Woodside’s Ongoing Woes

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This story features SANTOS LIMITED, and other companies.
For more info SHARE ANALYSIS: STO
The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

Back in September I discussed the ongoing issues surrounding the Santos ((STO)) GLNG coal seam methane project, the question of specific gas reserves to feed a second train, and the surprisingly cheap sell-down of a stake to Total. (Is GLNG A Fizzer For Santos?).

Since September Santos' GLNG fortunes have improved somewhat following a successful issue of hybrid debt in Europe to help with funding costs and, only last Friday, government environmental approval being granted albeit with a mere 300 conditions. But meanwhile over on the other side of the country, a similar story has been playing out.

While Woodside Petroleum ((WPL)) chugs along nicely on its legacy oil and gas assets such as the North West Shelf, the company's new Pluto project off the coast of WA is to Woodside what GLNG is to Santos – a potential share price re-rater. Both GLNG and Pluto have initial LNG trains underway and both are looking toward a final investment decision (FID) on a second train which, in both cases, is dependent on sufficient gas reserves.

When Santos released its September quarter production numbers recently stock analysts were unmoved. Production was in line but realistically any significant share price movement would be entirely driven by any further news on GLNG-2, they suggested. When Woodside released its equivalent production report on Friday, it was a case of pros and cons.

Production was ahead of most expectations thanks to a strong contribution from the North West Shelf while revenues were ahead of all expectations thanks to additional LPG sales. In the latter case, strong revenues were net of a fall in the natural gas price since the June quarter. These results encouraged most brokers to increase their earning forecasts for 2010 (WPL works off a calendar financial year).

This is all well and good, but it's not what will drive Woodside share price outperformance. For that, Woodside needs to achieve sufficient milestones at its Pluto project initially and then its Browse LNG and Sunrise floating LNG projects subsequently. The latter two are greenfield projects while Pluto-2 provides the only brownfield opportunity on the West Coast, which in BA-Merrill Lynch's opinion thus has the the potential to accelerate past other greenfield competition in the region.

Pluto-2 may be the great hope, but Pluto-1 is still being built and progress is frustratingly slow. On the release of its production report, Woodside announced that Pluto-1 was 94% complete but then as JP Morgan notes, it was 92% complete at the company's half-year result in August and 91% complete at its June quarter result in July. Not exactly rocketing along.

Pluto-1 has quite simply been continually disrupted by delays, and one of the main sources of delay has been industrial action. Industrial action is still ongoing and to date such delays, along with the rising cost of labour and equipment, has meant constant total capital expenditure assumption increases. Now there is a new problem.

As we approach the WA cyclone season, it appears the main Pluto-1 flare tower does not comply with cyclone-proof standards. Thus it will have to be dismantled and reestablished and other towers will also need to be properly built. This adds time and money.

Woodside will release its periodic cost schedule and evaluation report on November 11. Analysts will have a better understanding of progress thereafter, but it hasn't stopped them mostly reducing 2011 earnings forecasts assuming some delay. Macquarie notes that when the same periodic report was released last year, announced cost overruns were in the order of 10%. Analysts are either quite optimistic or rather pessimistic on Pluto-1's start-up timing.

Credit Suisse, for one, is sticking to the schedule of February next year. UBS has pushed its assumption out from March to April while Macquarie suggests mid-2011, JP Morgan says June and Deutsche Bank is assuming July. That's several months' worth of disagreement.

Yet whenever it might be that Pluto-1 is up and running, it is the planned second train which provides a lot of the share price upside potential. Woodside hopes to reach FID on Pluto-2 next year but to do so will mean being able to confirm sufficient gas feedstock before entering into a very expensive LNG train building exercise.

On that front, Woodside is hoping its exploration program will result in enough gas being confirmed. If Woodside can't find enough gas of its own, then it will have to buy in gas from nearby third parties and that cost will cut into earnings. Woodside's success rate from eleven wells drilled to date has been 55% which in gas exploration terms, notes JP Morgan, is a “solid” result.

But there have been no new gas discoveries announced since August, and the latest hopeful (Camus-1) has come up dry. Not that anyone cared (Sorry, that's just a little existentialist joke. Of course they cared.) Woodside is planning two new exploration wells before year-end and it's getting to the cross-fingers stage.

In the meantime, Woodside is reluctantly continuing with pre-emptive negotiations with neighbours Hess and Exxon-BHP Billiton ((BHP)) and analysts are beginning to feel this will be where the gas comes from for Pluto-2.

There was no new news forthcoming at the production report release regarding either Browse or Sunrise. There is also a Pluto-3 plan, but we might want to walk before running.

Since the end of 2008, Woodside's share price has risen from a low around $30 to an April peak around $55 before falling back to wallow near $45 ever since. In the same time frame, the oil price has jumped from US$30 to hover around US$80/bbl, although the natural gas spot price has been little moved. Not that the US natural gas price is particularly relevant to Asian regional LNG contracts, but there is no haste on the buy-side nevertheless.

Impeding Woodside's share price performance has been Pluto-1 delays and cost overruns and general Pluto-2 doubt. Santos has been having a similar experience. For either share to re-rate gas offtake contracts need to be secured on expansion projects and at the moment that timing seems like Chinese water torture. Analysts are leaning one of two ways.

Five of the eight brokers in the FNArena database have a Buy on Woodside for the simple reason Pluto will, if it ever happens, make a big difference to Woodside. Two brokers, along with Goldman Sachs, are on Hold citing concerns over Pluto costs and timing. One broker – Citi – is negative enough to suggest that Pluto-2 may need to be abandoned and gas finds to date used as back-up for Pluto-1. Citi has a Sell rating and prefers the prospects of Santos and Oil Search ((OSH)) which both have interest in the more advanced PNG LNG project.

Despite Woodside's surprisingly good quarterly production and revenue report, the consensus price target in the database has fallen from $50.77 to $50.20. Targets range from Citi on $42.91 to Credit Suisse (Outperform) on $54.90. The target range is consistent with the broker's range of Pluto-1 start-up expectations.

For the investor, it's a simple case of faith or lack thereof. Noting that the oil price has been stuck in a US$75-85/bbl range for some time now, a break-out might spark Woodside shares into life but underperformance is pretty much guaranteed until there is finally some good news on Pluto.

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