The shale gas revolution is igniting BHP's US fortunes

BHP Billiton might be committed to rationing capital across its portfolio but it seems that commitment doesn’t extend to its US onshore gas business.

Even with the more frugal mindset established by Andrew Mackenzie, BHP continues to plough $US4 billion a year into the US shale gas business established, at a cost of about $US20bn, by former chief executive Marius Kloppers three years ago.

It’s easy to see why. Even against a backdrop of falling oil prices and a rapid increase in the global supply of gas that is emerging, the US shale gas revolution continues. New LNG projects, particularly those offshore Western Australia plants and the three big onshore Queensland coal seam gas-fed plants, are about to further significantly increase supply.

BHP’s petroleum and potash president Tim Cutt gave a presentation  in New York overnight in which he was very upbeat about the performance and prospects of the US gas business.

That business is centred on the Eagle Ford formation in Texas, regarded as the best shale gas region in the US. Cutt said 75 per cent of BHP’s onshore US drilling and development expenditure in the year to June was focused on Eagle Ford.

Within BHP’s operations in southern Texas, the drilling was further concentrated on its liquids-rich Black Hawk acreage, which Cutt said generated earnings before interest, tax, depreciation and amortisation margins of more than 75 per cent at current prices.

Black Hawk is, he said, expected to be the single largest producer in the group’s entire petroleum portfolio this financial year. In the June quarter it was operating 284 producing wells with an average net production of 82,400 barrels of oil equivalent a day.

In the Permian basin in West Texas, BHP increased its position by 25 per cent last financial year. It says it remains on track to build a 100,000 barrels of oil equivalent a day business by 2017-18. Between Eagle Ford and the Permian basin, BHP expects to be producing about 200,000 barrels of oil equivalent a day by 2016-17.

This year the entire petroleum division is expected to increase production by five per cent to 255 million barrels of oil equivalent. Within that, onshore US liquids production is expected to rise 50 per cent, or by 17 MMboe. Higher-margin liquids are expected to account for 40 per cent of US onshore production and 65 per cent of revenue. The US business has become the division’s growth engine.

The mainly dry gas at Fayetteville -- BHP’s entry point to the US shale gas sector, which that was written down by $US2.8bn in 2012 -- is being left largely alone for the time being as the group focuses on the higher-margin liquids-rich acreage. With Henry Hub domestic gas prices above $US4 a unit, however, exploiting even that dry gas would generate attractive returns.

This year Cutt says BHP expects the US gas business to be strongly positive at the earnings before interest and tax level and free cash-flow positive next financial year, generating about $US3bn a year of free cash by the end of this decade. Even in BHP’s context, that’s a very sizeable business.

Cutt’s presentation explains why the capital-conscious Mackenzie is prepared to continue signing off on the $US4bn a year capex bill in the business. It’s a business that conforms to his productivity agenda.

Cutt said the repetitive, manufacturing-style nature of shale gas developments were "ideally suited" to the BHP agenda. It had achieved a 21 per cent improvement in drilling times at Black Hawk last financial year, reduced the variability in drilling performance and cut drilling costs by 29 per cent between the first quarter of 2012-13 and the last quarter of 2013-14.

BHP claims to be the best-in-class in recovered reserves and believes it can replicate its productivity successes across the rest of its onshore business.

The US shale gas business therefore fits neatly into a group that, with the announced demerger of assets that don’t fit Mackenzie’s criteria of tier-one basin assets, will contain only high-quality, large-scale and high-margin assets.

The liquids-rich assets within the portfolio allow BHP to focus on value over volume, while the learning curve BHP has been on since entering the sector is now helping to drive significant and continuing productivity improvements.

The plunge into the sector was controversial. The original Fayetteville cost Kloppers and the then head of petroleum, Mike Yeager, their bonuses. But the business is now close to more than justifying the investment in it.

While oil prices have fallen quite sharply in recent weeks, probably due to the weakening of both the European and Chinese economies as well as some increased production, the US economy has been strengthening, putting a floor under US gas prices and, if the recovery is sustained, something of a safety net beneath BHP’s shale gas operations.