Why BHP is prepared to sell US shale oil and gas interests

BHP believes controversy over shale and the associated paper losses on shale investment are obscuring its cost reductions.

Andrew Mackenzie, chief executive officer of BHP Billiton Ltd. Picture: Bloomberg.

BHP has made a significant change in strategy — it is prepared to sell its US shale oil and gas interests if the buyers are prepared to pay the right price.

Six months ago, BHP, as a long term bull on the oil price, did not want to sell shale at current levels. But the relentless attack on BHP by the Elliott groups is taking a toll.

BHP believes that the controversy over shale and the associated paper losses on the shale investment are obscuring the dramatic reductions in capital and operating costs that have been undertaken by CEO Andrew Mackenzie and his team. Worse still, it’s germinating a company killing cancer in the short term thinking institutions that demands BHP stop developing new areas like Potash.

Nevertheless, all long term BHP shareholders will be hoping BHP directors don’t panic and sell shale at a low price as some institutions want them to do.

In this context I found it valuable to look more closely at BHP’s US shale oil and gas so as to better understand the strategic decisions facing Australia’s largest non bank company.

History is important. In 2011, BHP, at what was close to the top of the US shale boom, outlaid some $US20bn for a major stake in US shale oil and gas industry. Although BHP was

buying into a boom it expected the investment to deliver long term rewards and provide a skills base to enable global oil and gas investment in shale. The oil price collapsed and big world shale oil deposits proved to be confined to the US and Siberia. As expected, BHP’s mining expertise has enabled it to be one of the most efficient developers of shale oil in the US but with lower oil prices the expected rewards did not materialise. But there was a twist to the BHP shale tale. Some years after the big purchases were completed the executive who was appointed by Andrew Mackenzie to head BHP petroleum and sort out the BHP shale problem, Tim Cutt, took a fascinating non BHP-like step. He began pegging and acquiring shale areas in the so-called Permian/ Delaware basin, deal by deal.

BHP was a regular attender in the courts to gain approvals acre by acre. This was an area north of the boom acquired acreage and few others were interested. It was a magnificent call by Cutt and BHP on paper has made billions albeit insufficient to cover the losses on the $US20bn purchase.

Two other companies joined the Permian/Delaware race — US oil company Anadarko, which has a market capitalisation of about $US26bn, and world oil giant Shell.

The end result was a mess because each of the three players now need part of the others’ acreage to run an efficient operation. Because a deal needs to be done, both Shell and BHP have restrained their development expenditure in the Permian but Anadarko has spent large sums. This is a major world oilfield. BHP’s areas can produce 150 million barrels a day. If a deal is done the whole area can produce two or thee times that figure which brings us close to the maximum Bass Strait production.

There are three ways to go. First, the whole area can be combined and each of the three agree on a percentage stake in the total. Second, each of the three can swap parts of their areas so each has wholly owned efficient acreage. Thirdly, one or two of the parties can sell. We now know that if BHP gets the right offer it will sell — the total extraction basin costs are just above $US40 a barrel although some of BHP’s area will come in around $US25 a barrel. If BHP does not sell and holds a negotiated efficient stake in the Delaware/ Permian it needs to spend about $US2bn developing the area. BHP also has substantial commitments in the Gulf of Mexico so it’s total US oil development outlay will exceed $US4bn.

The other areas of the US shale operations consist of two gas production areas and a shale oil stake. With most of the development work undertaken in these areas their sale is about realising a defined cash flow, subject of course to the oil price. Macquarie estimated that Delaware/Permian is worth about $US4bn and total shale is worth around $US8-10bn. The total written down book value is $US14bn.

Whereas the Gulf of Mexico offshore operation links into BHP’s role as a middle sized oil player the shale technologies can’t be used elsewhere in oil production.

Australian institutions hate BHP in petroleum because the institutions undertake their energy research separately to other minerals, so they want BHP to sell oil/gas so their bookkeeping is improved. It’s a nonsense argument but that’s Australian professional share management 2017 style. Its one reason why so many Australians have their own superannuation fund.

Unless it receives a huge unexpected offer BHP does not intend to sell its Gulf of Mexico areas. Footnote: Tim Cutt left BHP last year to become CEO of Cobalt International — a Gulf of Mexico explorer/developer with debt challenges. Cutt also drove the BHP Gulf of Mexico push.