Freeport-McMoRan 2014 Annual Report Download - page 91

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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operations’ long-lived assets for recoverability, estimates of
after-tax undiscounted future cash flows of FCX’s individual
mining operations are used. An impairment is considered to exist
if total estimated future cash flows on an undiscounted basis are
less than the carrying amount of the asset. Once it is determined
that an impairment exists, an impairment loss is measured as the
amount by which the asset carrying value exceeds its fair value.
As quoted market prices are unavailable for FCX’s individual
mining operations, fair value is determined through the use of
discounted estimated future cash flows. Estimated cash flows
used to assess recoverability of long-lived assets and measure
the fair value of FCX’s 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.
Estimates of future cash flows also include estimates of
commodity-based and other input costs; proven and probable
mineral reserve estimates, including any costs to develop the
reserves and the timing of producing the reserves; and the use of
appropriate escalation and discount rates. FCX believes its
estimates and models used to determine fair value are similar to
what a market participant would use.
Oil and Gas Properties. FCX follows the full cost method of
accounting specified by the U.S. Securities and Exchange
Commission’s (SEC) rules whereby all costs associated with oil
and gas property acquisition, exploration and development
activities are capitalized into a cost center on a country-by-
country basis. Such costs include internal general and
administrative costs, such as payroll and related benefits and
costs directly attributable to employees engaged in acquisition,
exploration and development activities. General and
administrative costs associated with production, operations,
marketing and general corporate activities are charged to expense
as incurred. Capitalized costs, along with estimated future costs
to develop proved reserves and asset retirement costs that are
not already included in oil and gas properties, net of related
salvage value, are amortized to expense under the UOP method
using engineers’ estimates of the related, by-country proved oil
and natural gas reserves.
The costs of unproved oil and gas properties are excluded from
amortization until the properties are evaluated. Costs are
transferred into the amortization base on an ongoing basis as the
properties are evaluated and proved oil and natural gas reserves
are established or if impairment is determined. Unproved oil
and gas properties are assessed periodically, at least annually,
to determine whether impairment has occurred. FCX assesses
oil and gas properties on an individual basis or as a group if
properties are individually insignificant. The assessment considers
the following factors, among others: intent to drill, remaining
lease term, geological and geophysical evaluations, drilling
results and activity, the assignment of proved reserves and the
economic viability of development if proved reserves are
assigned. During any period in which these factors indicate an
impairment, the cumulative drilling costs incurred to date for
such property and all or a portion of the associated leasehold
costs are transferred to the full cost pool and are then subject
to amortization. The transfer of costs into the amortization base
involves a significant amount of judgment and may be subject to
changes over time based on drilling plans and results, geological
and geophysical evaluations, the assignment of proved oil and
natural gas reserves, availability of capital and other factors.
Costs not subject to amortization consist primarily of capitalized
costs incurred for undeveloped acreage and wells in progress
pending determination, together with capitalized interest
for these projects. The ultimate evaluation of the properties will
occur over a period of several years. Interest costs totaling
$88 million in 2014 and $69 million in 2013 were capitalized on
oil and gas properties not subject to amortization and in the
process of development.
Proceeds from the sale of oil and gas properties are accounted
for as reductions to capitalized costs unless the reduction causes
a significant change in proved reserves, which absent other
factors, is generally described as a 25 percent or greater change,
and significantly alters the relationship between capitalized costs
and proved reserves attributable to a cost center, in which case
a gain or loss is recognized.
Under the SEC full cost accounting rules, FCX reviews the
carrying value of its oil and gas properties each quarter on a
country-by-country basis. Under these rules, capitalized costs of
oil and gas properties (net of accumulated depreciation, depletion
and amortization, and related deferred income taxes) for each
cost center may not exceed a “ceiling“ equal to:
• the present value, discounted at 10 percent, of estimated future
net cash flows from the related proved oil and natural gas
reserves, net of estimated future income taxes; plus
• the cost of the related unproved properties not being
amortized; plus
• the lower of cost or estimated fair value of the related unproved
properties included in the costs being amortized (net of related
tax effects).
These rules require that FCX price its future oil and gas
production at the twelve-month average of the first-day-of-the-
month historical reference prices as adjusted for location and
quality differentials. FCX’s reference prices are West Texas
Intermediate (WTI) for oil and the Henry Hub spot price for natural
gas. 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
reserve estimates exclude the effect of any crude oil and natural
gas derivatives FCX has in place. The estimated future net cash
flows also exclude future cash outflows associated with settling