Freeport McMoRan Copper (FCX), the world’s largest copper miner, is set to release its Q1 earnings on Thursday, April 18. The majority of the company’s revenues are derived from copper, which is extremely sensitive to cyclical industries like construction and industrial machinery manufacturing. These industries in turn are heavily influenced by the macroeconomic sentiment and outlook. Macroeconomic factors in the first quarter haven’t been very encouraging, particularly as far as China is concerned. This has led to much lower copper prices year-over-year as well as sequentially and will have a negative impact on Freeport’s revenues.
The other issue in focus will be the the status update on Freeport’s pending mergers with McMoran Exploration and Plains Exploration and Production. These are oil and gas companies which were acquired by Freeport last year but the deals are expected to conclude sometime in Q2 2013.
The three companies’ boards are interconnected in a convoluted manner which has resulted in the deal receiving a lot of criticism. McMoran Chairman Moffett could collect $73 million cash for his shares while Plains Chief Executive Jim Flores stands to get $65.4 million for his. Flores could also receive a change-in-control payout of as much as $150 million. These apparent conflicts of interest have made investors question whether the deals have been made more for personal reasons rather than commercial.
Effect Of Macroeconomic Factors On Copper Prices
Copper is often called “Dr. Copper” for being a bellwether of the world economy due to its close correlation to economic growth. It is used by many industries and prices typically rise when the world economy is growing. Hence, macroeconomic factors are important for copper and Freeport.
Going by the copper price data on the London Metal Exchange (LME), the average realized price of copper for Freeport is likely to be lower this quarter on a sequential and year-over-year basis. Volumes sold are not likely to be higher than the previous quarter so we don’t expect much revenue growth. Prices were influenced largely by the prevailing macroeconomic scenario.
Global macroeconomic conditions remained challenging this quarter. The events in Cyprus disturbed the nascent positive sentiment in Europe and also had an adverse impact on base metal prices like copper. Also, China reported a year-over-year Gross Domestic Product (GDP) growth rate of 7.7% for the first quarter of 2013. This was lower than the growth rate of 7.9% reported in Q4 2012. Since the country accounts for almost 40% of global copper consumption, China’s economic conditions have a significant impact on prices of commodities like copper. The Chinese stockpiled a lot of copper last year which has affected purchases related to restocking, especially since industrial production figures for the first quarter point to lower consumption of the metal. The steep drop in copper prices observed in February came after China announced steps to curb the rapid rise in real estate prices by making it tougher to purchase homes. Almost 40% of the worldwide demand for copper comes from the construction industry.
Outlook For Copper
The future for copper prices doesn’t look bright because according to the International Copper Study Group, supply is expected to outstrip demand in 2013. According to the group, while refined copper production is expected to rise by 6% to 21 million tonnes in 2013, refined copper usage is projected to rise only by 1.5 per cent to 20.7 million tonnes. This will result in a production surplus of 460,000 tonnes.
In addition to all this, there are reports of copper inventories piling up at LME warehouses. This is likely to keep a further lid on prices going forward.
Re-entering The Energy Business
Freeport announced its reentry into the energy business in December last year when it announced the acquisition of McMoran Exploration and Plains Exploration and Production. Freeport had exited its energy business in 1994 by spinning off McMoran Exploration as a separate company.
You can read the details in our previous article here. The acquisitions are expected to conclude at the end of Q2 this year.
The oil and gas upstream business can give potentially much higher returns than copper mining. We note that both Plains and McMoran Exploration’s have excellent assets in the U.S. These deals will give Freeport access to shale formations in Texas and Louisiana that produce both oil and gas as well as offshore oil and gas production facilities in the Gulf of Mexico. The McMoran Exploration portfolio is expected to provide a large, long-term and low cost source of natural gas production. McMoran has been developing expertise in drilling at extreme depths below sea level in the shallow waters of the gulf. Although commercial success has eluded it thus far, the potential is estimated to be huge. Naysayers counter that oil revenues dominate the revenue mix from acquired assets so any upside resulting from high natural gas prices in the future will be limited.
One of the risks that we see here is the high correlation between copper and oil. Both commodities tend do well when economic conditions are good. Copper is an industrial metal and oil runs the world’s economic engines. But come choppy waters and prices of both commodities go haywire. In the present scenario, prices of both copper and oil are going down. We wonder if the diversification strategy is really going to work. We expect questions to this effect to be asked in the earnings conference call.
Disclosure: No positions.