MY TRIP to Texas as a guest of BHP and my subsequent talks in New York with economists, analysts and investment bankers in New York about America's shale oil and gas production boom meanwhile underlined that BHP Billiton got its biggest shale deal in the US right. The growing consensus on Wall Street is also that the US shale boom is a global economic and geopolitical game-changer.BHP's first purchase of shale gas leases in Arkansas for $US4.6 billion was fully valued at the gas price of the day, and the $US2.84 billion write-down the group announced in August was arithmetically generated as US shale gas production soared, and US gas prices plunged.
The group's subsequent $US15 billion takeover of US group Petrohawk at 65 per cent premium to Petrohawk's market price could produce an asset valuation uplift this financial year that more than compensates for the first write-down.
BHP can still earn returns of more than 20 per cent by developing gas wells in Arkansas, but it is aiming instead to increase production of oil and other liquids that are roughly four times more valuable by 15 per cent in 2012-13 by redirecting the vast bulk of its $US4 billion shale capital expenditure budget to Petrohawk's oil and liquids-rich fields in Texas.
In New York, the big bulge-bracket banks are all doing their sums on the shale boom. One estimate of the value transfer from the rest of the world to the US is already $US900 million a day as US domestic production grows and imports fall. That's an amount equal to 2.2 per cent of raw GDP, but what the US does with the income windfall is the key, as it was here during the commodities boom. To the extent that the new income finances consumption of imports, for example, domestic benefits of the boom will be lower.
The US will certainly benefit from cheap domestic gas that will deliver cost benefits to heavy industries including petrochemical plants and power stations, but the horizontal drilling and rock-fracturing technology that is freeing up shale gas and oil will ultimately generate sweeping global changes.
Shale oil can be commercially exploited at oil prices as low as $US80 a barrel, and as shale oil volumes rise, oil price spikes in response to accelerating growth in demand that work to slow demand again will be much less frequent. Shale oil, in other words, is going to raise the maximum speed limit of the global economy. I will have more about the amazing shale boom and BHP's piece of it in coming columns.
Saturday, 24 November 2012
Monday, 27 August 2012
Australian mining giant BHP has lost a quarter of its former market capitalization since its acquisition of US shale acreage from Petrohawk and Chesapeake last year. The company is keen to point out that worldwide economic conditions have impacted the price and volume of the commodities that BHP extracts and sells on a global basis. BHP’s US shale gas assets are part of its declining performance. Having paid a whopping $19bn for the shale plays in 2011, BHP now faces serious write downs. Ruud Weijermars and Matthew Hulbert ask the serious question whether the lost value simply is a result of changed market conditions - or was the acreage already worth much less at the actual time of its purchase by BHP?BHP management concedes it is currently assessing the near-term gas price effect on the value of its gas properties acquired last year from Chesapeake (CHK) and Petrohawk (HK). To many industry analysts this is no surprise; the economic fundamentals of US shale gas production and reserves were already questioned long before the BHP sales went through. Petrohawk had never managed to earn any operational profit from its shale gas assets over its 15 years of operations. HK sold gas below the full-cycle production cost and its accumulated losses amounted to some $1 billion when the company was bailed out by BHP last year.
In short, Petrohawk was a ‘precursor’ to Chesapeake’s recently publicized cash-flow crunch predicament. The lack of access to financing, combined with overleveraged debt and lack of operational earnings from gas wells meant one thing: sell assets quickly. One can confidently conclude that HK shareholders were remarkably lucky to receive a very handsome price – twice the market value - for their distressed gas assets in June 2011.
In our opinion, a significant portion of HK’s formerly ‘approved’ gas reserves more likely than not was overdue for downgrading to ‘contingent’ resources by the time of their sale to BHP. In ball park terms, that’s the difference between gas assets that can be produced commercially at current prices, and those which can’t ...
The core of the problem with shale acreage valuation is that the net present value of gas reserves has become as volatile as the gas price itself. But companies have been slow in exercising due diligence if not outright reluctant to depreciate assets. In spite of the low gas prices in 2009, 2010 and 2011, companies like Chesapeake and Petrohawk continued to aggressively book proved undeveloped reserves (PUDs). Both Petrohawk and Chesapeake needed these new reserves on their balance sheets - without these reserve additions, they would have landed into collateral default. And although SEC rules mandate companies must duly impair PUDs when overall project cost have become uneconomic, PUDs now account for nearly half of CHK’s (and former HK’s) proved reserves. Chesapeake’s reported proved reserves comprised 42% PUDs in 2009, and the proportion grew to 47% in 2010, and settled at 46% in 2011.
