November 1, 2013 7:58 am

BHP likely to refocus its oil business

Chief executive to present a review of unit next month

Petroleum is the least understood of BHP Billiton’s four businesses or “pillars”. So when its chief executive Andrew Mackenzie presents a review of the division in Houston next month, there will be understandable interest from shareholders.

Over the past two years, the performance of BHP’s petroleum division has deteriorated, with marked declines in returns and cash flow. In part this reflects heavy investment in US shale, where BHP has spent $20bn acquiring assets, but also disappointing production volumes from conventional fields.

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To address this weak performance analysts expect Mr Mackenzie and new petroleum boss Tim Cutt to refocus the business and offload non-core assets. Indeed, Mr Mackenzie has already dropped some hints, suggesting during a recent meeting with analysts that BHP is seeking a simpler oil and gas portfolio. BHP has also put up for sale half of its oil and gas acreage in the US Permian basin.

The company has a tail of petroleum assets and joint ventures which sit awkwardly with its philosophy of investing in projects that are “large, long life, low-cost, expandable” (and preferably located in OCED countries). These include the Liverpool Bay operation in the UK, the Pyrenees oilfields in Australia as well as assets in Algeria, Trinidad and Tobago and Pakistan.

A sale of these assets could generate $6bn-$7.7bn, according to analysts at Morgan Stanley, and the proceeds could be used to either pay down debt, reinvest in existing business or be returned to shareholders – or a combination.

Arguably it will be decisions like this, as much as cost-cutting or productivity initiatives, that will determine winners and losers in the mining sector in the future.

Many investors have lost track of the fact that mega miners will generate significant amounts of cash over the next five years as non-core assets are sold and spending on new projects and expansion declines, while production increases and new supply comes on line. Macquarie estimates BHP and Rio Tinto will generate almost $80bn of cash flow between now and the end of the decade (assuming commodity prices don’t collapse).

“Aside from uncontrollable macro swings, we believe it will be capital management, rather than ongoing cost cutting or productivity initiatives, which will be the single biggest driver of shareholders’ returns going forward,” says the bank.

However, this potential won’t be reflected in share prices until investors are sure mining companies won’t blow the lot on big, bold projects and acquisitions. Shareholders want to see it invested wisely or returned to them via share buybacks or increased dividends. And they are yet to be convinced.

Which brings us back to BHP.

There are already gripes from analysts that BHP is investing too much money in US shale and a Canadian potash project. “Even for a company the size of BHP Billiton, putting nearly half of capex in assets [during 2014-15] where return expectations are poor, is too much in our view,” says Morgan Stanley.

Mr Mackenzie is well qualified to oversee changes to the way the petroleum division is run given his oil and gas background – he worked at BP for 22 years before joining the mining industry.

Mr Cutt, also a former oil man from ExxonMobil, has already separated BHP’s capital intensive US shale operations, which he sees as the division’s growth engine, from its conventional oil and gas interests. This, he says, will ensure BHP is focused on both businesses.

Just how focused, investors will find out in December.

The Commodities Note is a regular online commentary on the industry from the Financial Times

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