BHP quietly cooking with gas

Marius Kloppers could have been permitted a wry smile last week as, with little fanfare, US natural gas prices edged above $US4 per MBTU for the first time in about 20 months.

Kloppers, of course, has worn heavy criticism at times for the $US20 billion plunge by BHP Billiton into the US shale gas sector through the $US4.75 billion acquisition of interest in the Fayetteville region of Arkansas from Chesapeake Energy in early 2011 and the subsequent $US15 billion acquisition of Petrohawk Energy.

It is the Fayetteville interests, bought when the gas price was above $US4 per MBTU, which have caused the most angst, with BHP writing the predominantly dry gas assets down by $US2.8 billion last year, a writeoff that cost Kloppers and his petroleum chief, Mike Yeager, their bonuses (they volunteered to forego them).

Unhappily for Kloppers and Yeager, the value of the Fayetteville assets was assessed as at June 30 last year, when the price was around $US2.70 per MBTU, having earlier dropped below $US2 per MBTU. Within months it was back up above $US3 per MBTU and it has kept creeping up towards the $US4 per MBTU that had been its long-term average.

BHP has essentially put exploitation of the Fayetteville interests on hold, focusing its drilling activity on the liquids-rich Eagle Ford shale assets. The group is spending, and plans to spend, about $US4 billion a year to develop the Eagle Ford and Permian Basin interests in Texas acquired with Petrohawk, which have exceptionally quick payback periods and among the highest returns in the BHP portfolio.

Yeager has said that at gas prices above $US3.50 per MBTU the returns from the Fayetteville assets would become attractive, although the super-returns from the liquids-rich shale would obviously be compelling in the current environment of lower prices for the hard commodities in the BHP portfolio.

If US gas prices remain above $US4 per MBTU, however, it would validate the original Fayetteville purchase (could the writeoffs be reversed?) and perhaps create a stronger appetite for more acquisitions by BHP in the US.

Kloppers will retire later this year. His successor, Andrew Mackenzie, has had considerable experience in the oil and gas sector with BP and – while he has committed to maintaining BHP’s strategy of being highly diversified even if that means restricting the growth of some divisions – could see shale gas as providing a medium term earnings buffer against the anticipated pressure on earnings from the group’s hard commodities as China’s economy enters a less steel-intensive phase.

The other aspect of the rebound in US domestic gas prices is that, if it is maintained, it will probably reduce the amount of US gas that might eventually find its way into international markets to compete with the raft of big Australian export LNG projects under development off Western Australia and at Gladstone in Queensland.

The US authorities are still wrestling with the issues created by the sudden emergence of shale gas and its implications for its own energy self-sufficiency and are yet to decide whether to approve a queue of applications to build export LNG facilities. At present only one facility has been given a go-ahead and there is a powerful lobby of US manufacturers arguing against exporting the gas.

Once the liquefaction, transport and re-gasification costs are added the US could sell Henry Hub-priced gas into the Asian markets today at a discount to the existing oil-linked prices Australian producers receive.

If US domestic gas prices continue to rise the margin for discounting would shrink and the economics of simply selling that gas through the ubiquitous US networks of gas pipelines, rather than investing billions of capital in LNG facilities to challenge established producers with long-term contracts with the major Asian customers, would become more compelling. If the economics of exporting the gas were attractive, of course, that would tend to push up US domestic gas prices and reduce that incentive to export.