McMoRan: Investment Remains Intact Despite Mechanical Issues

| About: McMoRan Exploration (MMR)
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McMoRan Exploration Co. (NYSE:MMR) shares plunged on Monday after the company reported more mechanical issues with the hopefully prolific Davey Jones No. 1 well. Investors had expected results from this well over a year ago, but problems continue to frustrate all involved in this historic drilling effort.

The company is attempting to lead the world in ultra-deep drilling in shallow waters off the Gulf of Mexico. It has numerous exploratory and development wells in the sub-25,000-feet zones. Investors interested in the stock should heed warnings from the CEO, Jim Bob Moffett, who was quoted in a recent Bloomberg article as saying:

"People call us pioneers. Well, that's great, I guess, (though) some people say pioneers end up with arrows in their back."

The huge expense to drill the Davey Jones and the shrinking liquidity levels have naturally made investors concerned about a potentially predatory financing to complete the ultra-deep drilling program. The concern was large enough for legendary investor Lee Cooperman, Chairman and CEO of Omega Advisors, to join the GOM update call to ask numerous questions based on his large investment in the company.

Q3 2012 Highlights

The company reported the following highlights for Q3 2012 back in October:

  • The company reported a net loss of $64.0 million or $0.40 per diluted share, compared to net loss of $9.4 million or $0.05 per diluted share for the quarter ended June 30, 2012.
  • The company had revenues of $91.8 million for the quarter ended September 30, 2012, compared to revenues of $138.1 million for the comparable quarter last year.

The current earnings totals aren't very meaningful at this point. The loss includes some one-time charges that could be removed to compare results.

The real importance of the earnings report is to find out updates on the development of potentially prolific fields such as the Davey Jones. Just as important is to understand the current liquidity position.

Davey Jones No. 1

The field encompasses a large ultra-deep structure encompassing four OCS lease blocks totaling 20,000 acres. The company estimates multiple Tcfe of natural gas in the section. It owns a 63.4% working interest and a 50.2% net revenue interest. Energy XXI, JX Nippon Oil Exploration, and Moncrief Offshore LLC hold the remaining interests.

The ongoing mechanical issues with this field encompass the reason for the stock plunge this week. Investors had expected gas to be flowing by now, yet the company has encountered more problems with barite plugging the perforated holes. Unless the company can unclog the holes, some analysts fear it may have to ultimately plug the hole.

The well logged 200 net feet of pay in multiple Wilcox sands, and the CEO remains bullish that the issues will ultimately get resolved. Other investors such as partner Energy XXI (EXXI) remain bullish. The CEO was clear on their recent earnings call that signs exist that the issue is more in controlling the flow of gas as opposed to whether any gas exists.

The company has spent an astonishing $961M as of September 30th on the play, including $474.8M in allocated property acquisition costs.

Reserves

Until the company has completed flow tests for the Davey Jones, the reserve numbers remain a big question mark. The company, though, estimates the potential to exceed 130 Tcfe for the existing leases with working interests - an incredible amount for such a small company with a market cap of only $1.3B.

Development Activities

As the slide below shows, the Davey Jones No. 1 is far from the only opportunity for the company to score big results. The company has several other development and exploratory wells, as highlighted below:

Davey Jones No. 2 - completion and testing of the Davey Jones offset appraisal well is expected to commence following review of results from Davey Jones No. 1. The exploratory well confirmed 120 net feet of pay in multiple Wilcox sands. It also encountered 192 net feet of potential hydrocarbons in the Tuscaloosa and Lower Cretaceous sections.

Blackbeard East - the company plans to test and complete the Upper Miocene sand during 2013 using conventional equipment. The exploratory well was drilled to 33,318 feet in January 2012. The results show hydrocarbons below the salt weld in several geologic formations.

The results are potentially very positive for other strategic areas including the Blackbeard West No. 2, Barbosa, and Queen Anne's Revenge.

The play is located in 80 feet of water. McMoRan holds a 72% working interest and 57.4% net revenue interest. The company has spent over $300M on this play as of September 30th.

