Was BHP Billiton Smart To Bet $20 Billion On Gas Fracking?

BHP Billiton Chief Marius Kloppers just placed a $20 billion bet on U.S. natural gas. That’s pretty risky, even for him.

At the start of last year Marius Kloppers had $10 billion burning a hole in his pocket. Rebuffed in attempts to acquire mining rival Rio Tinto as well as Potash Corp. of Saskatchewan, the chief executive of BHP Billiton needed a big deal to deploy the $24 billion in profits the company had piled up last year feeding China’s insatiable appetite for natural resources.

He found it in Arkansas, shelling out $4.75 billion to acquire gas giant Chesapeake Energy’s acreage in the Fayetteville Shale. Then in July he bet again, paying $15 billion—a 65% premium to market value—for Petrohawk Energy and its accumulation of prime shale fields in Louisiana and Texas. Though BHP had zero experience drilling for shale gas, the deals suddenly made the world’s largest and richest mining company, headquartered in Melbourne, Australia, one of the 15 largest natural gas producers in America. Even for Kloppers, who’s a 19-year veteran of BHP Billiton and known for his steeliness in building one of the most powerful commodities companies of the past half-century, it all looks risky—maybe too risky

Evy Hambro, manager of a $30 billion mining fund at BlackRock, wondered aloud last fall what BHP had gotten his clients into. “We are waiting to be educated by BHP on these transactions,” Hambro said at a Melbourne conference in October. “When you start putting something on your stall that you’ve never told investors about, people are naturally a bit reserved. So when you are suddenly exposed to shale gas, you want to know why.”

For one thing, BHP Billiton Petroleum, the oil-and-gas subsidiary, has focused mostly on deepwater projects; it hadn’t “fracked” a single shale well until it took over the operations of Chesapeake. Meanwhile, the U.S. nat-gas glut shows no signs of abating. The price of domestic gas already appeared to be at a nadir at $4.25 per thousand cubic feet (mcf ) when the Petrohawk deal was cut. Yet in the intervening months prices fell to $2.30 per mcf in early February, a depth not seen since 2002 and so low that drillers are losing money on marginal shale fields. Shares of big gas drillers have fallen, and in January gas giants Chesapeake Energy and ConocoPhillips both announced they would curtail gas development to pare losses.

As if that weren’t enough for shareholders to worry about, the $20 billion shale outlay is just an ante. Michael Yeager, the Houston-based chief executive of BHP Billiton Petroleum, says it will take ten years and at least $50 billion in capital investment to develop these assets. By comparison, Rio Tinto and Potash Corp. are already mature companies that throw off loads of cash.

Kloppers shrugs off the Cassandras. “Shale gas is like coal mining,” he says. “Like coal the formation is extensive, and you can programmatically and at lowest cost move through the basin and extract the gas.” Besides, it has held on to most of Petrohawk’s 800 employees and many key engineers.

Yeager admits that for the average well in the Fayetteville and Haynesville shales BHP needs gas prices of $3 and $4 per mcf just to break even. Yet, he says, Petrohawk had laid claim to the thickest, juiciest acres in those plays, where the economics are slightly better. What’s more, in the oil-rich Eagle Ford and Permian Basin acreage, BHP can give away the gas and still make good profits on the oil.

The executives believe that in time demand will follow supply. “Shale is a game changer; it’s real, it’s abundant, it’s economic,” says Yeager, a former Marine who spent 26 years at Exxon. “On a global basis it is cheap molecules.” Eventually “the U.S. will connect cars to natural gas,” says Kloppers. And if that’s not enough to raise the gas price, there are exports. A handful of liquefied natural gas export terminals are already in the works on the U.S. Gulf Coast. Considering that LNG fetches $15 per mcf in Asia and $10 per mcf in Europe, “putting a price marker down for export gas is an important thing,” says Kloppers. He’s convinced that natural gas, like oil, will someday fetch pretty much the same price all over the world. “We are confident, based on all the other products we’ve got, that the arbitrage will continue,” says Kloppers.

Forbes

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