Investing in Copper Mining

There are times in business when 1 + 1 = 2.5, such as when an acquisition creates a company that is greater than the sum of its individual parts. Any overlap in the two companies’ production chains reduces cost, and the combining of their markets widens the playing field.

Freeport-McMoRan Copper & Gold Inc. (NYSE: FCX) is doing even better by acquiring two companies. Not simply increasing its resource reserves and synergizing to save costs, it is also diversifying across a broader spectrum of commodities.

Storing Up Energy

Freeport-McMoRan Copper & Gold Inc. has solidified its presence in the energy sector through last week’s finalization of its acquisition of U.S. oil and gas producer Plains Exploration & Production Co. The transaction cost some $16.3 billion comprised of $3.3 billion in cash, $2.9 billion of Freeport stock, the assumption of $9.7 billion of Plains debt, and a special dividend of $3 per Plains share.

What did Freeport buy for all that money? Quite a lot of fuel, which, according to Plains’ 2011 annual report, includes reserves of 244 million barrels of oil (about 1.18% of America’s proven crude oil reserves, according to CIA World Factbook), plus natural gas, from properties in California, Wyoming, Texas, and the Gulf Coast.

Freeport is also getting plenty of income through Plains’ annual net profit, which totalled $298 million for the year ending 2012.

But there are even more energy reserves on the way, as Freeport is soon to complete the acquisition of another energy producer, McMoRan Exploration Co. (NYSE: MMR). For the $2.1 billion price tag, Freeport will be getting MMR’s “owned or controlled interests in 1,003 oil and gas leases in the Gulf of Mexico, Louisiana and Texas covering approximately 511,000 net acres” with an “estimated proved oil and natural gas reserves totalling 219.9 billion cubic feet equivalent”, as Yahoo! Finance reports.

As for income, Freeport is getting a bit of a bleeder in MMR with its net loss of $104.3 million for 2012.

Group Restructuring?

Yet Freeport-McMoRan Copper and Gold Inc’s purchase of McMoRan Exploration may be a little more than just a resource grab. It may be part of a broader restructuring to rebalance assets and close some gaping holes.

According to MMR, in 1994 Freeport-McMoRan Inc. spun off its oil and gas exploration unit as McMoRan Oil & Gas Co. That exploration unit then merged with Freeport-McMoRan Sulphur Inc. in 1998 to form the present McMoRan Exploration Co., which is now being absorbed by Freeport-McMoRan Copper & Gold Inc.

This is kind of like a teen (McMoRan Exploration) leaving mom and dad (Freeport-McMoRan Inc) to live on his own for a while, and then moving in with his older, wealthier brother (Freeport-McMoRan Copper and Gold).

And oh how wealthy that older brother is! F-M Copper and Gold has reported astronomical net incomes of $3.1 billion in 2012, $4.5 billion in 2011, and $4.3 billion in 2010. We can understand why the company is going on a shopping spree, as well as helping out a struggling younger brother (McMoRan Exploration) by taking him in.

Oh, and there must be some tax saving motivation as well.

Shifts in Copper Supply/Demand

But this restructuring may be more than just a means of plugging up bleeding operations. The commodities landscape seems to be getting ready to shift once again, and reposturing now before the anticipated pickup in demand is crucial to keeping ahead of the competition.

Soon after putting in a double bottom at the end of April, copper prices jumped upward nearly 10% during the first week of May from $3.10 to $3.40 a pound before stabilizing for the remainder of the month around the $3.30 mark.

Likely contributing to the copper price rebound was a Chilean report, which showed April’s output from the world’s largest copper producing nation – supplying nearly a perfect third (33.6%) of global supply – fell by 1.2% from 12 months prior due to strikes, production problems, and lower ore grades.

On the demand side, traders in Shanghai have been betting on increasing Chinese imports of copper for May. “The arbitrage between the LME and Shanghai (copper) did open up this week. I suspect we will see a bit more Chinese buying,” Citi analyst David Wilson noted to Reuters. He then tempered, “I think it’s a tad artificial. Prices are not going anywhere because macro data in China is not showing any acceleration in activity.”

But others, like analyst Dan Smith of London’s Standard Chartered, see $150 premiums for bonded copper in Shanghai as a clear sign that China’s shortage of copper scrap metal is already curbing internal copper production and drawing stockpiles down.

“People are underestimating the pace of growth of demand in China,” Smith emphasises. “On the copper side of things we think demand is holding pretty well, and the tightness in the scrap market in China is also quite notable.”

Undoubtedly affecting China’s imports of copper is mid-May’s collapse of Freeport-McMoRan Copper and Gold’s copper mine in Indonesia, the world’s second largest copper mine. Although scheduled to partially reopen last week, the miners’ trade union is insisting workers not return to the mine until investigations are complete and the mine is declared safe, continuing the pressure on the commodity’s supply.

Preparing For Global Expansion

By using its stellar mining profits of the past several years to acquire large oil and gas reserves, Freeport-McMoRan Copper and Gold Inc. is positioning itself as a well-diversified global energy and resources producer ready to supply the world’s energy and materials needs of the future.

Exactly when global production and expansion will finally resume, no one can tell for certain. Financial crises still plague Europe, while the demand for resources is still muted in Asia and the Americas. But investing convention does tell us that the time to buy is when prices are depressed. Freeport-McMoRan and its group of subsidiaries are doing precisely that.

Trading at around $31 a share, FCX’s stock has established a remarkably sturdy base at this level for over 3 years since early 2010. With enviable profits of several billions each year even in the slow economic environment of late, the company should fare all the better when global expansion finally resumes. Holding FCX may be a profitable means of gaining exposure to the commodities that benefit the most during expansionary phases, including copper, oil, and natural gas.

And if you’re worried about how long it will be before that next global expansionary phase, FCX is prepared to pay you 4% in dividends to wait. As a bonus, the company will also be paying an extra dividend of $1 per share (currently 3.2% of the share price) with a record date of June 14^th, according to Dividend.com.

Joseph Cafariello

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