Mike Henry saw a bright future for oil at BHP. At least he did 15 months ago.
“We like the commodity,” the mining giant’s chief executive said in May 2020. “It is on strategy, and it remains core to BHP.”
But in the volatile resources sector, 15 months is a long time. Long enough for ironclad forecasts to be thrown into doubt.
When will the world’s thirst for oil peak and start to decline? As coronavirus slows travel and cars electrify, the answer could be sooner than many once thought. But more importantly, the global push to arrest climate change has become markedly more urgent. And for firms that remain in the business of drilling for fossil fuels, investors are dialling up the heat.
At 4.45pm last Tuesday, just after the stock market had closed, Australia’s biggest company unveiled one of the most significant shifts in its history: After 50-plus years, BHP was exiting oil and gas entirely.
It was a blockbuster deal. Following months of talks and intense speculation, BHP has agreed to sell its whole petroleum division — spanning Australia, the Americas and North Africa — to Perth-based Woodside in exchange for shares to distribute among its investors.
Shareholders in Woodside would own 52 per cent of the merged entity, the companies said. BHP shareholders would own 48 per cent.
For BHP, which counted petroleum as a core commodity behind iron ore and copper, the move is a radical portfolio shake-up. It also signifies a major acceleration of Henry’s big-picture plan to reposition BHP for a fast-changing corporate world in which environmental, social and governance (ESG) credentials are more important than ever.
“Ultimately this is a call on where ESG pressures are headed,” says Adrian Prendergast, an analyst at Morgans. BHP has concluded it is “better off jettisoning” petroleum, he says, to clean up its portfolio and preserve its cost of capital.
The story of BHP and petroleum goes back decades. It begins in the narrow sea between Victoria and Tasmania, in the 1960s when BHP was mainly a miner and a steelmaker. BHP and ExxonMobil drilled Australia’s first offshore wells in Bass Strait. In 1965, they struck gas at the Barracouta field. In 1967, they landed Australia’s first major oil field discovery: Kingfish. It remains the country’s biggest ever oil field to date.
In the years that came next, their joint venture would build the Bass Strait fields into a world-class oil and gas development, with Gippsland’s Longford gas plant, dozens of offshore platforms and 600 kilometres of underwater pipelines.
BHP’s petroleum interests today span far-flung corners of the globe: assets in Western Australia, the US Gulf of Mexico, Trinidad and Tobago, Algeria. Last year, it brought in $2.3 billion in underlying earnings, about 6 per cent of the group’s total.
Henry has repeatedly declared he sees a solid outlook for petroleum, for at least the next decade, likely more.
“Let’s frame this,” he said, back in May last year. “Even low-case forecasts are for the world to consume another trillion barrels of oil over the next 30 years … and that’s relative to 900 billion over the past 30 years.”
Finding a better home
Explaining the rationale now to exit, Henry insists the solid fundamentals behind the assets’ mid-term outlook remain unchanged. Rather, he says, the motivation is that Woodside will be a better home for them, and would unlock value for shareholders through synergies of up to $US400 million a year.
As well, it will free up capital within BHP to increase its spending on parts of the business that it is more eager to expand — such as commodities standing to benefit from accelerating global efforts to decarbonise, electrify transport and feed a fast-growing global population.
“This is no grand statement about oil and gas,” Henry says, “it’s all about driving greater value for shareholders.”
Still, he also acknowledges the benefit of giving shareholders the choice to “manage their own decisions” as to whether they want to retain or remove their exposure to those fossil fuels.
For signs that investor attitudes to oil and gas are rapidly shifting, you don’t have to look far. Big Oil’s climate reckoning has arrived in force this year. And the shock is being felt around the world.
BHP should know it’s better to exit petroleum sooner rather than later.
Credit Suisse’s Saul Kavonic
At ExxonMobil, an activist hedge fund has ousted three directors deemed out of step with necessary climate action. Shell has been ordered by a Dutch court to commit to a vastly stronger decarbonisation plan by 2030. The International Energy Agency issued a landmark report in May containing a stark warning the world must avoid funding any new oil and gas fields to achieve the Paris Agreement’s goal of limiting temperature increases to 1.5 degrees.
Investors and analysts are left with little doubt as to BHP’s motivations.
“Petroleum simply no longer fits within BHP’s portfolio or future-facing strategy,” says Saul Kavonic, an analyst at Credit Suisse.
