This Global Mining Giant Is Spending $9 Billion to Get Into the Energy Business

A deep-pocketed mining conglomerate has just anted up $9 billion to make a high-stakes wager on energy. 

Freeport McMoRan (NYSE: FCX) is best known for its massive metals hoard, most notably the Grasberg complex in Indonesia, which is the largest gold mine and third biggest copper mine on the planet. With operations on four continents, the company holds 102 billion pounds of copper reserves, 40 million ounces of gold, 266 million ounces of silver, 2.5 billion pounds of molybdenum, and 700 million pounds of cobalt.#-ad_banner-#

Starting soon, this world-class asset portfolio will be joined by millions of barrels of crude oil and trillions of cubic feet of gas. 

On Dec. 5, Freeport McMoRan extended a bold $9 billion buyout offer ($20 billion including the assumption of debt) for two mid-tier exploration and production (E&P) firms. 

The first target is McMoRan Exploration (NYSE: MMR), which, as you might guess, once belonged to Freeport McMoRan. MMR gained its independence via spin-off in the mid-1990s. After amassing 255 billion cubic feet of proved oil and gas reserves, MMR is now reuniting with its former parent. 

The second prize in this mega-deal involves Plains Exploration (NYSE: PXP), which incidentally owns a sizeable stake in MMR. Plains itself is still digesting a $6 billion acquisition of offshore properties belonging to BP (NYSE: BP) and Shell (NYSE: RDS) that are currently generating 67,000 barrels of oil per day

After the deal closes in the second quarter of 2013, the Freeport McMoRan natural resource empire will dramatically expand its reach.

Opportunity in the Gulf
The common thread that binds these dual transactions is offshore production in the Gulf of Mexico. Freeport is paying $2.1 billion for McMoRan Exploration (net of what it already owns) to gain control of what could potentially be one of the largest discoveries on the Gulf of Mexico shelf in decades.

Prior to the buyout, MMR was a portfolio holding in my Exploration & Paydirt newsletter. So I’m well acquainted with the firm’s shallow-water, ultra-deep drilling targets, which are brimming with eight trillion cubic feet of natural gas resources, perhaps more. 

A precise reserve figure can’t be nailed down just yet because the company has been stymied by a series of flow test delays. McMoRan is anxiously waiting to test its highly promising Davy Jones well, but progress has been hampered by drilling mud blockage and other setbacks. Of course, that happens when you’re working 30,000 feet below the surface under pressures that exceed 25,000 pounds per square inch.

Now, it’s up to Freeport to finish the job and get Davy Jones and other nearby wells flowing. 

McMoRan Exploration is situated in the middle of a 200-mile band of offshore drilling targets. And to bolster its position, the company recently outbid its neighbors for 14 new lease blocks that will add 65,000 acres in the heart of its territory.

Given the potential for blowout production, I can see why Freeport McMoRan was anxious to bring these assets back under its roof. In fact, the company was so optimistic that it offered a buyout premium of nearly 80%. 

And this was the smaller of the two purchases.

Freeport is also writing a $6.9 billion check for Plains Exploration, which is already reporting record oil sales. Most of the credit goes to the Eagle Ford Shale in Texas, where the firm’s output has surged six-fold over the past year, to 30,400 barrels per day from 5,200 barrels per day. 

But that’s nothing compared to what lies ahead.

On Nov. 30, 2012, Plains finalized a deal with BP (NYSE: BP) and Shell (NYSE: RDS-A) to acquire $6 billion of deep-water assets in the Gulf of Mexico. The purchase included wells that are currently spitting out 67,000 barrels of oil per day — along with enough exploration and development acreage to last into the next decade.

How I Plan to Profit
Had Freeport McMoRan not beaten me to the punch, Plains Exploration would likely have been one of my next portfolio candidates. Fortunately, Freeport is in my Scarcity & Real Wealth portfolio, which by extension means I’ll soon own Plains as well. 

Some investors wanted Freeport to remain a metals pure-play and would rather get their energy exposure elsewhere. But pairing the two diversifies the firm’s asset base with resources that are vital to global economic stability and growth.

And the bigger question is whether this is an efficient use of shareholder capital. I would say unreservedly yes. Following the acquisition, Freeport will generate about $9 billion in annual cash flow, assuming conservative commodities prices. Based on a pro-forma market cap of $44 billion, the firm’s operations will be throwing off a cash flow yield of 20% ($9b/$44b).

And that’s just based on today’s production, without any regard to future success on the exploration front.

Better still, Freeport didn’t have to break the bank to make this deal happen. With interest rates near record lows, the company was able to take advantage of cheap financing to acquire long-lived assets that will grow increasingly valuable in the years to come. 

Action to Take –> With more financial resources, Freeport will be able to milk the vast tracts of prospective oil-bearing land held by Plains and bring McMoRan’s ultra-deep plays to the finish line.

The timing of this deal was opportunistic, considering both companies’ market values had been beaten down because of unforeseen mishaps that had nothing to do with the value of their oil and gas in place.

The influx of cash will allow Freeport to deleverage, raise dividends, and plow money into new mines and expansion projects.

In a world where currencies are depreciating and paper assets could blow away, I find Freeport’s world-class mines and energy reserves highly reassuring. 

P.S. — The abundance of natural gas in the U.S. could lead to a third industrial revolution. One analyst is predicting a stock could rise 1,566%. Another stock has already jumped over 1,000% and is expected to keep going. To learn more about investing in the natural gas boom, click here.