Going to Scarborough Fair

Woodside Petroleum held its annual investor briefing, which management noted it had purposely delayed to enable it to demonstrate the progress that had been made on the company’s key growth projects. These include the Scarborough/Pluto project and the Browse/North West Shelf (NWS) project, as well as Sangomar (formerly Senegal’s SNE development) and Myanmar.


Our previous research on Woodside had suggested the company’s growth projects yielded relatively low returns. However, Woodside recently upgraded the resource estimate for its Scarborough gas field (off Western Australia) by 52%, to 11.1 trillion cubic feet, which has directly addressed this issue. The gas from the Scarborough field will be processed through the Pluto refinery near Karratha, which is planning a US$16bn expansion.


The agreement with BHP Group (BHP, Hold) on the tolling charge to process the Scarborough gas through the Pluto refinery removes a major obstacle to the project winning final investment approval in CY20. The increase in scale of the Pluto Train 2 expansion, without a corresponding increase in capital expenditure, means Woodside should have sufficient capital to fund its near-term projects and maintain its dividend without the need for more equity.


Woodside’s 12% hurdle rate may appear modest for large-scale development projects, although the joint-venture partners are looking to minimise development risk through binding fixed-price contracts with suppliers.


With the Scarborough/Pluto project now derisked, the next step will be achieving similar progress on the Browse/NWS development, which has been delayed. Woodside believes the project is now ready for front-end engineering design, although it still needs to finalise the gas processing agreement with its joint-venture partners. The project will now be developed in two stages in order to manage capital risk.


With a clearer outlook and the stock trading below our revised $38.50 target price (which has risen from $34.00), we have upgraded our recommendation on Woodside to Accumulate from Hold.