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McMoRan Exploration Co.

Part I.  FINANCIAL INFORMATION

Item 1.

Financial Statements.

McMoRan EXPLORATION CO.

CONDENSED BALANCE SHEETS (Unaudited)

The accompanying notes are an integral part of these financial statements.

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McMoRan EXPLORATION CO.

STATEMENTS OF OPERATIONS (Unaudited)

The accompanying notes are an integral part of these financial statements.

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McMoRan EXPLORATION CO.

STATEMENTS OF CASH FLOWS (Unaudited)

The accompanying notes are an integral part of these financial statements.

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McMoRan  EXPLORATION CO.

NOTES TO FINANCIAL STATEMENTS

1.    BASIS OF PRESENTATION

McMoRan Exploration Co.’s (McMoRan) financial statements are prepared in accordance with accounting principles generally accepted in the United States.   As a result of McMoRan’s exit from the sulphur business, as evidenced by its sale of substantially all of its sulphur assets, its sulphur results have been presented as discontinued operations and the major classes of assets and liabilities related to the sulphur business have been separately shown for all periods presented.

2.   EARNINGS PER SHARE

Basic and diluted net income per share of common stock was calculated by dividing the income (loss) applicable to continuing operations, income (loss) from discontinued operations, cumulative effect of change in accounting principle and net income applicable to common stock by the weighted-average number of common shares outstanding during the periods presented.  For purposes of the earnings per share computations, net income (loss) applicable to continuing operations includes preferred stock dividends and related charges.  

With respect to the 2003 period, the diluted earnings per share calculation excludes the assumed conversion of the 1.4 million shares of McMoRan’s 5% mandatorily redeemable convertible preferred stock issued in June 2002 into 7.1 million shares of McMoRan common stock and of 1.74 million stock warrants, issued to K1 Ventures Limited Inc. (K1) in December 2002, into 1.74 million shares of McMoRan common stock.  These items were excluded considering McMoRan’s net loss from continuing operations, which made the assumed conversion of these instruments anti-dilutive.  In addition, McMoRan had stock options representing approximately 113,000 shares of McMoRan common stock that otherwise would have been included in the diluted earnings per share calculation but were excluded because of the net loss from continuing operations.   There were no dilutive stock options outstanding during the first quarter of 2002.

Outstanding stock options excluded from the computation of diluted net income per share of common stock because their exercise prices were greater than the average market price of the common stock during the period are as follows:

Stock-Based Compensation Plans.  As of March 31, 2003, McMoRan had four stock-based employee compensation plans and one stock-based director compensation plan, which are more fully described in Note 8 of McMoRan’s 2002 Annual Report on Form 10-K.  McMoRan accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, which require compensation cost for stock-based employee compensation plans to be recognized based on the difference on the date of grant, if any, between the quoted market price of the stock and the amount an employee must pay to acquire the stock. The following table illustrates the effect on net income and earnings per share if McMoRan had applied the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation,” which req uires compensation cost for all stock-based employee compensation plans to be recognized based on the use of a fair value method (in thousands, except per share amounts):

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For the pro forma computations, the values of option grants were calculated on the dates of grant using the Black-Scholes option-pricing model.  The weighted average fair value for stock option grants was $4.95 per option in the first quarter of 2003 and $3.17 per option for the first quarter of 2002.  The weighted average assumptions used include a risk-free interest rate of 3.8 percent in the first quarter of 2003 and 5.1 percent in 2002; expected volatility of 65 percent for grants made in the first quarter of 2003 and 55 percent in for grants made in the first quarter of 2002; no annual dividends; and expected lives of 7 years for both 2003 and 2002 periods.  The pro forma effects on net income are not representative of future years because of the potential changes in the factors used in calculating the Black-Scholes valuation and the number and timing of option grants. No other discounts or restrictions related to vesting or t he likelihood of vesting of stock options were applied.

3. CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE

Effective January 1, 2003, McMoRan adopted SFAS No. 143, “Accounting for Asset Retirement Obligations,” which requires recording the fair value of an asset retirement obligation associated with tangible long-lived assets in the period incurred.  Retirement obligations associated with long-lived assets included within the scope of SFAS No. 143 are those for which there is a legal obligation to settle under existing or enacted law, statute, written or oral contract or by legal construction.

McMoRan used estimates prepared by third parties in determining its January 1, 2003 estimated asset retirement obligations under multiple probability scenarios reflecting a range of possible outcomes considering the future costs to be incurred, the scope of work to be performed and the timing of such expenditures.  Using this approach, the estimated undiscounted retirement obligations associated with McMoRan’s oil and gas operations approximated $9 million and for our former sulphur operations approximated $32 million.  The total of these current estimates was less than the amount of the total obligations accrued as of December 31, 2002 primarily because of the effect of applying weighted probabilities to the multiple scenarios used in this calculation and the time value discounting aspect of the calculations.  To calculate the fair value of the estimated obligations, McMoRan applied an estimated long-term annual inflation rate of 2.5 percent and a market risk premium of 10 percent, which was based on  estimates of rates that a third party would have to pay to insure its exposure to possible future increases in the costs of these obligations.  McMoRan discounted the resulting projected cash outflows at its estimated credit-adjusted, risk-free interest rates, which ranged from 4.6 percent to 10 percent, for the corresponding time periods over which these costs would be incurred.  

At January 1, 2003, McMoRan discounted its estimated asset retirement obligations to their estimated fair value by using McMoRan’s credit adjusted risk free interest rates in effect for the corresponding time periods over which these estimated costs would be incurred.  The estimated fair value of McMoRan’s total asset retirement obligations on January 1, 2003 approximated $27 million, of which approximately $8 million relates to its oil and gas operations.  McMoRan recorded the fair value of the obligations relating to its oil and gas operations together with the related additional asset cost as of January 1, 2003.  McMoRan did not record any related assets with respect to its sulphur asset retirement obligations and reduced the accrued sulphur reclamation obligations by approximately $19 million to their estimated fair value.  The net difference between McMoRan’s previously recorded reclamation obligations and the amounts recorded un der SFAS No.143 resulted in a $22.2 million gain , which was recognized as a cumulative effect for a change in accounting principle. Assuming no significant changes in its currently estimated retirement obligations, McMoRan expects that its adoption of SFAS No. 143 will cause future results of operations to include higher charges for depletion, depreciation and amortization than it otherwise would have recorded. The increased depletion, depreciation and amortization charges will include the accretion expense associated with the discounted asset retirement obligations as well as additional charges related to the increased oil and gas property assets.

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McMoRan’s first-quarter 2003 depletion, depreciation and amortization expense includes $0.4 million of charges associated with its adoption of SFAS No. 143, including $0.3 million of accretion expense, of which $0.2 million is associated with its previously fully accrued closed sulphur facilities, and $0.1 million of additional depletion, depreciation and amortization expense on its increased oil and gas property assets .   Had SFAS No. 143 not been adopted effective January 1, 2003, McMoRan would have recorded approximately $0.1 million of depletion, depreciation and amortization expense associated with its oil and gas reclamation obligations and would not have recorded any expense associated with its discontinued sulphur reclamation obligations.

Shown below are McMoRan’s actual reported results and pro forma amounts that would have been reported on McMoRan’s statements of operations had those statements been adjusted for the retroactive application of this change in accounting principles (in thousands, except per share amounts):

4. OTHER MATTERS

Stock-Based Awards

At the February 3, 2003 McMoRan Board of Directors’ meeting, the Board approved the grant of 525,000 options priced at $ 7.515 per share.  These option grants, of which 300,000 are immediately exercisable with the remainder vesting over four years, are subject to approval by the shareholders of the related stock option plan at the May 1, 2003 Annual Meeting of Stockholders.  Under current accounting rules, the difference between the market price on the date of Board approval of the stock option grants and the market price at the date of shareholder approval will be charged to earnings over their vesting period.   In addition, awards of 100,000 restricted stock units convertible into 100,000 shares of McMoRan common stock will also be granted upon shareholder approval of the related stock option plan.   The market value of these restricted stock units will be charged to earnings over their three-year ves ting period.

