The theme of the second day of BHP Billiton Petroleum’s investor briefing focused on 'value over volume'. One might well ask why that wasn’t always the objective.
The answer is probably tied up in a number of factors, not least BHP’s $US20 billion ($A21.93 billion) plunge into the US shale gas sector. This occurred at a time when the group was awash with free cash at the very peak of the China’s inspired commodity price boom.
It also coincided with a sharp downward break in US gas prices as a direct consequence of the surge in US production.
That led to the embarrassing $US2.8 billion write-down of shale gas assets only relatively recently acquired, with personal financial consequences for former chief executive Marius Kloppers and former BHP Billiton Petroleum chief Mike Yeager.
BHP Billiton wasn’t alone in making mistakes in the land grab for shale gas assets. Shell has said it regrets its $US24 billion-plus plunge into the sector and most of the heavyweights had to write down the value of some of their assets when the Henry Hub price was around the $US2 mark. The price has since recovered, with gas now trading above $US4 per MMbtu.
As the investor briefing noted, this has also presented something of a learning curve for BHP Billiton and others given the relative brief history of large-scale shale gas exploitation. The more BHP Billiton has learned about optimising its shale gas portfolio, reducing extraction costs and improving recoveries, the more it has realised that shale gas plays to its strengths.
As it says, shale gas production is akin to a manufacturing process. BHP Billiton will be able to improve the productivity of its process to lower costs and improve recoveries to increase already attractive margins. Petroleum’s new head Tim Cutt says that across the entire BHP group, the shale business could offer the largest productivity opportunities.
While there has been some cost to the learning curve and BHP Billiton’s response to it – the original write-downs and a fresh $US270 million of charges disclosed in the briefing for terminating rigs and paying for underutilised pipelines – BHP Billiton has shifted its focus from its extensive dry gas acreage to its higher-margin liquids-rich holdings. BHP has a leading position in some of the most productive liquids-rich regions.
It expects to lift liquids production by 75 per cent this financial year. While there will be heavy depreciation charges – about $US600 million this year – there will be no earnings before interest and tax contribution this year, even though the business will have earnings before interest, tax, depreciation and amortisation margins approaching 60 per cent.
From 2014-15, earnings before interest and tax will start to climb steadily. BHP Billiton expects its shale gas business to be self-funding by 2016 and generating nearly $US3 billion a year of free cash flow by the 2020 financial year.
At a time when BHP Billiton is carving into its capital expenditure budget – lowering it by 25 per cent or more than $US5 billion this year, with plans to reduce it further beyond that – it still plans to invest $US4 billion a year in the business, as part of an overall budget for the petroleum division of about $US6.2 billion. It expects to be producing about 200,000 barrels of oil-equivalent a day from its liquids-rich Eagle Ford and Permian acreage.
If it wanted to, it could spend more and profitably extract dry gas at still-attractive margins and returns at today’s US gas prices. But, as it said, it can defer that investment without losing value. There is a real option value to those dry gas reserves that exists regardless of whether it is exercised any time soon.
The concentration on the highest-yielding acreage fits with Andrew Mackenzie’s broader approach to the BHP portfolio. The capital available to the businesses within the diverse portfolio will be rationed to force the business units and individual projects to compete and ensure that the lower-risk, higher-return, less capital-intensive expansions are prioritised.
The US onshore gas business – and the entire petroleum division – is also reshaping its holdings. It is looking to sell some of the less productive segments of the portfolio while still in the market for assets that would add to its liquids resources and conform to the new emphasis of value over volume.