pretty clear that the company will also exit its position in California. Flores noted on the conference call that its onshore oil assets could fetch a premium as MLPs in particular want these high-margin, low-decline assets in their portfolio. He believes the company can use the cash from a sale to pay down debt and also quickly replicate the production by increasing its investments in the Gulf of Mexico. 

The switch is not without risk
While Flores is pretty confident in the company's ability to replace its onshore production with growth from the Gulf, it's not without risk. In fact, buried within the company's second quarter press release was a note that the company's Tara exploratory prospect, located in Keathley Canyon in 8,700 feet of water and drilled to approximately 20,800 feet, was evaluated and found not to contain commercial quantities of hydrocarbons.

As the slide below notes, Tara is in close proximity to the Lucius development that's being led by Anadarko.

Source: Freeport-McMoRan Inc Investor Presentation 

Freeport-McMoRan thought that Tara would be an analog to Lucius. Unfortunately that isn't the case and it reminds investors of the risks of developing deepwater prospects in the Gulf.

Freeport-McMoRan has mixed its investments in the Gulf between sure bets like picking up Apache's interests in Anadarko's development projects, Lucius and Heidelberg, along with riskier exploration prospects. The Apache deal, for example, included 11 exploration leases that could turn out to be filled with projects as large as Lucius, or these could all end up as duds like Tara. In addition to these leases the company also picked up 20 tracts of land in the Gulf for $330 million from the U.S. Bureau of Ocean Management. Again, these blocks could contain high-impact oil discoveries or the company could end up with nothing but a dry holes. More than likely it will be a mix between the two, with enough wins to make the bet pay off.  

Investor takeaway
Freeport-McMoRan is making a strategic shift to focus its energy business offshore. If all goes according to plan it can cash in on its onshore assets to pay down its debt while bolstering its opportunity set in the Gulf. Further, the company believes it can completely replace the production it's planning to sell in just a couple of years as long as it doesn't encounter too many more dry holes. If all goes somewhat according to plan then Freeport-McMoRan's investors should be well rewarded as the shift should reduce the company's debt burden while increasing its production and cash flow. 

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