Woodside takes on a lot of risk as it bets big on its only option

For Woodside, the Scarborough gas field has gone from nothing to central to its existence in just five years, and the company has taken on an unprecedented level of risk to make it happen.

Success will be determined by how a volatile LNG market, a tight WA construction sector and a myriad of regulatory and legal decisions play out over coming years.

Gas from the Scarborough field would be processed 430 kilometres away at Woodside’s Pluto LNG plant near Karratha.Credit: Woodside

Monday’s commitment to develop the Scarborough field and pipe gas 430 kilometres to an expanded Pluto LNG plant at a cost of $US12 billion ($16 billion) will largely determine the future of the $21 billion company.

For a decade, Woodside struggled to find replacements for declining production from its original North West Shelf project and the Pluto fields that would follow later this decade.

When the Perth-based LNG specialist bought 25 per cent of Scarborough from BHP in 2016, it was just one more option to let it break away from being a two-asset LNG company.

The lead contender - the Browse fields off the Kimberley - fell victim to high costs and high emissions in a world that wants the opposite. In May, Woodside abandoned plans to develop the Kitimat project in Canada.

As the alternatives dwindled, Woodside’s commitment to Scarborough grew. It bought ExxonMobil’s 50 per cent share in 2018 but struggled to get BHP, which maintained a 25 per cent stake, committed to the project.

To get vital front-end engineering started in 2019, Woodside had to foot the entire bill as BHP would not put its hand in its pocket.

The two Australian resource giants were in very different positions.

BHP has a torrent of cash from near-endless reserves of Pilbara iron ore to finance growth in its “future-facing commodities” like nickel and copper that will see demand escalate as the world abandons hydrocarbon molecules for renewable-generated electrons.

Woodside’s gas cash cows, however, are in decline.

Hydrogen, which offers the prospect of diversification into an area where an oil and gas company could have some competitive advantage, is a decade or more away from having sufficient scale to replace declining LNG revenue.

Woodside needed Scarborough to fill the gap but selling down equity or securing finance to fund the investment proved difficult.

However, BHP wanted to sell off its petroleum division, as it was doing with thermal coal, to complete an exit from fossil fuels and present itself to investors as a supplier of green materials.

The scrip sale of BHP’s petroleum division to Woodside announced in August that will result in the miner’s shareholders owning 48 per cent of the new larger Woodside solved both company’s problems.

BHP freed itself of oil and gas in one package deal, avoiding the near-impossible task of selling its 50 per cent interest in ExxonMobil’s ageing Bass Strait operation in a standalone deal.

Woodside no longer needed support from a reluctant partner, and BHP’s assets gave it the short-term cash flow to finance the construction of Scarborough.

However, to clear the path for Scarborough, Woodside has taken on huge risks.

The BHP deal doubles Woodside’s exposure to decommissioning the North West Shelf project that both companies have a one-sixth interest in. More immediately, in the Bass Strait, 180 wells must be plugged and ten platforms dismantled under regulator’s orders in coming years, with more work to follow.

Woodside is betting cost estimates for both decommissioning old assets and building new ones prove accurate.

Woodside CEO Meg O’Neill now has to ensure the returns from the opportunity outweigh the risks taken onboard to obtain it.Credit: Janie Barrett

Construction of Scarborough and the additional LNG train at Pluto is expected to create 3200 jobs in WA, according to the state government. Another 2000 workers will be needed if privately-owned Perdaman goes ahead with a nearby urea plant that will use gas from Scarborough. Both companies will hope that when construction activity peaks in a few years the Pilbara labour market is very different to today.

The most significant risk may be committing to a long-term investment in gas as questions about its role in the energy transition grow, and the International Energy Agency declares new fossil fuel projects are incompatible with limiting global warming to 1.5 degrees.

Not only may the LNG market be weaker than producers hope, but it is also likely to be competitive. Energy consultancy Wood Mackenzie noted in its commentary on the Scarborough decision that current high LNG prices could crash about 2026 when Woodside expects first production from Scarborough due to a “supply glut” from new projects led by Qatar.

Woodside’s most unusual risk comes from its aggressive approach of making a final investment decision with a significant number of regulatory approvals not yet secured.

In a month, the validity of decisions by the WA Environmental Protection Authority essential to Scarborough will be tested in the WA Supreme Court. An adverse decision announced in the new year will test what appears to be a ‘too big to fail’ strategy of project momentum before regulatory prudence.

Despite accumulating risks to Scarborough producing a satisfactory return to shareholders, Woodside had the entire burden until a week ago as it could not find a buyer for equity in either the Scarborough field or the new second LNG train at Pluto.

US-based Global Infrastructure Partners has now bought 49 per cent of Pluto Train 2, but the extraordinary deal leaves much of the cost, schedule and regulatory risk with Woodside.

Woodside chief executive Meg O’Neill, who joined the company less than four years ago, is not responsible for Scarborough being Woodside’s only option.

However, with the investment decision made, her task now is to ensure the returns from the opportunity outweigh the risks taken onboard to obtain it.

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