Woodside Petroleum is merging with BHP Petroleum at a time when the global oil price is geopolitically charged. The Independent Expert Report on the merger concluded the merger is fair. The deal does make WPL a better business, not just bigger, and it will generate a lot of cash in the near term. It does not, however, fix all the long-term challenges.
The most interesting part of the IER (Independent Expert Report) was the detail provided on BHP Petroleum which has hitherto been shaded by its iron ore cousin in the BHP family. The IER applied assumptions on future cash flows and capex and used a DCF (discounted cash flow) methodology to value each asset.
BHP Petroleum’s best assets are in the GOM (Gulf of Mexico), but we think the GaffneyCline (Independent Technical Specialists) approach to valuing them is too optimistic. Firstly, both Mad Dog (BHPP 23.9%, BP 60.5%) and Atlantis (BHPP 44%, BP 56%) are operated by BP whose epiphany on climate change raises doubts on its commitment to further investment in these assets, although we note that about half of BP’s 1P resources and 32% of its production is in Russia.
The 2P oil and condensate resources at Atlantis are 144.3 MMbbls at 31 December 2021. The IER anticipates this project producing 180 MMboe above its 2P reserves and 381 MMboe above 1P reserves which values it at more than US$56/boe on EV/1P. Given Atlantis forms 20% of the IER valuation for BHP Petroleum, this is not insignificant.
GaffneyCline has not provided post-2026 production for either Pluto or Scarborough due to ‘commercial sensitivities’. We see no logic for this omission relative to any other asset. We remain concerned about Pluto’s late life profile, underscored by the 10% 2P reserve downgrade in November last year. Could it be that Pluto’s production falls off a cliff sometime after 2026?
In addition, the IER valuation of Pluto includes the toll and infrastructure charges to Pluto 2, given they run to 2052, yet these charges remain a black box. In our view, this distorts any fair assessment of the underlying value of Pluto.
More positively, the merged balance sheet commences in great shape with gearing at less than 8%. Applying elevated prices for CY22 oil and LNG could generate operating cash flow above US$9 billion.
That will need to support capex of US$4-5 billion (assuming no sell downs) for the WPL assets and possibly US$1.6 billion for the BHP Petroleum assets although we have yet to hear of WPL’s plans for these assets, including exploration.
Until we can understand the combined investment strategy that is now competing for capital from a single balance sheet, we cannot write with confidence of the future capital management plans.
Investment view
The merger creates a more balanced geographical, production and customer mix than for WPL alone. The addition of the GOM assets reduces WPL’s heavy emphasis on Scarborough and Pluto although these remain very material within the enlarged portfolio.
On balance, WPL looks to be a better business with the BHP Petroleum assets in the portfolio, but care will need to be taken when considering the future production and capex requirements.
WPL’s dividend policy will remain unchanged at 50-80% payout of net profit after tax (excl nonrecurring items), subject to market conditions and investment requirements. The latter factor may prove to be influential in future dividends for the merged group.
Risks to investment view
The BHP Petroleum merger presents the main risk for WPL, followed by the execution of the new major project builds. Commodity price movements could affect earnings as would movements in the USD.
Recommendation
We have retained our Hold recommendation.
The IER set out its net cash flow projections to 2060 (Figure 1) in conjunction with GaffneyCline that shows a significantly boosted near term profile. This is particularly beneficial as WPL builds the Scarborough project, Pluto Train 2 LNG plant and the Sangomar project (Senegal) into production.
Additionally, WPL is planning to invest US$5 billion in new energy projects by 2030. The net cash flow profile excludes exploration expenditure.
