BHP bails on a blase gas sector

There are at least two dimensions to today's announcement that BHP Billiton will sell its interests in the Woodside Petroleum-operated Browse LNG project. One is internal to BHP and the other relates to the controversies surrounding the project and the rapidly shifting LNG landscape around it.

The internal dimension is quite prosaic. As with the other major miners, once the commodity price cycle starting changing quite dramatically last year and gathered pace this year the extraordinary windfall cash flows the big miners were experiencing evaporated and a lengthy queue of mega-projects within their pipelines were abruptly put on ice.

For BHP that meant Olympic Dam and the Outer Harbour project at Port Hedland have been pushed far into the future, while marginal coal mines are being closed and the fate of its West Australian nickel business is now in question. It also sold its Canadian diamond business for $500 million.

From being awash with cash BHP's cash flows for the next couple of years are completely committed to projects still underway, which is generating far more scrutiny of assets that are marginal or regarded as non-core. The same kind of focus is apparent within Rio Tinto.

BHP's 8.3 per cent of the East Browse joint venture and 20 per cent in the West Browse joint venture are, for the world's biggest resource group, non-core and passive interests and therefore it isn't a surprise that they should be sold to PetroChina for a tidy $US1.63 billion.

There is, however, a backdrop to the manoeuvring within the $30 billion Browse joint venture, with obvious tensions between the partners at various times about the best way to develop it and a different level of tension with the WA state government and its insistence that there is only one option and one site for the processing elements of the project.

The government wants Browse's processing to occur onshore at James Price Point, despite the environmental controversies that is generating.

Shell has been promoting its floating LNG processing technology which it is deploying for the Prelude project and which would generate a considerable reduction in capital costs, but the government wants the investment and the royalties from an onshore facility. Other partners wanted to look at linking the project to the existing North West Shelf project's infrastructure.

BHP's Marius Kloppers has made it clear that he isn't comfortable that the options for the development of the project have been so limited and pointed to the option that partners had to exit the joint ventures, which BHP has now exercised.

The continuing debate about how best to develop Browse is occurring even as the costs of the mega LNG projects are blowing out, as evidenced by Chevron's recent disclosure that its $US37 billion Gorgon project is now expected to cost $US52 billion, and the firsts threats of structural change to the LNG market are starting to appear.

While the prospect of a flood of US shale gas-based LNG could easily be over-stated, even a relative trickle of that gas, which Shell's Anne Pickard has said has a 20 per cent cost advantage over Australian LNG, could have a material impact on LNG pricing and not just because of the extra and lower-priced supply.

Japan is trying to change the way LNG is priced. Where it is currently linked to the oil price, Japan wants it to be priced independently and is very keen to see US gas, which would use Henry Hub pricing, enter the market to force that change.

There is a real risk, given the scale of the cost blowouts occurring in the Australian offshore LNG projects, that despite the still-attractive economics of the LNG sector the competitiveness of Australian gas and the returns it could generate will be undermined by the extra capital and operating costs being baked into the projects.

The national interest would appear to dictate that these projects should be built as efficiently as possible, with that goal determining the best approach to developing them. Issues like the level of domestic investment or whether royalties will flow to the federal or state governments are secondary and could be sorted out by the governments concerned.

To the extent that green and red tape add to costs and the time it takes to bring the projects into the market, they also require focus from governments and significant and urgent change.

Unless the environment for Australian offshore LNG projects is made significantly more efficient and attractive there is a risk that the escalating costs and lengthening development phases will truncate the pipeline of new projects and the opportunity to rival and even displace Qatar as the world's largest LNG exporter will be lost, along with massive levels of export income.

We've already seen the investment boom in the hard commodity sectors of the resources industry peak and the pipeline of new projects abruptly truncated. There is a very real risk of a repeat of that experience in LNG if the settings aren't changed and the inflation in the cost of the projects isn't slowed.

BHP's isn't the first change in the equity structure of the Browse project. Earlier this year Woodside reduced its interest by selling an effective 14.7 per cent of the project to Japan's Mitsui and Mitsubishi for $US2 billion and earlier Chevron sold out of Browse via an asset and cash deal with Shell, with dissatisfaction with the development plan cited as its reason for exiting.