Within weeks of downgrading its Wheatstone resources, Woodside Petroleum has taken the red pen to its Pluto reserves. The company’s reserve life is diminished by these adjustments, but we understand this will not affect the merger ratio with BHP Petroleum.
WPL has upgraded its 1P reserves at its Greater Pluto asset, but has downgraded the 2P reserves by 10% to 356.5Mmboe. In a further twist, the company has changed from a deterministic method to a probabilistic method to calculate the reserves which is the opposite to what is convention in the industry for producing assets. WPL notes that it does use both methods but did not explain why it changed.
It is also normal for valuations of reserves to be based on 2P reserves, not 1P reserves, so the give and take within WPL’s books is not as relevant from the market’s perspective.
Investment view
The combined reserve downgrades at Wheatstone and Pluto have effectively reduced WPL’s 2P reserves by approximately 10% - a material amount.
As we understand it, neither of these reserve downgrades can trigger an adjustment to the merger ratio between WPL and BHP Petroleum. But it does raise the question as to whether BHP knew that WPL was worth less than the market thought it was worth. Further scrutiny of this through the merger documents may reveal more information but for now, investors are stuck.
The price of oil has risen 64% so far this year to US$85/bbl while WPL’s share price has increased just 1.1% in the same time. To be fair, Santos is up 10.8% and Oil Search is up 15.4% on the same time frame, so WPL’s performance is as perplexing as its Australian peers.
There is an air of inevitability over the final investment decision on Scarborough which is due before the end of this year. This remains a problematic asset, in our view. Scarborough will require net capex of around US$10 billion with an assumed payback of 7 years implying an average of US$1.4 billion pa. Allowing for some inflation and a realistic 20% cost overrun to build the project, or even snipping just US$1/MMbtu off the LNG price would effectively annihilate the value of this project. While oil and LNG prices continue to head higher, this outcome seems less likely but we make the point to highlight the investment risk associated with Scarborough. On its own, pre the merger with BHP Petroleum, Scarborough is risking approximately half the company’s market capitalisation.
The merger with BHP Petroleum may dilute some of these WPL issues over time, but it does not make them go away. Perhaps the merger will provide scope for greater introspection on the company’s strategy, but we realistically accept it probably will not.
We will maintain our Hold recommendation while so much important information is yet to be made public.
