Freeport-McMoRan 2014 Annual Report Download - page 37

MANAGEMENT’S DISCUSSION AND ANALYSIS
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geographic location, type of production structure, water depth,
reservoir depth and characteristics, currently available
procedures and consultations with engineering consultants.
Because these costs typically extend many years into the future,
estimating these future costs is difficult and requires
management to make judgments that are subject to future
revisions based upon numerous factors, including changing
technology and the political and regulatory environment. Reserve
engineering is a subjective process of estimating the recovery
from underground accumulations of oil and natural gas that
cannot be measured in an exact manner, and the accuracy of any
reserve estimate is a function of the quality of available data and
of engineering and geological interpretation and judgment.
Because all reserve estimates are subjective, the quantities of oil
and natural gas that are ultimately recovered, production and
operating costs, the amount and timing of future development
expenditures and future oil and natural gas sales prices may all
differ from those assumed in our estimates.
Refer to Note 21 for further information regarding estimated
proved oil and natural gas reserves.
The average amortization rate per BOE was $39.74 in 2014 and
$35.54 for the period from June 1, 2013, to December 31, 2013.
Our oil and gas depreciation, depletion and amortization rate for
2015, after the effect of the ceiling test impairments recorded in
2014, is expected to be $36.39 per BOE. Changes to estimates of
proved reserves could result in changes to the prospective UOP
amortization rate for our oil and gas properties, which could have
a significant impact on our results of operations. Based on our
estimated proved reserves and our net oil and gas properties
subject to amortization at December 31, 2014, a 10 percent
increase in our costs subject to amortization would increase our
amortization rate by approximately $3.63 per BOE and a 10
percent reduction to proved reserves would increase our
amortization rate by approximately $4.04 per BOE. Changes in
estimates of proved oil and natural gas reserves may also affect
our ceiling test calculation. Refer to Note 1 and “Impairment of Oil
and Gas Properties“ below for further discussion.
Impairment of Long-Lived Mining Assets. As discussed in Note 1,
we evaluate our long-lived mining assets for impairment when
events or changes in circumstances indicate that the related
carrying amount of such assets may not be recoverable. In
evaluating our long-lived assets for recoverability, estimates of
after-tax undiscounted future cash flows of our individual mining
operations are used, with impairment losses measured by
reference to fair value. As quoted market prices are unavailable
for our individual mining operations, fair value is determined
through the use of discounted estimated future cash flows. The
estimated cash flows used to assess recoverability of our
long-lived assets and measure fair value of our mining operations
are derived from current business plans, which are developed
using near-term price forecasts reflective of the current price
environment and management’s projections for long-term
average metal prices. In addition to near- and long-term metal
price assumptions, other key assumptions include commodity-
based and other input costs; proven and probable reserves,
including the timing and cost to develop and produce the
reserves; and the use of appropriate escalation and discount
rates. We believe our estimates and models used to determine fair
value are similar to what a market participant would use.
Because the cash flows used to assess recoverability of our
long-lived assets and measure fair value of our mining operations
require us to make several estimates and assumptions that are
subject to risk and uncertainty, changes in these estimates and
assumptions could result in the impairment of our long-lived
asset values. Events that could result in impairment of our
long-lived assets include, but are not limited to, decreases in
future metal prices, decreases in estimated recoverable proven
and probable mineral reserves and any event that might
otherwise have a material adverse effect on mine site production
levels or costs.
Impairment of Oil and Gas Properties. As discussed in Note 1,
we follow the full cost method of accounting for our oil and gas
operations, whereby all costs associated with oil and gas property
acquisition, exploration and development activities are
capitalized and amortized to expense under the UOP method on a
country-by-country basis using estimates of proved oil and
natural gas reserves relating to each country where such activities
are conducted.
In evaluating our oil and gas properties for impairment,
estimates of future cash flows are used (refer to Note 1 for further
discussion of the ceiling test calculation). Additionally, SEC
rules require that we price our future oil and gas production at the
twelve-month average of the first-day-of-the-month historical
reference prices adjusted for location and quality differentials.
Such prices are utilized except where different prices are fixed
and determinable from applicable contracts for the remaining
term of those contracts, excluding derivatives. The pricing in
ceiling test impairment calculations required by full cost
accounting rules may cause results that do not reflect current
market conditions that exist at the end of an accounting period.
For example, in periods of increasing oil and gas prices, the use of
a twelve-month historical average price in the ceiling test
calculation may result in an impairment. Conversely, in times
of declining prices, ceiling test calculations may not result in
an impairment.
At September 30, 2014, and December 31, 2014, net capitalized
costs with respect to FM O&G’s proved U.S. oil and gas properties
exceeded the ceiling amount specified by SEC full cost accounting
rules, which resulted in the recognition of impairment charges
totaling $3.7 billion ($2.3 billion to net loss attributable to
common stockholders) in 2014. The twelve-month average of the