BHP's shale asset shift

With significant pressure from its shareholders after its $US20 billion plunge into US shale, BHP has signalled a significant change to its short-term shale strategy – it will be watching the investor reaction closely.

BHP Billiton’s petroleum chief executive Mike Yeager was expected to defend the group’s $US20 billion plunge into shale gas in the US when he fronted the Australian Petroleum Production and Exploration Association conference in Adelaide today and did, confirming a significant shift in BHP’s short-term strategy for exploiting its shale gas reserves in the process.

Despite the fact that BHP has portrayed the acquisition-driven entry into the US shale gas sector as a long-term, technology and capital-driven play, there has been a lot of speculation in recent weeks that the group would be forced into a major and embarrassing write-down of the investments it made last year because of the free-fall in US gas prices that has subsequently occurred.

The steep decline in prices – they have been as low as about half the prices that prevailed when BHP bought into the sector – is partly due to a mild US winter but is largely attributable to the advances in fracking technologies that has seen gas reserves and production in the US soar. The US now has the largest reserves of shale gas in the world, transforming its energy equations.

To, if not entirely avoid, then minimise the extent of any write-downs in the US – and any shareholder backlash – Yeager needed to create both a long-term and short-term narrative that validated BHP’s strategy despite the current pricing environment, with the emphasis on the near term.

BHP has done what it would have been expected to do. It has cut back significantly on gas production to focus on liquids until gas prices recover.

Yeager said today that early estimates for BHP’s Eagle Ford and Permian acreage indicated several billion barrels of liquids were in place and that BJHP was targeting recovery of about 1.5 billion barrels of liquids, or about 500 million barrels more than it outlined at last November’s investor briefing. BHP’s total onshore resource was about 8.3 billion barrels of oil equivalent within four giant fields with 50-year lives, he said.

That assumed single-digit percentage recovery rates, even though the industry had a record of more than doubling recovery rates over time as technology improved.

Moreover, BHP’s Eagle Ford resource, acquired as part of the $US15 billion acquisition of Petrohawk Energy, was, he said, rated as the lowest-cost play in North American liquids-rich shales and had among the highest returns and fastest paybacks of any of BHP’s investments, with many wells returning over 100 per cent and the average payback less than a year from first production.

Production from Eagle Ford was more than 50 per cent liquids, with production expected to grow to 300 Mboe a day, with 150 million barrels per day of liquids. In the Permian Basin area of Texas BHP says that, while it is still early, results had been better than expected and, with current production 80 per cent liquids, it was targeting a second 100 Mboe/d business.

Perhaps the best illustration of how significantly BHP has shifted its approach in US shale gas is that where previously it expected its drilling to be focused 52:48 between liquids and gas next financial year it is now targeting an 86:14 mix.

That provides some insight, not just in BHP’s response to the fall in gas prices, but the flexibility of its shale gas position and its ability to rapidly shift to a focus on liquids rather than dry gas. That flexibility, and the fact that paybacks are measured in months rather than years and the massive amounts of capital it takes to develop and generate returns from offshore has production, indicates why BHP sees shale gas as an important part of its overall energy portfolio and sees it ultimately as a global business where its capital and technological capacities and long-term investment time horizons can be deployed to competitive advantage.

One of the peculiarities of the US gas glut is that at a time when demand for LNG is soaring – hence the lengthening queue of massive LNG export projects in Australia – US gas prices have plunged. Conventionally that surplus gas would have found its way into the international market in search of oil-related gas pricing and that additional supply would have impacted the international price.

That hasn’t happened because the US has no export terminals for shale gas, although Yeager did say today that LNG export project applications now totalled 14 billion cubic feet of gas a day. If export terminals are built it would have a significant positive impact on the value of BHP’s US resources – and an adverse impact on the global supply/demand picture for LNG.

There is a view that the US, eyeing an historic energy self-sufficiency and structural boost to its competitiveness as a result of the dramatic increase in shale gas production, will be reluctant to create conduits for global pricing of that gas but it does need to encourage gas production. BHP certainly sees the US supplying LNG into the Asia Pacific region and, to a lesser extent Europe before 2025.

The big switch from gas to liquids production may help BHP minimise the extent of the write-downs it might face on its US shale gas assets and the up-beat assessment of the group’s position and prospects in the US might help dampen some of the shareholder unrest about the shale gas strategy and the size BHP’s financial commitment to it.

There is growing tension between BHP’s desire to keep investing through commodity cycles and increasingly aggressive shareholder demands that excess cash be return to shareholders and Marius Kloppers would be conscious that any significant ‘’stuff up’’ on a major investment would add fuel to that fire – and might scorch him and his management in the process. He, and his board, will be monitoring the reaction to Yeager’s presentation closely.

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