The timing of BHP Billiton’s $US20 billion splash on US shale gas ultimately forced chief executive Marius Kloppers and his petroleum boss J Michael Yeager to voluntarily forgo their short-term bonuses. But increasingly, the damage to the company is also looking short-term.
The slump in US gas prices, thanks to a historic surge in production, landed BHP with a $US2.8 billion writedown on the Chesapeake Energy Fayetteville assets in August. Five hundred million dollars in goodwill was gone.
But as BHP changed its production emphasis from shale gas to liquids, hopes grew that the liquid-rich shale assets of the Petrohawk deal, particularly Eagle Ford and Permian, would quickly make up for Fayetteville.
Speaking to journalists at BHP’s Houston headquarters, Yeager agreed with the suggestion that valuation increases for Eagle Ford and Permian could match the Chesapeake writedown that caused the company so much embarrassment. The phrase used was "in the ballpark".
Yeager pointed to the latest purchase by Chevron and Shell of a comparable stake in the Permian as reason to think that BHP’s asset accounting numbers are about to improve dramatically. "These were cash and north of $US3 billion.”
While an accounting adjustment on the back of shale liquids will help reassure investors about the long-term benefits of BHP’s investment – as opposed to forking out dividends – the question for many of us is when the miner will pivot from shale liquids back to shale gas.
Yeager has previously indicated that $US3.50 per thousand cubic feet is the magic number. At the moment, Henry Hub spot prices have rebounded from lows of $US2Mcf to around $3.30Mcf, or 65 per cent.
"We want to get a little more confident in the gas price, but we’re getting that way everyday,” says Yeager.
Of course the flip side of that is that BHP has reassigned its rigs and personnel to shale liquids and they’re currently providing a compelling rate of return. The right time to reverse that decision isn’t seen solely through the prism of the return on gas (priced regionally), but also the return on liquids (priced internationally).
"We don’t want to disrupt that (liquid crews) because it’s so powerfully economic,” says Yeager. "So our choice today would be, quite honestly, a little tougher. Because now we’re talking about adding to those 45 rigs.”
As we all know, US gas prices are currently trading at a staggering discount to other markets. In Japan the same stuff is changing hands at around $US15Mcf, while in Europe sellers are getting up to $US9Mcf. If America were to start exporting gas, particularly to Japan, which is looking to fill that nuclear hole, it would change the dynamics domestically and internationally.
Yeager says BHP has been examining the prospect of gas exports, which would pit cheap US supply against much more expensive markets, including Australia. Japanese electricity providers are central to this push.
But if this is a major proposition requiring infrastructure to keep costs down, there are a few hurdles.
The biggest is the US government. Many shale gas proponents, most notably legendary investor T Boone Pickens, have expressed opposition to the notion of American gas for export. His preference is for cheaper domestic prices and US consumers will undoubtedly be swayed by that idea.
Cheap gas for domestic consumption and export are not necessarily mutually exclusive. But until very recently America hasn’t been in the position to address this question. Earlier this year, The New York Times reported that Japanese officials had implored Washington to look at export facility permits. The answer they got was ‘wait until after the election’.
Speaking in Houston a few hours after Yeager, 20-year Goldman Sachs veteran Bobby Tudor, now chief executive of energy investment consultant Tudor Pickering Holt & Co, underlined just how much of America’s gas industry is running at a loss and how BHP is positioned for the failure of some of its rivals.
"Of the 40 or so independent gas companies that we cover and research in the US, exactly two generate more cash than they use,” says Tudor.
The graph below shows North America’s gas assets in order of break-even prices, plotted against total production. The long-term gas price is thought to be around $US6Mcf and you’ll find the names associated with BHP – Eagle Ford, Haynesville, Fayetteville and Permian – sit a lot closer to the profitable left hand side of the x-axis than the right.
One problem delaying the unwinding of unprofitable positions is that once you secure acreage in the US, it’s ‘use it or lose it’. While there are other players shifting from gas to liquid like BHP, others won’t have the liquid assets or the logistical firepower to do likewise.
They will fall over and with them will go their supply, but what about demand?
The big obsession in the US is to what extent gas will usurp coal production (and renewables) as a source of power generation, as well as oil as a feedstock for industrial manufacturers.
On the first question, Tudor says that gas tends to be favoured for power generation until it starts to go beyond $US4Mcf. After that, the preference switches back to coal. However, while Yeager wasn’t speaking to the carbon intensity of gas against coal, he did point out that there’s no carbon pricing in the United States as yet.
"We certainly still feel, just like it’s happening in Australia, there will ultimately be some type of cost of carbon coming here” says Yeager, adding that it wouldn’t have mattered if Democrat Barack Obama had lost to Republican Mitt Romney. Carbon pricing is coming to the US; it’s just a matter of when.
That will give gas a little more headway against coal for power generation and those generators will be factoring that into their strategies. What about the manufacturers?
Whether it's steel equipment makers for shale gas plays or petrochemical companies looking for feedstock, huge amounts of investment are flowing into the US as manufacturers look to take advantage of the shale revolution. Thirty billion dollars has been announced for feedstock cracking facilities alone. These players include Dow Chemical, Formosa Plastics, Chevron Phillips Chemical, Shell Oil and Bayer Corp, among others.
The question is what price manufacturers can cope with before moving to other markets or shifting back to oil becomes more economic. Tudor believes it’s somewhere around $US4.50Mcf.
But again, the introduction of carbon pricing could have implications for this balance. With the longer-term gas price headed towards $US6Mcf, there’s a clear case for petrochemical companies to look into long-term supply contracts and vertical integration. Expect some epic partnerships.
Speaking to Business Spectator, PricewaterhouseCoopers industrial products leader Robert McCutcheon explains that the American ‘repatriation of industrial manufacturing’ is also a reflection of a ‘regionalisation’ of manufacturing supply chains globally. Translation: don’t put your feedstock too far away from your customers because something big could get in the way.
"Although we’re operating in a global economy, supply chains have tended to move to lower cost labour, notwithstanding the cost of transportation to get that product back to the market,” says McCutcheon.
"Now with rising transportation costs, combined with the greater visibility of supply chain risk and disruption (earthquake in Japan), companies are finding the cost side of transportation with risk.”
Alexander Liddington-Cox is Business Spectator’s North America Correspondent. He travelled to Houston as a guest of BHP Billiton.