Lafitte - the company submitted development plans in October for the completion and testing of the Jackson/Yegua sands below 33,000 feet. The well was drilled to 34,162 feet and will require the development of 30,000 psi equipment in order to proceed.

The exploration results indicated presence of hydrocarbons below the salt weld in numerous geologic formations. These results enhance acreage positions in the Barataria and Captain Blood prospects.

McMoRan holds a 72% working interest and a 58.3% revenue interest in this play. The company has spent nearly $195M to develop the play.

Exploratory Wells

Lineham Creek - the onshore well in LA has tested positive for hydrocarbon bearing porous sands above 24,000 feet. The well will be drilled to 29,000 feet to evaluate other objectives. McMoRan has a 36% working interest with Chevron (NYSE:CVX) controlling the play with a 50% working interest.

Blackbeard West No. 2 - another ultra-deep well is currently drilling below 25,000 feet with an ultimate goal of 25,500 feet. Logging data shows the well encountered additional hydrocarbons above the previously reported pay zones. McMoRan holds a 69.4% working interest and a 53.1% net revenue interest.

Lomond North - the ultra-deep prospect onshore in LA is currently drilling at 10,700 feet with an ultimate goal of 30,000 feet. The company owns 80,000 acres in the region with a 72% working interest. The exploratory well has objectives of targeting the Eocene, Paleocene, and Cretaceous sections below the salt weld.

Prospects

The company has a plethora of prospects to explore once results can be confirmed from the existing development and exploratory wells. Not to mention, the company could use a partner to develop these areas that could cost $200M on average to develop.

As the reserves slide shows, the company has numerous prospects including the Barataria, Barbosa, Bonnet, Calico Jack, Captain Blood, Davey Jones West, Drake, England, Highlander, Hook, Morgan, and Queen Anne's Revenge.

Liquidity

With only $191M in cash and a capital budget forecast at $135M in Q4, liquidity is a prime concern for the company. Interestingly, though, the company has a limited net debt position, especially considering the massive reserve potential and the proximity to proving out some major reserves.

MMR Long Term Debt Chart

MMR Long Term Debt data by YCharts

Naturally, the company will have to show positive flow results on one of these wells in order to attract large investments, but the debt levels are relatively small compared to the potential. A company such as Chesapeake Energy (NYSE:CHK) has a much larger debt position and a higher debt to equity ratio.

Stock Price

The stock has spent the last three years going virtually nowhere. It almost looks like the stock has drilled a horizontal well that continues going sideways. The stock closed right above $8 leaving most investors within the last few years looking at a loss.

3-Year Chart - McMoRan Exploration

Conclusion

This company remains extremely cheap as it executes on a major drilling program into uncharted depths. Unfortunately, the drill-down-well-to-hell could end up that way for investors. The risk remains that a failed well would definitely hammer investors, while a successful well at this point could flood the markets with natural gas at a time of high inventories. Investors could lose either way. Being a pioneer isn't always a winning proposition, as investors could be on the verge of seeing arrows in their backs.

Conversely, McMoRan could be on the verge of rewarding investors with an Ultra-Deep 'franchise' comprised of almost invaluable data, technology, enhanced acreage positions, and positive drilling results encompassed by a 200 mile area in one of the most prolific basins in the world.

The risk/reward sure appears to favor McMoRan investors at this point. The company could have larger reserves than Chesapeake Energy, yet a substantially smaller debt load. Partner Energy XXI could provide a less risky way to invest in these ultra-deep plays, as the company typically owns a 10-20% working interest in most of the plays.

Investors selling the stock down 35% clearly see the risk as being all or none on the Davey Jones No. 1, while the other development activities, exploratory wells, and prospects suggest plenty of options exist. The company isn't a one trick pony, and has plenty of options to sell assets in order to avoid a liquidity event.

As the company reports flow results soon, investors need to take the results into context. With positive results, investors should likely pile head first into the stock, as the sky could be the limit. With negative results, cooler heads need to prevail, realizing that all is not lost. Chevron didn't just buy leases with McMoRan on a prayer that Davey Jones works. The data suggests massive hydrocarbons exist, and the only issue is when the company will be able to recover them.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in MMR over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Please consult your financial advisor before making any investment decisions.