Conversion of Mandatorily Redeemable Preferred Stock

In June 2002, McMoRan completed a $35 million public offering of 1.4 million shares of its 5% mandatorily redeemable preferred convertible preferred stock.  During the first quarter of 2003, 42,500 shares of McMoRan preferred stock were converted into approximately 221,000 shares of its common stock.  An additional 36,700 shares of McMoRan preferred stock were converted into approximately 191,000 shares of its common stock in early-April 2003.  For more information regarding our convertible preferred stock see Notes 3 and 4 of our 2002 Form 10-K.

Capital Resources and Liquidity Matters

See Note 3 of McMoRan’s Form 10-K for the year ended December 31, 2002 for a discussion of financial liquidity issues McMoRan faced as it entered into 2002 and the steps taken during 2002 to address these issues. At March 31, 2003, McMoRan had $9.7 million of unrestricted cash, positive working capital and no debt. While achievement of the company’s short- and longer-term objectives remain subject to various uncertainties, management believe s McMoRan will be able to fund its operations and meet its obligations during the remainder of 2003. Management also believe s that its recent successful exploration results, together with the significant exploration potential for its remaining acreage position and its opportunities to participate in new business development involving its Main Pass facilities and elsewhere in the energy industry through its affiliation with K1, provide significant opportunities to achieve McMoRan’s overall business objectives. For additional information regarding McMoRan’s exploration successes and affiliation with K1 see “Drilling Update” and “Joint Venture Activities” within Management’s Discussion and Analysis of Financial Condition and Results of Operations elsewhere in this Form 10-Q.   

5. RATIO OF EARNINGS TO FIXED CHARGES

McMoRan’s ratio of earnings to fixed charges calculation was 9.6 to 1 for the first quarter of 2002, while the calculation resulted in a shortfall of $2.7 million for the first quarter of 2003. For this calculation, earnings consist of income from continuing operations before income taxes and fixed charges. Fixed charges include interest and that portion of rent deemed representative of interest.

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Remarks

The information furnished herein should be read in conjunction with McMoRan’s financial statements contained in its 2002 Annual Report on Form 10-K.  The information furnished herein reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the periods.  All such adjustments are, in the opinion of management, of a normal recurring nature.

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INDEPENDENT ACCOUNTANTS’ REVIEW REPORT

To the Board of Directors of McMoRan Exploration Co.:

We have reviewed the accompanying condensed balance sheet of McMoRan Exploration Co. (a Delaware Corporation) as of March 31, 2003, and the related statements of operations and cash flows for the three-month period ended March 31, 2003. These financial statements are the responsibility of the Company’s management.  The accompanying statements of operations and cash flows for the three-month period ended March 31, 2002 were reviewed by other auditors who have ceased operations and whose report, dated May 9, 2002, stated that they were not aware of any material modifications that should be made to those statements for them to be in conformity with accounting principles generally accepted in the United States.

We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants.  A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States, which will be performed for the full year with the objective of expressing an opinion regarding the financial statements taken as a whole.  Accordingly, we do not express such an opinion.  

Based on our review, we are not aware of any material modifications that should be made to the financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States.

We have previously audited in accordance with auditing standards generally accepted in the United States, the consolidated balance sheet of McMoRan Exploration Co. as of December 31, 2002, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flow for the year then ended (not presented herein) and in our report dated January 22, 2003 we expressed an unqualified opinion on those consolidated financial statements.  In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2002, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

/s/ ERNST & YOUNG LLP

New Orleans, Louisiana

April 22, 2003

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Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations.

OVERVIEW

In management’s discussion and analysis “we,” “us,” and “our” refer to McMoRan Exploration Co. and its consolidated subsidiaries, McMoRan Oil & Gas LLC (“MOXY”) and Freeport-McMoRan Sulphur LLC (Freeport Sulphur).  You should read the following discussions in conjunction with our financial statements, the related discussion and analysis of financial condition and results of operations and our discussion of “Business and Properties” in our Form 10-K for the year ended December 31, 2002 (2002 Form 10-K), filed with the Securities and Exchange Commission.  The results of operations reported and summarized below are not necessarily indicative of future operating results.

