A small puff

SALE OF 10% INTEREST IN SCARBOROUGH

Need To Know

• WDS agrees a three-part US$880m deal with LNG Japan, including a 10% stake in Scarborough for US$500m.
• Sale partially de-risks WDS's exposure to the US$12bn Scarborough-Pluto developments.
• Risk and reward look finely balanced. Still a Hold recommendation.

Investment Implications

After a prolonged effort, Woodside has sold down part of its giant Scarborough joint venture to a Japanese partner for approximately US$500m. The sale partially de-risks WDS’s exposure to the broader Scarborough-Pluto LNG projects but not to the extent previously envisaged. The deal also signifies the willingness of foreign businesses to enter into energy deals in Australia, despite the current shambles that is Australian energy policy.

What is Scarborough?

In 2016 when WDS acquired its initial 25% stake in Scarborough from BHP for about US$400m, industry consultants Wood Mackenzie estimated the development cost at US$7bn assuming the gas was piped onshore to the existing NWS LNG plant. BHP and ExxonMobil had sat on the project for a long time and regarded it as a low priority. In 2018, WDS raised A$2.5bn equity to fund 50% of Scarborough lifting its exposure to around 6.4 Tcf of gas. At this point, WDS had decided to use the adjacent Pluto LNG project rather than the NWS. A 430km undersea gas pipeline would connect the Scarborough fields to a new Pluto Train 2 LNG plant to produce approximately 5mtpa of LNG and a further 3mtpa from Pluto Train 1.

In November 2019, WDS booked a 52% increase in the volume of gas in Scarborough to 11.1 Tcf which happily (for WDS) pushed the project above its 12% rate of return hurdle. At that time, WDS said the whole project (Scarborough and Pluto Train 2) would cost US$11.4bn with the offshore costs put at US$5.3bn and the second LNG train at US$6.1bn. Updated pricing from contractors in August 2021 pushed the cost up to a revised US$12bn (US$5.7bn offshore, US$6.3bn onshore) that included an 8% increase in offshore production capacity to 8mtpa. The August 2021 announcement that WDS would acquire BHP Petroleum brought 100% of Scarborough under its control and effectively paved the way to a Final Investment Decision – an extremely risky approach for an LNG project of such size. The additional twist was the commitment to the second train at Pluto for which the tolling terms have not been publicly disclosed instead of processing the gas at the NWS which has increasing amounts of spare capacity.

November 2021 saw the FID for Scarborough and Pluto Train 2 developments. WDS claimed the projects have a 13.5% rate of return on investment and a (fast) 6-year payback period and targeting its first LNG cargo by 2026. Approximately 60% of Scarborough gas was committed to customers on long-term contracts, mostly across Asia.

Is this a good deal for WDS?

WDS has tried valiantly to sell down its exposure to Scarborough but without success until now. Chinese interests were close to a deal before trade relationships between Australia and China turned to porridge.

At face value, the sale of a 10% stake in Scarborough seems modest although the US$500m price tag is broadly generous, in our view.

LNG Japan, a joint venture between Sumitomo Corporation and Sojitz Corporation, will reimburse WDS for its share of expenditure from 1 January 2022, the effective date of the transaction. On completion expected in early 2024, the total consideration will be approximately US$880m to WDS.

LNG Japan has agreed to purchase 12 LNG cargoes per year, amounting to about 0.9mtpa for 10 years commencing in 2026.

Sumitomo and Sojitz will also participate in new energy opportunities alongside WDS including ammonia, hydrogen, carbon capture and storage (CCS) and carbon management technology. WDS had already committed around US$5bn towards new energy projects as part of its decarbonisation strategy.

In our view, even a relatively small de-risking of Scarborough is a positive deal for WDS. Together with the ~US$880m of proceeds heading into WDS’s balance sheet, this deal could assuage some of the doubters about WDS’s risk profile.

Investment View

Scarborough may possibly be the last giant LNG project to be built in Australia for some time. For WDS to enter into FID owning 100% of the risk was a highly unusual approach so the announcement of a selldown is indubitably welcomed. To be clear, at 90% WDS still carries a very large risk exposure regardless of the much touted double-digit rate of return.

Qatar’s giant US$30bn North Field Expansion has attracted a who’s who of global energy companies interested in helping Qatar expand its annual LNG production from 77mtpa to 126mtpa by 2027. With competition like that, it is understandable why WDS has not attracted much interest in Scarborough.

The Scarborough-Pluto Train 2 developments are about 40% complete and are presently on target for first cargo in 2026. The near-term capex profile has the development consuming about 50% of the FY23 capex budget of US$6.0-6.5bn.

With the Gulf of Mexico developments and Sangomar also well underway, WDS has a stronger development pipeline than it has had for many years. The balance sheet leverage will need to be closely scrutinised although we note the dividend payout policy has already been revised to retain a greater proportion of earnings. WDS is devoted to maintaining its BBB+ investment grade credit rating. The target gearing range is now 10-20% through the cycle, down from 15-35% previously.

Global oil and gas prices have trended lower for much of the last year reflecting concerns over slowing global economic growth. As interest rates appear to be peaking, these concerns are giving way to the reality of lower global oil supply causing prices to begin to steadily rise. In 2022, the world’s largest E&P companies (ExxonMobil, Chevron, Shell, BP, TotalEnergies) reported record US$196bn in net profits but chose to return much of it to shareholders in dividends and share buybacks rather than investing in new supply. The IEA estimates that global upstream E&P spending has fallen to US$400bn in 2022, sharply down from US$900bn in 2014.