“After having waited too long to divest thermal coal, and now having to resort to selling for cents on the dollar, BHP should know it’s better to exit petroleum sooner rather than later.”
At the start of 2020, when Canadian-born Mike Henry was elevated to the role of BHP’s CEO, he began mapping out his strategy to lead the Melbourne-based miner into the future: exiting thermal coal, boosting “future-facing” commodities copper and nickel – two ingredients in electric batteries – and assessing a foray into potash.
On the question of where petroleum would fit in Henry’s forward-looking vision for BHP’s, the answer was not so obvious. Shareholders were providing BHP’s leadership “mixed feedback” about oil and gas. It was becoming an area of concern.
In August 2020, Henry sought to sell out of Bass Strait, but that proved difficult amid the crash in commodity prices and concerns about clean-up liabilities for the rapidly ageing assets deterring would-be buyers.
One option said to be on the table was a demerger of the entire division. The other was doing a deal with Woodside.
There has always been compelling logic to combining Woodside with BHP’s petroleum division, which are partners in two projects, including the $16 billion Scarborough LNG development in WA which they hope to green-light later this year.
This time around, tie-up talks kicked off in April.
“In oil and gas industry circles, a BHP Petroleum-Woodside tie-up has been on the deal dream list going back three decades,” Kavonic says.
“It’s taken a pandemic, ESG rhetoric signalling terminal industry decline, a looming major project final investment decision and refreshed management to finally see it arrive.”
While some investors query the rationale behind BHP ditching its entire petroleum division — especially its high-returning, cash-generative Gulf of Mexico assets — many are viewing it favourably through the lens of ESG.
Vincent Cook, portfolio manager at Clime Investment Management, says the fund likes the focus on future-facing commodities “given the increasing importance of environmental considerations”.
“The agreed exit from petroleum … is a big step in this direction,” he says.
Some, however, dispute the merits of divesting fossil fuels as opposed to gradually managing them down responsibly.
“Disposing of fossil fuel assets and making them someone else’s issue is not the solution,” ex-Glencore CEO Ivan Glasenberg said earlier this year. “It won’t reduce absolute emissions.”
Regnan, the responsible investment arm of investor Pendal Group, says the BHP-Woodside deal fails to address the system-level climate risks for institutional investors whose globally diversified portfolios are exposed to the impacts of global warming.
“Swapping assets between companies typically does nothing to address these system-level risks,” Regnan’s Alison George says.
Risky oil and cleaning bills
For Woodside, the BHP deal would be genuinely transformational. It will double its production levels, propelling it into the top-12 oil and gas producers globally, with assets around the world and new growth avenues.
First, though, the deal needs the approval of the majority of Woodside’s shareholders. “It may be difficult to get a vote across the line, with Woodside shareholders likely to question the value of the merger,” says Jamie Hannah at fund manager VanEck Australia.
A key area of concern includes the fact BHP’s assets are predominantly oil. On the spectrum of fossil fuels, oil is considered more at risk from decarbonisation than LNG, Woodside’s primary commodity, which may have a longer future as a potential “transition fuel” for countries to wean off coal.
Another worry is the estimated billions of dollars of clean-up liabilities Woodside will have to foot when it decommissions the ageing operations in Bass Strait.
Meg O’Neill, this week named as Woodside’s permanent CEO, is confident the tie-up is “the right thing to do for our shareholders”.
“This deal has been talked about and rumoured by analysts and investors for many decades,” she says, “and there are natural reasons why that’s the case.”
One hour after the deal’s announcement on Tuesday, Henry dialled into a conference call to discuss the sweeping changes. The first thing he was asked was a question on the minds of many: do you remain committed to metallurgical coal, the only commodity now standing in the way of a fossil-free BHP?
Henry reiterated BHP’s positive outlook on the resource, and said its position remained the same.
Widespread adoption of cleaner steel-making processes using hydrogen instead of coal still remains a long way off, Henry said. Meanwhile, as the green energy transition will call for huge amounts of steel to make green infrastructure like wind turbines, high-quality hard coking coal will be key to steel mills ensuring carbon-efficient operations.
“And BHP owns the world’s best resources of high-quality hard coking coal,” he declared.
Some are unconvinced: if ESG headwinds don’t favour gas, they won’t favour coal either. “BHP may deny it,” Credit Suisse says, “but they also denied desire to exit petroleum not too long ago.”
Much can change in 15 months.
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