Why Would Woodside Want Scarborough?

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Woodside Petroleum has surprised by acquiring a stake in the Scarborough gas fields, although brokers do see possible benefits for the North West Shelf.

-Economic and technical challenges a major hurdle at Scarborough field
-Varied interests create complexity in operational arrangements, options
-Scarborough likely to be low priority for JV partners ExxonMobil and BHP
-Transaction crystalises value in the asset for BHP
 

By Eva Brocklehurst

Woodside Petroleum ((WPL)) has bought a seat at the Scarborough gas field table, offshore Western Australia, from BHP Billiton ((BHP)). The transaction is in line with the company's previously stated focus on acquisitions in the sub US$1bn market and within its core competency. Brokers note it may bring a potential source of third party gas to be toll-treated at North West Shelf (NWS) once spare capacity is available as early as 2019/20.

The details of the transaction are thus: Woodside will pay US$250m on completion of the deal and another US$150m if final investment decision (FID) is reached, and the interests include half of all BHP's tenements in the Scarborough area.

This comprises a 25% interest in the majority of the Scarborough resource, with BHP retaining 25% and ExxonMobil holding the remaining 50% and operatorship. Woodside will acquire 50% of BHP's Thebe and Jupiter resources, adjacent to the main Scarborough resource, and become operator of these fields.

At first glance the decision to buy the stake may appear questionable, UBS asserts, given Woodside already has a 31.3% stake in the nearby undeveloped Browse gas fields. Yet, after the Scarborough JV delayed its plans to progress a 6-7mtpa floating LNG (FLNG) development, the broker believes the gas could find its way to the NWS as back-fill for existing LNG trains. In this way the acquisition metrics appear cheap to the broker, but only if there is a reasonable chance it eventually leads to commercialisation.

Scarborough gas is dry and the field is remote, with the economic and technical challenges a major hurdle. The current JV partners have flagged an FLNG facility as the preferred option, yet several brokers estimate that tying back the fields to an existing LNG terminal such as NWS, Pluto, Wheatstone or Gorgon would save substantial downstream investment.

The relationships are complex, with the likely operator, ExxonMobil, not holding any equity in Wheatstone, NWS or Pluto and BHP not holding an interest in Gorgon. Morgans does highlight the fact that Woodside has agreed to purchase the interests on the basis that it supports FLNG as the preferred, pre-concept, option.

Morgans, for one, would be surprised if Scarborough FLNG could be sanctioned at current market prices. Moreover, significant risk could emerge if development is initiated under the assumption that LNG prices will eventually rise to a level justifying investment.

A tie-back to NWS is likely to be more economic, with Macquarie calculating the cost would be in the vicinity of US$12-15bn as opposed to US$15-20bn for a FLNG development. Yet the broker highlights the fact the acquisition is long dated. Based on the current development scenario, FID is scheduled for 2019/20 and development 3-5 years, with the ultimate decision dependent on ExxonMobil.

Macquarie suggests first gas would not be available before 2023-25, around three years following the plateau decline anticipated at NWS. Still, the obtaining of an equity interest gives Woodside a handle on the project and the broker envisages the company will push for a NWS back-fill development.

While Woodside may be keen on the potential of Scarborough, the question for brokers such as Morgans is what it means for the two potential joint venture partners. ExxonMobil is observed to be cautious about Scarborough, having flagged development of both PNG LNG and Gorgon as higher priorities. Morgans also suspects the company's current brownfield growth prospects in PNG are likely to monopolise its attention.

BHP, in selling down its interest, is observed to be continuing its shift away from gas and towards liquids. The company has discussed at length its transition to a liquids focus amid preserving its free cash flow. Hence, Scarborough is also likely to be a lower priority, in the broker's view.

The transaction captures value for BHP from an undeveloped asset and reduces the company's capex obligations, Morgan Stanley notes, assuming the field is developed. While there has not been a gas asset deal in the region for several years by which to measure the transaction, the price per bcf, at around 2.5-3.0% of the current LNG price, is considered fair for an asset yet to reach FID.

The broker assumes Woodside's long-term goal is to back-fill NWS trains but notes this cannot be guaranteed, as ExxonMobil does not have an interest in NWS. Still, The Scarborough transaction displays similar qualities to the recent transaction in Senegal, Morgan Stanley observes, with a large resource being acquired for a relatively low price and with time on its side to compare options.

Ord Minnett agrees the transaction helps BHP crystalise value for an asset the market does not ascribe much weight to, but also highlights the fact BHP continues to envisage its advantage lies in North America for gas developments, once markets improve. Shale gas offers a shorter time to pay back and potentially higher internal rates of return with flexibility to ramp spending up or down. On this basis, Ord Minnett believes North America remains a more attractive long-term growth option for BHP.

Given the hurdles facing the development of Scarborough most brokers do not attribute much value to the asset in their models at present, either for BHP or Woodside. There are three Buy ratings, four Hold and one Sell (Credit Suisse, yet to update on the acquisition) for Woodside on FNArena's database. The consensus target is $29.96, suggesting 4.1% upside to the last share price. Targets range from $26.80 (Credit Suisse) to $34.15 (Citi, yet to update on the deal).

For BHP there are four Buy ratings and four Hold. The consensus target is $22.13, signalling 8.5% upside to the last share price. Targets range from $20 (Ord Minnett, Macquarie) to $26 (Morgans).
 

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