BHP paying the price for the shale fail of 2011

BHP has thrown close to $US40bn at a new endeavour that is still not turning a dollar.

There was a lot of goodwill floating around the place for BHP Billiton when it finally got around to doing the inevitable by slicing $US7.2 billion ($10.4bn) pre-tax from the value of its onshore US oil and gas shale business.

It wasn’t deserved, remembering the writedown is the fourth since BHP’s $US20.1bn entry into the business in 2011 through a couple of acquisitions, and that almost $US20bn has been spent growing the business, and still it’s not cashflow-positive.

BHP’s writedowns now stand at $US13.1bn pre-tax, making the carrying value $US12bn, which is probably still overly optimistic by at least $3bn or so, given the miserable near- to medium-term outlook for the underpinning commodities.

The book value is not the issue here, nor is yesterday’s “non-cash’’ writedown. What is at issue is that in space of less than five years, BHP has thrown close to $US40bn at a new endeavour that is still not turning a dollar.

It’s a lot of money. It would cover five years of BHP’s 2015 dividend. It would be enough to buy Woodside and have change left over.

So it can be said the push into the US shale business has been a disaster. BHP’s Alcan moment if you like.

And like Rio Tinto’s (even more) disastrous mid-2007 acquisition of Alcan, the hope has to be that never again will BHP get things so wrong.

When BHP made the push into the shale business, money was pouring in the front door.

It was in 2011 that iron ore hit $US191 a tonne. It’s now $40 a tonne.

Copper was more than $US4 a pound. It’s now $1.98 a pound.

Coking coal was $US300 a tonne. It’s now $US80 a tonne. And finally, oil was more than $US100 a barrel; it’s now $US31 a barrel. The monster cashflows demanded some empire building. After the failure to pull off the $US40bn bid for Canada’s Potash Corp in 2010, and the 2008 tilt for Rio, the push into the US onshore was tantalising simple in comparison.

But it soon soured, with the crash in gas prices and the more recent crash in oil prices making it ill-timed.

And given the need to fuel the business with an annual capital budget of $US4bn to make it meaningful, it has proven to have been ill-conceived.

Ill-conceived because the very nature of the shale business requires heavy ongoing investment.

Unlike the traditional oil game, where it is a case of stand back and watch the oil flow after making the upfront investment, the unconventional space of shale oil requires an industrial approach to drilling well after well to maintain production, let alone grow output.

It would have been fine had the boom in commodity prices held together. But as BHP often reminded us all during the boom, prices would always revert to mean.

For a company with a (soon to be junked) progressive dividend policy, that meant that the demands from a forever capex-hungry shale business would never make sense. Maybe for the likes of ExxonMobil, but not a BHP.

BHP’s expertise is in the traditional oil and gas space. That is where it should have stayed. And it is no accident that is where its future focus will be under Andrew Mackenzie.

There is no point rounding up those responsible for the push into shale and marching them off the end of the pier.

The psychology of the 2011 boom prices — miners thought they walked on water — cannot be over-estimated.

And to be fair, the depth of the oil price crash in response to the rise of US shale oil production, and Saudi Arabia’s decision not to cut output to accommodate the new boy on the block, was not on the radar back in 2011.

But had BHP stuck to its patch — deepwater offshore — there would be no sorry headline today.