We engage in the exploration, development and production of oil and gas offshore in the Gulf of Mexico and onshore in the Gulf Coast region.  We were also engaged in the purchasing, transporting, terminaling, processing and marketing of recovered sulphur through mid-June 2002, when we exited that business.  For more information regarding our exit from the sulphur business see Note 2 of the Notes to the Consolidated Financial Statements included in our 2002 Form 10-K.

BUSINESS PLAN

 During 2003, we are continuing to pursue exploration activities on our lease acreage in the Gulf of Mexico, principally through drilling arrangements funded by third parties.   In addition, we are continu ing to address our reclamation obligations resulting from our discontinued sulphur operations.  Funding for a substantial portion of our Main Pass Block 299 (Main Pass) reclamation activities has been secured through a joint venture transaction (see “Joint Venture Activities” below) and we are continuing our pursuit of alternative business uses for the remaining Main Pass facilities.   We are focused on preserving our financial resources and our liquidity through carefully managing our operations and limiting costs in all areas of our business.  Events involving uncertainties, including those beyond our control, could have an adverse impact on our financial resources and liquidity. Some of these risks include fluctuations in oil and gas prices, our oil and gas production rates, our exploration results and our reliance on third parties to conduct exploration and development activities on our current prospects.  For information on these risks factors and others see “Risk Fa ctors” in Items 1. and 2. included in our 2002 Form 10-K.

While our current cash flows continue to be sensitive to market, operational and financial risks, we believe that the current oil and gas market conditions and projected production levels from our existing producing properties, among other factors, will enable us to continue to fund our operations and meet our obligations during 2003.

Over the longer-term, we must develop financial resources and secure financing for our operations through the discovery, development and production of oil and gas reserves, and the identification and exploitation of new business opportunities involving our Main Pass facilities and elsewhere in the energy industry through our affiliation with K1 Ventures Limited and its affiliates (collectively “K1”).  We believe our recent successful oil and gas exploration results, together with the significant exploration potential for our remaining acreage position and the opportunities to participate in new business development in the energy industry through our affiliation with K1, including the Main Pass alliance, position us to achieve our goals.

For more information regarding our affiliation with K1, including our Main Pass alliance, and our securing the proceeds necessary to fund a significant portion of our Main Pass reclamation obligations see Note 2 of the Notes to the Consolidated Financial Statements included in our 2002 Form 10-K.  For additional discussion of our Capital Resources and Liquidity Matters see Note 3 of the 2002 Form 10-K.  

DRILLING UPDATE

As previously announced, the South Marsh Island Block 223 (“JB Mountain” prospect) exploratory well was drilled to a measured depth of approximately 22,000 feet and was evaluated with wireline logs, which indicated significant intervals of hydrocarbon pay.  A production test was successfully conducted in early March.  The production test indicated a flow rate of 14.25 million cubic feet of gas per day (Mmcf/d), 1,056 barrels of condensate per day, and no barrels of water on a 14/64^ths choke. Flowing tubing pressure was approximately 13,300 pounds per square inch at the end of the test period.  The flow test of this well was limited by the testing equipment as to the rate at which it could be flowed.   Further engineering analysis indicates the well has a potential of producing over 60 Mmcf/d and 4,900 barrels of condensate per day, approximately 90 Mmcfe/d.  Initial production from the well is expected in mid-year 2003, but will be limited until additional facilities are installed.

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Drilling of the Louisiana State Lease 340 (“Mound Point Offset”) well commenced during February 2003.  The Mound Point Offset well was drilled to a total depth of 19,000 feet.  Resistivity measurements from a log-while-drilling (LWD) tool indicated significant intervals of potential hydrocarbon pay.  The well has subsequently been evaluated using wireline logs, which are more precise than LWD logs and the presence of these significant intervals of hydrocarbon pay has been substantiated.   

