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Oil Industry's $3.4 Billion Bailout

Nothing Changes on Wall Street

Written by Briton Ryle
Posted December 14, 2012

Friends for more than 50 years, Jim Bob and Tex just got a bailout.

Now, this wasn't some $500 “get out of county jail on drunk in public charges” kind of bailout; nor was it a payday loan to keep their struggling tow truck company going another few weeks.

No, this bailout was of the multi-billion-dollar variety.

Truth be told, “bailout” might not be the best word for what happened. After all, Tex was #366 on Forbes' list of the Richest Americans just a few years ago.

Still, the fact remains both Tex and Jim Bob managed to preserved their wealth when things weren't looking too good — and it appears average investors are getting stuck with the bill.

The “Tex” I'm referring to is Tex Moncrief, a 92-year-old Texas oil man, rugged as any West Texas landscape.

Mean as a rattlesnake, too. He once sued his own nephew, the son of his deceased brother.

Rumor has it that Tex Moncrief may have defrauded the U.S. government out of as much as $300 million in taxes (but you didn't hear that from me). Tex settled for around $23 million in 1996 and the charges basically went away. A few Senators reportedly even apologized for bothering him.

And whether or not his alleged former mistress and long-time employee was actually guilty of embezzlement, or if Tex just wanted to be rid of her, may never be known...

He never managed to explain in court how his signature came to be on some $10,000-plus checks used to pay her Master Card bills.

The Real-life J.R. Ewing

Tex learned the oil business from his daddy, Monty Moncrief. Just 10 years old at the time, Tex actually saw the black plumed gusher that signaled a five billion barrel find in West Texas... and he was a millionaire when he graduated grade school.

Tex's biggest find was the three trillion cubic foot Madden Deep natural gas field, found in Wyoming in 1969. It's still one of Moncrief Oil's biggest assets.

His 20,000-acre ranch outside Fort Worth, Texas, sits in the middle of the Barnett Shale gas field. He hasn't started drilling for natural gas there — yet...

In 2009, Tex got a call from his old friend, Jim Bob.

Jim Bob Moffett was the CEO of oil and gas exploration company McMoRan Exploration. His company was doing some pretty radical deepwater drilling in the Gulf of Mexico.

The water his company was drilling in was often just 20 feet deep. But they were drilling 17,000, 20,000, even 26,000 feet down into the earth. And they had plans to go even deeper.

It was at these depths that McMoRan made a major discovery of oil and natural gas. The field, named Davy Jones, was thought to tap as much as six trillion cubic feet of gas and maybe 160 million barrels of oil.

It was one of the biggest finds in the Gulf ever — and one of the deepest, ultimately drilling down over 28,000 feet.

Under Pressure

Jim Bob offered his old friend Tex a 10% stake in the Davy Jones field, along with a percentage of other deepwater McMoRan wells.

At the time, Davy Jones had cost around $100 million. Several hundred million more would be spent.

The oil and gas they were finding was actually part of a larger proven formation that extended from the south-central United States into the deepwater Gulf. BP was drilling the same formation, but far from shore and in 5,000 feet of water.

Jim Bob and Tex were looking pretty smart. Even though they were drilling to incredible depths, the prospect of finding oil and natural gas seemed pretty low-risk.

There was just one problem...

Pressure. Nobody really knew how much pressure there would be 28,000 feet below the earth's surface.

And as it turned out, there was significantly more pressure than they expected — not to mention 400 degree heat.

Flow tests were delayed repeatedly, and the stock price bounced between $8 and $18 a share, depending on how optimistic Jim Bob and Tex sounded. In fact, two years after the discovery, McMoRan was still grappling with how to prevent the incredible pressure from producing a blowout.

Once this problem seemed like it was worked out, something called barite became a big problem. Barite is used to add weight to mud that is used sort of like a cork after a well is drilled, but before the well starts flowing.

The barite/mud used to “cork” the first Davy Jones well actually plugged it — and after months of trying, McMoRan couldn't unplug it.

Between November 23 and November 27, 2012, McMoRan stock fell from $12.45 to $8.18 a share. Ouch.

Analysts were saying the first Davy Jones well might have to be abandoned. Some wondered if the Davy Jones field itself could ever be developed.

Jim Bob and Tex were in trouble.

It was then, virtually out of the blue, that the bailout came...


Jim Bob and Tex's $3.4 Billion Bailout

On December 5, 2012, McMoRan agreed to a buyout offer that included $2.1 billion in direct compensation, some share in a royalty trust, and the assumption of $900 million in debt.

All told, the buyout was worth $3.4 billion.

Jim Bob's share of the company had fallen to around $25 million after the Davy Jones debacle. The buyout pushed his stake to $89 million, according to Bloomberg.

You probably know that McMoRan Exploration was bought out by copper giant Freeport-McMoRan (NYSE: FCX). The “McMoRan” name that both companies share is no coincidence...

McMoRan Exploration was spun off from Freeport-McMoRan 15 or so years ago. Freeport has been out of the oil business ever since. But it doesn't end there...

Jim Bob Moffett is also Chairman of Freeport-McMoRan's Board of Directors.

"Aha!" you say — and you are right.

This deal kind of stinks.

Though, I should tell you Freeport-McMoRan's move back into the fossil fuels business is a bit more complicated than I've characterized it. For one, McMoRan has more assets than Davy Jones. Freeport is paying around $40 a barrel for these assets.

Still, the deal raises a few concerns...

I have no problem with a company expanding into oil and natural gas production. To me, fossil fuels is the single most reliable growth industry in the U.S. today.

I'm not at all worried that Freeport will be distracted by its expansion. In fact, after Freeport-McMoRan fell +16% in the wake of the announcement, I considered the stock a “buy.”

No, my questions center on risk.

Why should Freeport buy Gulf of Mexico oil and gas reserves for $40 a barrel, when it could own much less risky onshore oil and gas for around $60 a barrel?

Not only would Freeport have avoided the steep decline in its own share price, but it might also have avoided the slew of investor lawsuits the deal has prompted.

Either way, it looks like Jim Bob and Tex are having the last laugh.

I wonder what they'll do with their bailout money...

Until next time,

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Briton Ryle

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.

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