McMoRan Drowning in Davy Jones’ Locker

by Aaron Levitt | November 27, 2012 3:48 pm

In the wake of the BP (NYSE:BP[1]) Deepwater Horizon disaster, the Gulf of Mexico is once again a hotbed of activity[2]. Production from the vast offshore field remains brisk, while drilling permits for both shallow and deepwater continue to rise. Perhaps more importantly, new seismic technologies have allowed a variety of E&P firms to discover new, huge reserves.

One of the more promising new finds was McMoRan Exploration‘s (NYSE:MMR[3]) huge Davy Jones prospect. The massive field is estimated to produce roughly 50 million cubic feet a day of natural gas and equivalents from its giant reservoir, and could have been a game-changer for the firm, along with partners Energy XXI (NASDAQ:EXXI[4]) and Plains Exploration & Production (NYSE:PXP[5]).

Sadly, after years of waiting and numerous test wells, investors might have to wait a little longer until the field starts producing any gas.

If the company can survive that long.

Burning Cash Among Testing

McMoRan on Monday reported the results of its umpteenth production flow test. The results — which were inconclusive, representing another setback in a long series of issues — triggered a nearly 34% plunge in MMR shares over the past two days.

The company has been working for months and has sunk more than $775 million into the ultra-deep Davy Jones-1 site to flow hydrocarbons at the field. MMR hopes to tap the site’s 20,000 acres’ worth of sub-salt riches and unearth the bounty trapped within the field.

The New Orleans-based company operates some of the deepest wells in the U.S. Gulf; however, in this case, the lack of depth of the drilling site[6] is the problem.

McMoRan is seeking to pioneer ultra-deep production from a shallow-water well — parts of the Davy Jones acreage are only about 20 feet below the surface. The problem is that the firm must tunnel roughly 29,000 feet amid high temperatures and pressures to get to the hydrocarbons. This is proving costly; the firm has had to develop new technologies and drilling muds to tap the opportunity.

These costs have been compounded as McMoRan has struggled with clogged well bores and Hurricane Isaac.

MMR has struggled with a component known as barite, which adds weight to the drilling mud used to hold back flow after a well is drilled. The problem is the barite drilling mud has clogged the well, and McMoRan — after months of trying — has been unable to clear it, preventing it from even testing the well. Hurricane Isaac added additional pressures as work on the well had to completely stop for a prolonged period of time. So far, it has been more than a year since the original flow test was scheduled to begin.

All in all, the drilling setbacks and higher-than-expected exploration costs caused McMoRan to report a third-quarter loss of $64 million (40 cents per share) that was much worse than the year-ago period’s $9.4 million (6 cents).

But the problems go much deeper than just the bigger loss and production stumbles.

McMoRan’s recent announcement of the test failure has raised more questions regarding the well’s ability to produce commercial amounts of gas. That’s a big deal considering the firm has pretty much put all its eggs in a cash-sinking basket. MMR recently raised its estimate for capital spending for 2013 by $50 million to $550 million due to extra costs at Davy Jones. However, the firm only had cash and equivalents of $287.1 million at the end of June.

Point-blank: If the E&P firm continues at its current capital expenditure rates, it’ll burn through its cash in the next quarter or two.

That means if McMoRan fails to unclog the well, it might have to abandon it all together.

Is There Any Value Left?

Given these facts and consistent disappointment from McMoRan, it’s easy to see why several analysts have slashed their ratings on the company. JPMorgan (NYSE:JPM[7]) even thinks shares have “zero equity value” left for investors. I tend to agree.

The Davy Jones is proving too costly to be a big hit. Analysts expect the company to tap its credit facility during the first quarter of 2013 or get another joint venture partner to continue funding the drilling site. The firm has become too risky for investment status.

A safer bet for investors looking at Davy Jones would be its two partners — Energy XXI and Plains Exploration — as they have plenty of other assets to cover themselves if the project goes bust. But, if you’re willing to gamble …

McMoRan currently is trading around the bottom of its three-year trading range. If MMR somehow got its act together and could reach the potential “trillions of hydrocarbons” locked in the field, the stock would soar. I just wouldn’t bet my house on it happening.

The other gamble for shares is always a potential buyout[8]. McMoRan holds roughly 920,000 gross acres — including 385,000 associated with the ultra-deep salt fields like Davy Jones. While it might not have the firepower to keep drilling and testing, someone like Chevron (NYSE:CVX[9]) — which owns acreage near Davy and has partnered with McMoRan on other Gulf sites — does.

Either way, a bet on McMoRan is firmly speculatory.

As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.

  1. BP:
  2. a hotbed of activity:
  3. MMR:
  4. EXXI:
  5. PXP:
  6. lack of depth of the drilling site:
  7. JPM:
  8. potential buyout:
  9. CVX:

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