There was a time when an update on BHP Billiton's (BLT) petroleum division would have generated a degree of interest, though not out of keeping with its 10%-15% contribution to equity value. Times have changed and with rampaging energy prices and recent major energy acquisitions, the petroleum division is no longer an also-ran concern. A November shale gas briefing from BHP Petroleum CEO Mike Yeager was keenly anticipated.
BHP's petroleum division accounts for just more than a third of our group valuation. That's the largest contribution from any segment unless you lump coking coal in with iron ore and manganese as carbon steel materials, generating more than 40% of group value. Petroleum's contribution to group EBIT was just 15% in fiscal 2011 but by mid-decade that share is likely to more than double, despite strong competing growth from iron ore and coking coal. Most of the proposed expansion comes via recent U.S. shale gas acquisitions and their ongoing development.
Not much has hit the score sheet to date with just 40 days' contribution from Petrohawk's onshore U.S. properties registering in BHP's first quarter 2012 operational report. BHP paid $15.1 billion for Petrohawk Energy in August this year, that on the heels of the smaller $4.75 billion acquisition of Chesapeake Energy's Fayetteville shale assets in February. Chesapeake brought 487,000 acres of shale gas real estate, increasing BHP's net reserve and resource base alone by 45% to 5.4 billion barrels of oil equivalent (boe). The larger Petrohawk deal brings 1 million net acres and 5.8 billion boe total risked resource base, doubling already enlarged net group resources to 11.3 billion boe--triple BHP's June 2010 status. Based on resources acquired, BHP is now the seventh-largest independent upstream oil and gas company globally, up from 21st.
The presentation from Yaeger reinforces the potential. Petroleum output is set to rise 45% on fiscal 2011's 155 million barrels oil equivalent (mmboe) to 225 mmboe in fiscal 2012, essentially all U.S. shale gas. Then combined with major growth in Western Australia and a re-invigorated Gulf of Mexico, shale is set to inflate annual group production to more than 365 mmboe by fiscal 2015, potentially reaching as high as 580 mmboe by fiscal 2020. A cumulative annual growth rate of more than 10%, including a quadrupling in shale gas output to 365 mmboe to more than 60% of group total.
Clearly BHP believes shale offers it the ability to rapidly increase gas volumes and earnings. It states it has the largest amount of the best acreage in the highest producing gas fields in the U.S., including Haynesville. Assets are long life, expandable and low cost. Cash operating costs are low by industry standards, $1.90 per thousand cubic feet gas equivalent (mcfe) or $2.60 including depreciation. The aim is to improve the cost position further by doubling the percentage of liquids produced by fiscal 2015, via scale on service contracts, by optimising well spacing and through advances in fracking techniques.
On environmental opposition BHP goes to considerable pains to disassociate shale gas from coal bed methane (CBM). Shale gas holes are over a kilometre deep, well below and without the interaction of shallower CBM holes to the water table. The surface footprint is minimised by drilling as many wells together from one location as possible. And shale does not produce the water that coal seams do. We doubt BHP's shale gas plans will progress uncontested by environmental groups or without some community unease. But the long history of fracking in the U.S. combined with the opportunity to reduce reliance on energy imports would seem strong motivators for ongoing development. No change to earnings forecasts or valuation.
The above is an excerpt from Morningstar equity analyst Mark Taylor's research report on BHP Billiton. Read the full report, including fair value estimate, earnings estimates, and investment thesis, by clicking here. Morningstar Equity Research is available to Premium subscribers--find out more here.
