Woodside's hot spots gamble

PORTFOLIO POINT: Woodside appears to be moving up the investment risk chain as it explores deals in Burma and Israel. But are investors ready for more risk?

Israel and Burma are not low-risk countries, which is why Woodside Petroleum’s proposed entry into both countries raises doubts about its promise to take fewer risks – unless the prize is so big that management cannot resist the temptation.

Whatever the correct answer, and a few interesting possibilities are starting to surface, the appeal of Woodside to conservative investors has declined.

The reason for shifting the stock from being a key component in a balanced portfolio into a higher-risk category is that Woodside is embarking on a hunt for growth options.

While such a pursuit is admirable, if not essential given the company’s failure to find local growth options, Woodside has an appalling record of mucking up all previous international growth forays, whether into the Gulf of Mexico, Libya, Kenya, or Mauritania on the west African coast.

It is only within the past three years that Woodside, at the urging of its major shareholder, Royal Dutch Shell, abandoned its international search for growth, retreating to the comfort and relative certainty of Australia, and its backyard in the waters off the north-west coast.

Israel and Burma might be different to Libya and Mauritania, but Woodside management would have to say that or it wouldn’t be taking the company on a tour of global hot spots.

For investors jaded by the frequent failures of Australia’s biggest pure-play oil and gas company, an explanation of the potential move into two countries better known as trouble spots is clearly required, but not yet forthcoming.

Ratings agencies such as Fitch would undoubtedly appreciate an explanation, having just upgraded its outlook for Woodside from negative to stable because of the “more conservative strategy” of the company’s chief executive, Peter Coleman.

What Fitch liked was the strong cash flows being generated by the newly-completed Pluto LNG project, and the expanded production forecast to an annual maximum of 86 million barrels of oil equivalent compared with a previous maximum estimate of 83mboe.

Concern in the market about Woodside’s bid for assets in Israel and Burma appeared to weigh on the stock today, with its 1.5% share price slide topping widespread declines in the oil sector that was pulled down by the lower oil price. Most other oil stocks fell by about 1%.

Of the deals announced in the past week, the Burma play is the lower risk of the first major foreign forays since management control at Woodside passed from its previous high-risk, high-reward, chief executive, Don Voelte, to the far more conservative hands of Coleman, a former ExxonMobil executive.

What Coleman is proposing for Burma looks to be a conventional exploration move into a country close to Woodside’s home base in Australia. It will not be expensive, and very much along the lines of a first look.

Israel is very different, and no-one needs a lesson in why it is regarded as one of the world’s riskiest addresses for anything, let alone a multi-billion-dollar plunge by a relatively small and accident-prone Australian oil and gas company.

So, what is it that attracts Woodside to Israel and its near island neighbour, Cyprus?

There are four possible reasons which collectively might provide an answer to that question, but whether any justify the risk involved is a question that will have analysts scratching their heads for some time.

The attractions of the eastern Mediterranean are:

• Huge gas discoveries by a consortium of US and Israeli companies in waters bordered by Israel, Lebanon and Cyprus;
• A need for those companies to secure a partnership with a company that has LNG and deepwater gas production experience;
• An invitation from the Israeli Prime Minister, Benjamin Netanyahu, for Australia to lend a hand; and
• The pressure that investing in Israel might apply on Shell to sell its residual 23% stake in Woodside.

The gas discoveries, while largely unknown to most Australian investors, are a major talking point in the Middle East and the US.

Not only do they promise to resolve Israel’s long-running energy supply shortfall, but they promise to be a lightning rod for fresh disputes between neighbours. Money always does that.

Until now, ownership of the Tamar and Leviathan gasfields, has rested with a consortium of Israeli and US companies: Delek and Avner from Israel, and Noble Energy from the US.

None of the current owners has LNG or deepwater gas production experience, triggering a worldwide hunt for a partner with those skills, plus strong cash flows to help pay for the development of the gasfields.

Enter political connections (Netanyahu in talks with Australia’s Workplace Relations Minister, Bill Shorten), followed by Woodside, which sent Coleman to Israel last week for talks with Netanyahu.

Missing from the list of invitees to the Israeli gas party are the usual suspects of global oil and gas such as Coleman’s former employer, ExxonMobil, and Woodside’s biggest shareholder, Shell.

Why?

The answer is that none of the oil majors dare invest directly in Israel or they risk jeopardising their much bigger investments in other, Arab-controlled (anti-Israel) Middle East countries.

In other words, Israel is too hot for the oil majors to handle, but perhaps not for a small Australian company with growth ambitions, possibly in joint venture with a Far East partner such as Korea’s Daewoo, which is teaming up with Woodside in Burma.

For Woodside investors, and that especially means Shell, there is huge uncertainty about what happens if their company wins a slice of the 17 trillion cubic foot Leviathan gasfield, and emerges as the leader of an Israel-based LNG development?

The aftershocks of a Woodside win could be profound, such as:

• Elevating the company’s risk profile even higher, because a multi-billion-dollar LNG project in Israel would be a prime target for that country’s aggressive neighbours;
• Force Shell to accelerate its sell-down of Woodside shares, a process started two years ago; and
• If Shell sells, who could emerge with its 23% stake in Woodside.

Whatever does occur in the next few weeks, investors would be wise to look at Woodside in a different way than they did as recently as last month.

It is no longer the near-annuity they saw, reaping cash off domestic oil and gas production and paying handsome dividends.

Woodside is a company chasing growth, but it’s doing it in a way which significantly raises risk (and the potential reward), and its past pursuits of global growth have all failed.