Woodside Petroleum formally announced two landmark deals that signals the beginning of an extremely high risk, high capital intensity and commercially irrational pathway for the company. The merger with BHP Petroleum, on its own merit, is a good decision, but it has given licence to WPL's almost reckless determination to accommodate the flawed Scarborough project in its portfolio.
Putting on our BHP goggles for a moment, CEO Mike Henry was presented with an opportunity to exit the company's very profitable and world class oil and gas business by merging it with WPL. BHP's strategy is based on what it calls 'future facing commodities' including copper, nickel, potash and iron ore, while exiting those commodities that do not fit this mantra such as thermal coal and oil and gas. So BHP needed little convincing that the merger with WPL was a good idea – it just needed to negotiate a good deal for its shareholders who will own 48% of the combined business by way of an in-specie fully franked dividend distribution of WPL shares on completion of the deal expected to be Q2 of 2022.
Concurrently, WPL has made its Final Investment Decision (FID) on the giant Scarborough project which has been made in conjunction with the Pluto Train 2 project. WPL currently owns 73.5% of Scarborough and will own 100% of it when the merger with BHP Petroleum is completed next year.
WPL says it has contracted 60% of the LNG output from Scarborough but that is misleading. The '60% contracted' is of WPL's 73.5% which will increase to 100% from the merger, or from BHP's put option should the merger not complete. In reality, only about 28mt of LNG is contracted with 8mt of that effectively a shift from existing WPL portfolio sales to Scarborough. With approximately 8mtpa of LNG on a 22 year reserve life (Scarborough), that means about 16% of LNG volumes are actually contracted.
WPL has adopted a fairly cavalier attitude towards the risks associated with Scarborough, even now that it has been approved. WPL will own 100% of the project post-merger and casually adds that the sell-down of the project (to whom and at what price and terms?) is underway. For a project costing US$12 billion, that is brazen.
WPL has stubbornly pushed for Scarborough gas to be processed through Pluto LNG and has made it happen with FID for Pluto Train 2 and the associated sell-down to GIP. One side effect of this strategy is the long term impact it may have on the North West Shelf LNG plant, right next door to Pluto LNG, in which WPL has a 16% stake, soon to be 33% when it absorbs BHP's stake in the merger. The NWS is already looking for more gas to keep its operations going and all logic suggested Scarborough could have filled that void, subject to some upgrade spending. But WPL decided Pluto would be the recipient instead. Which now leaves WPL with a bigger problem at NWS than before.
The Scarborough projects adds a significant 11.1 Tcf to 2P gas reserves (100% share) which increases WPL's total 2P reserves by 1.4 billion boe to 2.3 billion boe.
After the sell-down of 49% of Pluto Train 2 to GIP, WPL's share of the onshore capex for Scarborough is now US$6.9 billion, while the offshore component stands at US$5.7 billion.
There is still a substantial amount of information needed to properly assess the value of BHP Petroleum to WPL and this will help to understand the overall future shape of the merged portfolio.
BHP Petroleum's operating earnings are shown in the following chart which includes the US onshore assets up until they were divested in 2018.
Investment view
We understand WPL's enthusiasm to promote the positive elements of the BHP Petroleum merger and the approval of the Scarborough and Pluto Train 2 projects. They are indeed mammoth deals and we see the merger as highly promising in transforming WPL's future.
But we are disturbed at how little attention has been paid to the risk associated with the Scarborough project in particular. Taking 100% of the upstream risk of an LNG project of this magnitude is mind-boggling and even in the event of a promised sell-down to 50% still carries excessive risk, in our view.
We have a clear preference for Santos (merging with Oil Search) in the Australian E&P sector notwithstanding the risks involved with that deal.
The only factor holding us back from placing a Sell recommendation on WPL is the potential for the BHP Petroleum merger to deliver real value for WPL shareholders.
Source: WPL
