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BHP Stirs Memory of Alcan Writedowns as Shale Gas Sours: Energy

BHP Stirs Memory of Alcan Writedowns as Shale Gas Sours
A natural gas drilling rig stands on a Chesapeake Energy Corp. drill site in Bradford County, Pennsylvania, U.S. Photographer: Daniel Acker/Bloomberg

BHP Billiton Ltd.’s $20 billion foray into U.S. shale gas has been hit by a decade-low plunge in prices, raising the specter over the world’s biggest mining company of the Alcan Inc. deal that almost sank Rio Tinto Group.

U.S. natural gas is the worst performer in 2012 among 22 commodities ranked by Bloomberg, amid an increase in output and the fourth-warmest winter on record. The drop threatens to force Melbourne-based BHP to write down shale assets bought in 2011.

“On some levels the comparison to Alcan is warranted,” said Glyn Lawcock, a Sydney-based resources analyst with UBS AG, which cut its valuation of the shale assets by 15 percent to $18.5 billion. The Petrohawk deal “has been going against them every day since the day they bought it,” he said.

Headwinds buffeting BHP after it bought Petrohawk Energy Corp. for $14.9 billion last year are somewhat like those Rio suffered after its $38 billion cash takeover of Alcan in 2007, Royal Bank of Scotland Group Plc said in a Feb. 14 report. The debt burden drove Rio, the world’s third-largest miner, to sell assets and shares during the global financial crisis.

Slumping natural gas prices forced OAO Lukoil, Russia’s second-largest oil producer, this month to shelve a plan to make a $1.8 billion U.S. shale acquisition, backing away because the returns were unacceptable. BHP last month started targeting more output of higher-priced petroleum liquids from its shale fields, following a similar decision by Royal Dutch Shell Plc.

‘Little Bit Challenging’

BHP shares have dropped 26 percent in Sydney trading over the past 12 months. That compares with a 22 percent slide in the Bloomberg World Mining Index over the same period. Spokesman Ruban Yogarajah declined to comment and referred to an investor briefing by Chief Executive Officer Marius Kloppers on Feb. 8.

“We invest for the long term, and while the current gas pricing environment is a little bit more challenging than we envisaged when we made the acquisition, the total value proposition by the acquisition is unchanged,” Kloppers said. “I’m very happy to confirm that the 7.6 billion barrels of oil equivalent, gas and liquids, the resource is every bit as large and as high quality as we had hoped for.”

The company has 12 months from the acquisition to allocate the cost of the takeover to the individual assets, he said.

U.S. gas prices have declined since Feb. 22 last year, when Kloppers made his first foray into shale, a $4.75 billion purchase of assets from Chesapeake Energy Corp. giving it access to the Fayetteville assets. Front-month gas futures in New York fell from $3.867 per million British thermal units to close at a 10-year low of $2.302 yesterday.

Shale Asset Valuations

Credit Suisse AG has a net present value estimate for the shale gas assets of $17.6 billion, Paul McTaggart, a Sydney-based resources analyst with the bank, said March 6. Macquarie Group Ltd. said in a Dec. 1 report that the NPV of the assets would shrink almost 70 percent to below $8 billion should the gas price remain below $4 in the long run, versus the bank’s long-term forecast of $6.

Aluminum forward prices plunged to $1,288 a ton on Feb. 23, 2009, the lowest in almost eight years, compared with $2,800 a ton when Rio completed the Alcan transaction on July 12, 2007. They had risen as high as $3,317 a ton in mid-2008 before the financial crisis.

Five years on, the fallout continues, with Rio last month booking a $8.9 billion one-time charge to write down the value of its aluminum unit, prompting Chief Executive Officer Tom Albanese and Chief Financial Officer Guy Elliott to forgo annual bonuses. In terms of scale, shale gas is less significant to BHP, than Alcan was to Rio, RBS said in the report. It doesn’t have the same damage potential as Alcan, UBS’s Lawcock said.

Alcan Comparison

“Alcan was a problematic acquisition -- they bought it at the top,” said Prasad Patkar, who helps manage about $1 billion at Platypus Asset Management in Sydney, including Rio shares. “BHP’s acquisition doesn’t feel as wrong as that yet, but if gas prices go to $1, it’ll have to be something where they’ll have to take writedowns.”

Raymond James Financial Inc. last month cut its 2012 U.S. natural gas price forecast by 23 percent to $2.50 per thousand cubic feet ($2.43 per million British thermal units) from $3.25, because of rising output, J. Marshall Adkins, an analyst at the company in Houston, said in a note on Feb. 6. Gas may “easily” hit $1.50 a million Btu in spring if supply continues to rise, Societe General SA analyst Laurent Key said in a Feb. 2 note.

Environmental Opposition

Kloppers, 49, who said on a July 16 teleconference that the shale purchases were not a price play, needs his shale strategy to work as he’s had three deals totaling more than $100 billion aborted or rejected in the past four years, including hostile bids for Rio and Potash Corp. of Saskatchewan Inc.

“BHP’s track record of doing deals isn’t any better” than Rio’s, Peter Esho, City Index’s Sydney-based chief market analyst, said in a March 6 note. “There could be some pressure if the value of assets recently acquired was to decline. Some ambitious projects might need to be pushed out a little, deferring growth.”

Shale-rock formations require injection of water, sand and chemicals to release gas. Environmental groups have opposed using the process called hydraulic fracturing, or fracking because of concerns of air pollution and tainted water supplies. Producers are also facing increased state and federal regulation.

‘Good Strategic Move’

The company is betting that U.S. gas prices, which were less than a quarter of those paid by Japanese importers, would rise as producers export liquefied natural gas, J. Michael Yeager, CEO of BHP’s petroleum unit, said on a call with investors on Nov. 14. Prices are forecast to trade at $4.75 per million Btu by 2015, according to the median of seven analysts estimates compiled by Bloomberg.

“Strategically it was probably quite a good move,” Peter Chilton, investment analyst at Constellation Capital Management Ltd., who holds BHP shares in Sydney, said by phone. “You have to spend lots of capital to get these assets and in 20-30 years’ time you look very smart and shareholders will really be benefiting from it.”

BHP’s U.S. onshore gas business had a loss in the first-half of about $73 million in underlying earnings before interest and tax, according to estimates from JPMorgan Chase & Co.

Both BHP and Rio referred to forward prices to justify the value of their acquisitions, RBS said in the report. Time showed the aluminum forward curve was a poor predictor of spot prices and the same risk applied to forward gas prices, it said.

“It’s a real uphill battle to get a return on their initial acquisition,” said Lyndon Fagan, a Sydney-based resources analyst with RBS. “At the moment, it’s not looking like a good deal. BHP’s book value for its shale gas assets would be under pressure.”

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