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Oil the cause of BHP-Billiton’s troubled waters

5 March 2016

9:00 AM

5 March 2016

9:00 AM

Until late last year, BHP was sticking to its promise of ‘progressive dividend’ increases. This effectively, if innocently, misled investors, like me, who ignored widespread analyst rejections of CEO Andrew Mackenzie’s dividend assurances and bought BHP shares for the big yield, only to see the dividend cut by 75 per cent in February’s interim result. But when the oil price continued its journey south, from over $US100 a barrel to under $US30, BHP was hit with the perfect storm. Coinciding with the China-related fall in BHP’s export commodities like iron-ore, coal and copper, and the Brazil dam disaster, there was, for totally unrelated reasons, a collapse in the oil price. Despite the dominance of iron ore in BHP’s revenue (down 36 per cent to $US5.3 billion in the six months to last December), BHP’s 51 per cent drop in oil prices and 44 per cent cut in petroleum revenue were by far its worst results. And BHP’s first-half loss of $US 5.7 billion would have been a modest profit but for the $US7.2 billion write-down of the value of its oil and gas onshore assets in the US that it bought for $20 billion less than five years ago (and on which it has since probably spent as much again).

But BHP is only one of many Australian hydrocarbon companies suffering, with Woodside reporting a 99 per cent fall in full year profit and indicating its huge Browse LNG project is unlikely to proceed. This is another blow to what was supposed to be Australia’s next boom; Liquid Natural Gas was planned to surge past coal and iron-ore within a couple of years to become Australia’s biggest export earner. But all bets are off since Saudi Arabia decided to flood the world with oil and trash its price in a successful attempt to damage rival producers both by halting the technology-based advance of the US as a competitor and by hitting political and religious opponents like Russia and Iran. Australia has ended up with some collateral damage – despite the modest net economic advantage the Reserve Bank reckons emerges for consumers from lower fuel costs.

After investing $US200 billion in seven projects making up our largest-ever industrial infrastructure development, the LNG revolution was due to lift Australia to become the world’s top exporter of LNG – the least polluting of fossil fuels in an environmentally sensitive age. But while the export volume boom is now getting under way, the income is only a fraction of what was expected – or what is needed to make these projects economic. Unless there is a significant reversal of the collapse of the world price of LNG (which is related to the 75 per cent slump in the oil price), there is unlikely to be any further investments in this capital-intensive industry once the current projects are all on stream by next year.

‘The economic viability of these projects is uncertain’ at current low prices, said a Harvard study a little over a year ago, particularly those based on coal seam gas, and since then prices have fallen much further. ‘After the plunge of oil and LNG prices… Australian LNG risks becoming one of the worst investment stories of the last few decades in the oil and gas sector’ – but that was before the recent collapse of so many US shale producers. The IEA recently echoed this concern.

There are still some with faith, like the CEO of EnergyQuest, Dr Graeme Bethune, who reckons that Australia’s low break-even cost and the fact that most exports are on fixed contracts, means that lower gas prices will not dent the rapid growth in Australian LNG output as producers seek to maximise income by producing as much as possible. And Stephen Bartholomeusz in the Business Spectator recently opined that while the ‘projects will be under pressure just to generate cash, let alone a profit… over the longer term the supply and demand settings for Australia’s LNG sector appear very positive, made even more attractive by the impact of the current low oil price’ (by discouraging the development of potentially competitive capacity). Sooner or later the Saudis will have to call a halt to oversupplying a world market that has defied the rule that lowering the price increases the demand. In the meantime, the lack of resource company profits means that May’s federal budget is missing out on billions of dollars of tax revenue that could have helped dent the deficit.

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