BHPs dramatic transformation overshadows stunning profit result

August 17, 2021 â€" 6.50pm

The prospective dramatic transformations of two of the country’s biggest companies completely overshadowed Tuesday’s release of BHP’s annual earnings and the extraordinary torrents of cash it is generating and distributing to shareholders.

The confirmation of the proposed effective demerger of BHP’s petroleum business through its sale, debt-free and apparently without a premium, to Woodside for scrip to be distributed to BHP shareholders; the collapse of BHP’s much-debated dual-listed structure and the long-awaited green-lighting of the giant Jansen potash project in Canada eclipsed the attention given to what in any other circumstances would have been regarded as an exceptional result.

BHP has sold its oil and gas assets to energy giant Woodside.Credit:

At another time, the 88 per cent increase in attributable profit, to $US17 billion ($23 billion), and the $US15 billion of shareholder returns once the $US2 a share final dividend is paid would have dominated attention. Instead it’s a footnote at the bottom of a string of momentous announcements.

The decision to exit an oil and gas business that has been one of the pillars of BHP’s portfolio for more than half a century, along with the go-ahead for Jansen, will result in the most significant reshaping of BHP’s portfolio since its 2001 merger with Billiton.

The success or otherwise of the transformative moves will have a profound influence over BHP’s performance over future decades and will determine how history will judge the tenures of chairman Ken MacKenzie and its still relatively new chief executive Mike Henry.

In exiting the oil and gas sector and shedding high-margin but capital-intensive assets that have contributed about a fifth of its earnings over the past decade, BHP â€" which also has its thermal and lesser-quality metallurgical coal assets on the market â€" is trying to position itself for a decarbonising future.

While there will be a lot of money to be made from oil, gas, and coal over the next decade or two because demand keeps rising but investment in new resources and production is falling, BHP is looking to the longer term and timing its exits while the assets still have material currency.
At face value, the petroleum business might appear to have less currency than expected, with its valuation in the deal with Woodside appearing to reflect little, if any, premium and perhaps even a discount.

The value implied by the merger ratio â€" 52 per cent Woodside shareholders, 48 per cent BHP shareholders â€" is about $US13.5 billion, which would be well below the low end of analysts’ ranges, where the consensus was that the petroleum business was worth about $US16.5 billion.

Yet, given BHP shareholders will end up with almost half the enlarged Woodside, and get their share of the $US400 million-plus of estimated annual synergies, the deal looks far more of a pure merger than an acquisition by Woodside.

The big cash flows from BHP’s oilfields and the massive expansion in the merged group’s equity base will enable Woodside to finally self-fund the big projects it has on the drawing board.

BHP Group chief executive Mike Henry has made a bold move in trying to set up the mining giant for a decarbonising world.

The terms of the merger ought to assuage some of the angst some Woodside shareholders were demonstrating even before they had seen the terms of the deal.

Meanwhile the decarbonising of BHP will enable it to quit its most carbon-intensive assets and will appeal to ESG investors but leave it with a skinny, less-diversified portfolio. Iron ore will remain a dominant core but China’s demand is probably at peak levels and will gradually shrink over the next decade or so even as new supply from Brazil and Africa enters the market.

BHP (and Rio Tinto and Fortescue) are at the low end of the cost curve and will remain profitable even at much lower prices but the extraordinary profitability of recent results and which under-pinned BHP’s 2020-21 earnings will recede.

Copper is a target for expansion but new large low-cost copper ore bodies are rare and tend to be found in difficult jurisdictions rather than the big developed-world basins BHP has traditionally prioritised.

The exit from petroleum and coal means BHP will be putting a lot of eggs and its future growth prospects in the potash basket after deciding it would proceed with Jansen.

BHP spent more than a decade, and more than $US4 billion ($US2.1 billion of which it has now written off) evaluating Jansen. and sinking the 1000-metre-deep production and service shafts since its (thankfully) aborted $US39 billion bid for Canada’s Potash Corp in 2010.

It’s a peculiar industry, where the markets have been shaped by cartels. Prices plummeted from almost $US1000 a tonne in 2010 to around $US200 a tonne after the collapse of the Russian cartel nearly a decade ago and have generally remained just above that level since.

The next $US5.7 billion BHP will spend to complete phase one of the project and bring four million new tonnes of potash into the 70 million tonne market represents a major bet on potash’s future, with implications for the reputations and positions of all involved.

To put it into perspective, however, those extra tonnes only equate to the average annual growth in demand of about 3 per cent over recent decades. Demand is underpinned by deteriorating global soil quality and the need to improve agricultural productivity as China and other developing countries shrift up the wealth and consumption curves.

The exit from petroleum and coal means BHP will be putting a lot of eggs and its future growth prospects in the potash basket after deciding it would proceed with Jansen.

For Jansen to be a new pillar within BHP’s portfolio and replace some of the lost contributions from the exits from petroleum and coal, however, it will need to be expanded after it starts operating in 2027 and, as the supply and demand balance continues to improve, BHP might also have to revisit growth via acquisition.

While BHP is (momentarily?) shrinking its way to greatness Woodside, of course, is proposing to almost double its size, add a big stream of oil to what has been a gas-dominated portfolio, add a big presence in the Gulf of Mexico and become a player of global scale in a sector being reshaped by the fast-emerging “net zero by 2050” consensus.

It will have a much bigger and stronger balance sheet and far bigger and more resilient cash flows along with a far larger shareholder base to support the future funding needs of an extremely capital-intensive business.

Woodside, as a pure energy play, is committed to the sector. It doesn’t have BHP’s options.
The demerging of petroleum, using Woodside as the vehicle, both completes a phase in BHP’s history and starts a new one.

The group has emerged from a period of introspection and simplification (which included the demerger of South 32) under Andrew Mackenzie after the frenetic era of expansion of the Marius Kloppers during the China-inspired post-financial crisis resources boom.

Henry is completing the reshaping of the remaining portfolio and collapsing the dual-listed structure BHP constructed for the merger with Billiton.

With a smaller and simpler BHP, meagre earnings within the Plc arm of the structured after the spin-off of South32 and, once the Mt Arthur coal mine which once housed a pile of tax losses has been offloaded, there are now fewer arguments for retaining the structure.

Having cleared the decks, a somewhat denuded BHP, armed with a big and conservative balance sheet and some years yet of gushing cash flows and profits from iron ore, will need to develop or acquire the tier one, future-facing assets that will validate the decision to offload the carbon-intensive assets that were so important to its past.

Whether or not it succeeds will determine how the Mackenzie and Henry era and the bold moves to so radically reshape BHP’s portfolio will be judged. Just as history will judge the decision of Richard Goyder and the Woodside board he chairs to double-up on carbon-intensive assets in a decarbonising world.

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Stephen is one of Australia’s most respected business journalists. He was most recently co-founder and associate editor of the Business Spectator website and an associate editor and senior columnist at The Australian.

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