The JB Mountain and Mound Point deep-gas prospects are located in water depths of 10 feet in an area where we are a participant in an exploration program that controls an approximate 80,000-acre exploratory position including portions of OCS Lease 310 and portions of the adjoining Louisiana State Lease 340.  The program currently holds a 30.4 percent working interest and a 21.6 percent net revenue interest in the Mound Point Offset prospect.  The program currently holds a 55 percent working interest and a 38.8 percent net revenue interest in the JB Mountain prospect.  As previously reported, under terms of the program, the operator is funding all of the costs attributable to our interests in four prospects, including the JB Mountain and Mound Point Offset prospects, and will own all of the program’s interests until the program’s aggregate production from the four prospects totals 100 billion cubic feet of gas equivalent, at which point 50 perce nt of the program’s interests would revert to us. Under the terms of this program all exploration and development costs associated with any future wells in these areas will be funded by the exploration partner during the period prior to when our potential reversion occurs.

The program is planning two additional near-term wells in the OCS 310 and Louisiana State Lease 340 area.  We expect the Hurricane (JB Mountain Intermediate) exploration prospect at South Marsh Island Block 217 to commence by mid-year 2003.  In addition, drilling plans for the JB Mountain Offset well are currently being finalized, with an anticipated commencement date of mid-year 2003.

In April 2003, drilling commenced on the Main Pass Block 97 (“Shiner” prospect) No. 1 exploratory well. The well was drilled to an approximate depth of 9,300 feet and subsequent evaluation of the related data indicated that the well did not contain commercial quantities of hydrocarbons, resulting in the well being plugged and abandoned.  We participated in this well pursuant to our joint venture arrangement with K1 (see “Joint Venture Activities” below).   In February 2002, we sold certain of our lease rights in the Shiner prospect (see “Capital Resource and Liquidity” below); however, because the acquiring party decided not to participate in this exploratory well, these lease rights reverted to us. This is the third well drilled at the Shiner prospect, with the previous two wells resulting in discoveries during the fourth quarter of 2000.  Both of the se Shiner wells have been completed with initial production expected to commence later this year.  

Our current exploration acreage position consists of approximately 365,000 gross acres, including approximately 100,000 gross acres in the program.  Over the past two years, our exploration team has undertaken an intensive process to evaluate our substantial acreage position from a technical standpoint and this evaluation has resulted in a group of over 20 prospects being identified, including deep exploration targets for natural gas accumulations in the shallow waters of the Gulf of Mexico near existing production infrastructure. We are currently evaluating financing alternatives to provide funding for these prospects either through industry farm-outs or other financing.

Other

Drilling commenced at the Lighthouse Point – Deep prospect, located in a water depth of 10 feet, in June 2002.  The well was drilled to a measured depth of approximately 17,900 feet.  In February 2003, the well was determined not to contain commercial quantities of hydrocarbons and was plugged and abandoned.  We incurred no costs associated with the Lighthouse Point – Deep exploratory well, which was drilled in accordance with the terms and provision of the exploration program discussed above.

In December 2002, drilling commenced on an exploratory well at Garden Banks 228 (Cyprus prospect).  The Cyprus well was drilled to a measured depth of approximately 16,900 feet.  Evaluation of the drilling results determined that the well did not contain commercial quantities of hydrocarbons and the well was plugged and abandoned.  As a result, we recorded a charge of $0.1 million to exploration expense at December 31, 2002 for the related drilling costs incurred through that date, and we recorded an additional charge to exploration expense totaling $0.9 million for the remaining drilling costs incurred during the first quarter of 2003.

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We farmed out our interests in the West Cameron Block 616 field to a third party in June 2002.  We retained a 5 percent overriding royalty interest, which will increase to 10 percent after aggregate production exceeds an additional 12 billion cubic feet of gas.  The third party drilled two successful replacement wells and production from the field re-commenced during the first quarter of 2003.  

JOINT VENTURE ACTIVITIES

As previously reported, in December 2002, we formed a joint venture with K1 named K-Mc Energy Ventures.  We are managing th