Woodside Petroleum: Raising Billions To Fund The Development Of Another Large Gas Project

Summary

• Woodside Petroleum has now purchased an additional 50% of the Scarborough gas asset from ExxonMobil.
• This brings its ownership to 75%, and its share of the development expenses to $7.5B.
• Two large projects will start contributing to the operating cash flow in 2018 and 2019, further expanding the free cash flow.
• Woodside Petroleum definitely remains on track to produce 100 million barrels of oil-equivalent by 2020.

Introduction

Almost three years ago, I had a close look at Woodside Petroleum (OTC:WOPEF) (WOPEY), as I believed in the company’s asset base. The oil and gas market was nearing its lows, and although Woodside had quite a bit of debt on its balance sheet, I believed the company’s pursuit of its gas strategy (and LNG) would be a solid move.

Source: asx.com.au

Fast forward to now. The oil and gas markets are stronger, Woodside is doing well (and still pays an attractive dividend), but even more interesting, it isn’t scared to double-dip on the gas and LNG opportunities in Australia. It has just purchased an additional 50% interest in the Scarborough from Exxon Mobil (XOM).

Although Woodside has a market capitalization of approximately A$30.4B (US$24.3B), it still has just one primary listing. That’s its ASX listing where the company is trading with WPL as its ticker symbol. The average daily volume is 2M shares for a total dollar volume of A$60M (US$45). Although Woodside is an Australian company trading in Australian Dollars, it does report its financial results in USD. All numbers are based on USD.

Woodside is buying an additional 50% of Scarborough – and plans to quickly develop the asset

Perhaps even more important than the company’s announcement of its full-year results was the announcement it was acquiring an additional 50% stake in the Scarborough gas field from Exxon Mobil (XOM). Woodside is paying US$444M for the 50% stake and will wire an additional $300M to Exxon Mobil upon a positive final investment decision.

An interesting price, considering Woodside purchased BHP Billiton’s (BHP) 25% stake for $250M + $150M. Despite a higher gas price and Woodside’s access to more capital, Exxon Mobil is receiving more than 10% less than BHP did (during worse market times, just 18 months ago). It’s a heavy bet from Woodside, but I do have the impression it’s getting the better end of the deal.

Source: Scarborough fact sheet

Why is it a heavy bet, and why is Exxon Mobil selling at a lower price than BHP Billiton? I think a lot has to do with the high capex commitment associated with the construction of Scarborough. According to Woodside Petroleum, the development capex is expected to be $6B for the upstream assets and $2.5-3.7B for the downstream side of the development for a total price tag of up toe $9.7B. Exxon Mobbil would have been on the hook for close to $5B in capex, for a non-core asset, 300 kilometers offshore Western Australia. So its reasons to sell are understandable. It might be better to cash in almost $750M, rather than forking over $5B for an attributable 3.65B Tcf of gas (of which 3B would be recovered).

The acquisition makes more sense for Woodside as it plans to tie the Scarborough gas field into the existing Pluto LNG facility. And this will allow Woodside to benefit from an expected surge in the demand for LNG from 2020 on. Sure, the demand has always been there and has been steadily increasing over the past few years, but the supply will have difficulties to catch up with the demand growth:

Source: press release

And that’s why Woodside is so keen to rapidly advance the asset. As it knows it needed the cash to buy the stake and to develop Scarborough, Woodside has launched – and completed – an A$2.5B capital raise priced at A$27 per share, which was a 10% discount to the share price.

As this is less than US$2B, more funding sources are required for the $7.5B development commitment, and although a large part will be funded through debt, but we also shouldn’t discard Woodside’s ability to generate hundreds of millions of free cash flow.

A look at the company’s own internal cash flows

Woodside’s financial results in 2017 are interesting, but not very important in the greater scheme of things. It reported an operating cash flow of US$2.88B but after taking the working capital changes as well as the taxes and interest payments into consideration, the adjusted operating cash flow was approximately US$2.2B.

Source: annual report

A decent amount of money, but as the capex level was $1.4B, this left just $800M in free cash flow on the table. And that’s not particularly impressive considering the 936M shares outstanding. But you guessed it right. There’s more than just the ‘bare numbers’. Let’s have a closer look at how the capex was spent in 2017 and 2018.

Source: press release

As you can see, a large chunk was spent on the Wheatstone LNG train last year, and this expense will fall off a cliff this year. Why? Because the first train was up and running late last year, whilst the second LNG train will start producing any day now. So rather than being a cash drain, the Wheatstone LNG plant will start to throw off serious amounts of free cash flow.

You’ll also notice a shift towards spending the money on a new development project: Greater Enfield. The subsea installation of the production units has been budgeted for 2018, and Greater Enfield will start producing oil in the summer of 2019. This means the capex level will drop substantially in 2019 and 2020, whilst the additional production from Wheatstone and Greater Enfield will actually allow the operating cash flow to increase.

Source: press release

Based on the capex breakdown, it looks like the sustaining capex + exploration expenses are just $700-800M per year. Based on the 2017 operating cash flow, this would leave roughly $1.4B in free cash flow on the table, but then we are completely ignoring the additional operating cash flow from the Wheatstone and Greater Enfield projects. I don’t think it’s far-fetched to assume a free cash flow result of $2B in 2020 (excluding the Scarborough payments and development expenses).

Investment thesis

Woodside Petroleum impressed me in 2015, and is still impressing me today. The company definitely appears to be on the right track to produce 100 million (!) barrels of oil-equivalent by 2020, and this doesn’t even include the development of the Scarborough field.

The capex in 2018 is expected to be $1.6B (excluding the Scarborough payments), and this should leave plenty of free cash flow on the table to fund those payments as well as the dividend. Woodside’s net debt will very likely slightly increase into 2018 and 2019, and will probably remain stable in 2020-2021 when the Scarborough gas field will be fully developed. But as the EBITDA continues to increase (due to the commissioning of the two new projects), Woodside’s leverage ratio should remain relatively low. As of at the end of FY 2017, Woodside had a net debt position of $4.75B and a net debt/EBITDA ratio of 1.66.

I currently have no position but am planning to go long on weakness.

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