Pluto 2 pushed out, but still coming

Woodside’s past was all about oil, but its success in this area has provided the cashflow to set the foundations of a potentially far more lucrative future in the form of LNG. There are many LNG projects in Australia, but Woodside’s Pluto project stands out as one of only two that have actually reached a final investment decision (FID) in the last 5 years. The other is of course the monstrous Gorgon development, also located in WA.

Pluto was originally scoped as a possible 3 train project, but that was subsequently increased to 5 trains, of which 2 would probably process third party gas.

The requirement for adequate gas reserves often gets lost in amongst the glossy presentations that accompany a typical LNG project. The initial train is on schedule to commence activity early next year, with first LNG production in late 2011. The company has however not had sufficient luck on the exploration front. Despite some success, the FID for train 2 has been deferred from the initial plan of December this year to sometime next year.

Delays and deferments are never viewed positively by the market, but we do not consider the deferment of the second train’s FID as a significant setback. One of the key reasons that management wanted to achieve FID this year was to ensure that Woodside is not going head-to-head with Gorgon for skilled labour. Gorgon’s development has however progressed more slowly than Woodside expected and this affords them more time. The additional time will also allow management to appraise recent discoveries.

Woodside’s Pluto exploration program was initially slated to cover 20 wells prior to the original FID date of December 2010. In the event Woodside only tested 10 of the targets. This was due to the late delivery of one of the deepwater drill rigs and mechanical difficulties with two of the wells. Woodside fortuitously hit gas at Alaric and Larson Deep just days before releasing its first half result. As a result of which, Woodside has a 60% hit rate from its ten exploration wells, which is better than we would reasonably expect.

Four of the successful wells are located in the central hub area of the exploration region. This has seen Woodside focus more attention on the central hub and a further five wells will be drilled in the area. Once this is done, management will move into the appraisal phase to confirm the volume of gas the discoveries have delivered. This will then feed into the second train’s FID process and if all goes very well, possibly the third.

Management is also in active discussions to process third party gas, which two of the potential five Pluto trains are currently reserved for. Processing third party gas is an attractive bolt-on extra to the project, which could generate very attractive low risk returns.

The capital expenditure associated to additional production trains is considerably less than the initial train, because the key infrastructure already exits. Processing third party gas would also alleviate the costs associated to exploration and development of the resources.

First half performance

Woodside’s first half production came in at 36.7 million barrels of oil equivalent (boe). This is down 8.5% from the 40.1 million boe achieved in the same period last year. The weaker production is partly a function of natural oil field decline, but also due to the sale of Otway back in March.

The lower production was more than offset by a higher average oil price of US$78 compared to US$52 previously. This generated a flood of dollars for the company, lifting Woodside’s first half sales revenue 45% to US$2.1 billion and operating cashflow from US$412 million to US$1 billion. The sales growth flowed through to the bottom line with net earnings up 40% to US$901 million or US$813 million after removing the $149 million Otway sale gain and other one-off adjustments.

In terms of the outlook, management has not made any change to full year production guidance of 70-75 million boe. There is no requirement for an improved second half, given that a repetition of the first half’s performance would hit the upper end of the range at 73.4 million boe.

Meanwhile, Woodside’s balance sheet de-levered somewhat following the late 2009 capital raising. The company’s net debt has pulled back from US$3.732 billion as at 31 December 2009, to US$3.141 billion. This has seen Woodside’s gearing fall 7 percentage points to 23%.

Woodside held US$1.8 billion in cash as at 30 June 2010, with a further US$1.7 billion of undrawn debt facilities. There will not be any major debt maturities until a little under US$2.5 billion rolls over in 2012. A continuation of strong operating cashflows, in conjunction with Woodside’s existing cash and debt facilities will cover the approximately US$4 billion 2010 capital expenditure budget. Of this, US$2.5 billion is required for Pluto.

Pluto 1’s capital expenditure is expected to come in at 6-10% more than the original US$11.2 billion FID number. Any further industrial action will drive up costs, to the tune of about 0.25% of the total for each week of stoppage. This would be a negative of course, but there is considerably less risk given the late stage of the project’s development.

Since finding solid support at the $40.00 psychological region, Woodside has rebounded strongly. Currently, Woodside is once again testing the broader term downtrend line. A convincing break above this resistance level would give rise to an upside target towards the 200 period moving average (red line) at $44.72.

From a longer-term perspective, the uptrend in place since late November 2008 is weakening as evident from the short term downtrend. However, the weekly MACD has just recently crossed to the positive side above the zero line, which is an early indication that the trend is turning to the upside. This would be confirmed upon a convincing break above the 200 week moving average (red line) at $45.36. Should this scenario occur, we would expect a continuation of the broader term uptrend.

Woodside will remain held in the Fat Prophets Portfolio and we recommend the stock as a buy to Members without exposure under $45.