Oddly enough, once a company has sunken the cost for well development of a PUD, the developed proved reserves need only be impaired if the annual cash flow turns negative, which would require gas sales to dip below operating expenses. In the well’s subsequent life-cycle, SEC rules leave room for continued classification of a well’s resources as reserves, as long as annualized cash flows remain positive. This encouraged companies to continue quickly sinking cost in wells that may not, in fact, ever have been economic (on a full cost basis) in the first place. By doing so, companies quickly 'prove' the reserves of a new shale gas play, and the acreage value rises. This also means that many US shale gas companies have essentially ignored full cycle economics. The sunk cost game continues even today.
Investors still appear prepared to bear the cost, but may not be fully aware of the additional risk.
With gas prices plummeting, the SECs former ’premium label’ of proved reserves has lost its stable foundation. In fact, full cycle economics for the majority of US shale gas plays has been largely negative for the past four years. The SEC has been lenient and one might speculate that overly aggressive reserve reporting appeared an affordable governance risk for shale gas operators. There has been no favourable gas price for adding proved reserves, yet unconventional gas companies have booked reserves by operating aggressively on a sunk cost basis. As a result, US shale gas investments have now become less secure than the reported reserves suggest – something investors seem to haven glossed over far too lightly.
Thursday, 8 December 2011
It may seem somewhat audacious for a company with a market value of $16 million to propose a world-leading energy project nearly one hundred times its value. But, says Petratherm managing director Terry Kallis, if you don’t dream, you don’t get. And he just happens to think he’s sitting on a unique opportunity.
Kallis, on Wednesday, outlined his vision for a $1.5 billion clean energy precinct in the outback of South Australia that would take advantage of the unique combination of geothermal, solar and wind energy resources, the intersection of major gas pipelines, and the proximity of the world’s largest mine and other major developments.
The big opportunity is, of course, to service the massive energy demands of BHP Billiton’s proposed Olympic Dam expansion – which could be more than 700MW at that site alone – as well as other mine proposals or expansions such as Prominent Hill and Carrapateena. Mine managers do not normally think along the lines that Kallis has proposed – they will simply build a new transmission line if a connection is close enough, or build enough gas or diesel to ensure the operations keep going 24/7.
However, BHP Billiton have shown that they are willing to consider all options. As we reported in May, the world’s biggest mining company is effectively hedging its bets around the supply of energy and, after conducting a detailed analysis, is willing to concede that geothermal and solar power have the potential to offer the cheapest form of emissions reductions by the end of the decade, if not earlier, and the cheapest form of energy.
Kallis’ idea is to show BHP the path to get there, and to keep their options open as long as possible, so that they can take advantage of the opportunities when the new technologies are bankable, and can deliver at the costs anticipated. Kallis, of course, has great interest in this, because his company proposes to supply the geothermal energy – and Olympic Dam is too good an opportunity to let slide. "We want to make sure we don’t lose the opportunity to get geothermal into that market," he says.
Kallis proposes to create a clean energy precinct on the Moolawatana cattle station around 50km north of Petratherm’s Paralana geothermal prospect, and just over 200km from Olympic Dam. The plan calls for an initial 300MW of capacity – mostly gas sourcing fuel from the passing Moomba-Adelaide gas pipeline, and wind – and have that ready by 2016, around the time Olympic Dam would need it. The wind resource is not officially documented, but the cattle station’s name comes from the local indigenous word for “windy place", so Kallis expects that should not be a problem.
The idea is then to add another 300MW or so of geothermal and solar energy as those technologies mature by the end of the decade, and around the time Olympic Dam would be contemplating its next stage of expansion. The mixture of those four energy sources should provide the miner with the confidence of a secure supply. Kallis says they will be able to deliver attractive hybrid products that lower electricity costs and improve reliability, while also reducing carbon emissions.
Kallis has aligned himself with some unnamed parties – presumably gas, transmission and technology people – and plans to open formal talks with BHP with the view to obtaining a power purchase agreement. Failing that, they will talk to the local utility. Petratherm is, of course, in no position to fund this project, but as it has done by bringing in TruEnergy and Beach Petroleum to partner in its geothermal development, Kallis anticipates there will be no shortage of potential partners.
Of course, Kallis is not the only one to dream of creating a new energy precinct based around the needs of a large mining operation. The so-called “green grid" proposal to unlock huge wind resources in South Australia’s Eyre Peninsula is still awaiting the opportunity to proceed and will rely mostly on an upgraded connection to the eastern seaboard and the Copperstring project in Queensland, a project that was noisily supported by local member Bob Katter and hoped to link Townsville and Mt Isa and open up a string of renewable energy plays in wind, solar and biomass along the way.
However, such was the length of the transmission line that the fate of Cooperstring rested on the support of a single end user in Mt Isa, in this case Xstrata. Despite support from the Queensland state government, the Swiss-based Xstrata board plumped for the easy, not necessarily cheaper, option of a gas fired power station, and Copperstring is now dead. BHP, at least, is alert to the options, and as the country's biggest company with the world's biggest mine, would be aware of strong signal it would send to the broader economy.
