Woodside goes it alone on Scarborough LNG
Luring investment into greenfield gas projects is tough, even in a gas-starved world
Not even a global gas shortage can convince investors to put their faith in newbuild liquefied natural gas projects, it seems. Australia’s Woodside Energy made big, risky concessions with private equity financiers to get its flagship Scarborough LNG project off the drawing board. Scarborough is a drop in the global LNG ocean, but the trouble faced by Woodside to get this far speaks volumes about the challenges of building greenfield plants today.
Woodside took a positive final investment decision (FID) on Monday at the Scarborough gas project offshore Western Australia and an expansion of the existing onshore Pluto facility. Gas from Scarborough will produce 8 million tonnes per annum (mtpa) of LNG from the expanded Pluto plant for export to Asian markets, with some gas sold to local WA domestic and industrial consumers. Scarborough and Pluto combined represent a $12 billion bet that Asian demand for gas will grow steadily out to 2050.
If Woodside is right, the investment will yield an internal rate of return (IRR) of more than 13.5% with an all-in cost of LNG supply to north Asia of ~$5.80/MMBtu. Right now, Asian spot LNG futures are changing hands for $36/MMBtu and a 13% Brent slope gives an oil-indexed LNG price of $10.64/MMBtu. But global gas markets are fickle. Those figures can and will change over the 20+year lifecycle of Scarborough and Pluto T2.
The spectacular margins being enjoyed by LNG exporters and traders today could be a distant memory by the time the first cargo of Scarborough LNG sets sail from Pluto’s second train in 2026. Global LNG liquefaction capacity is expected to grow by 70% by 2025. Major expansions are planned in North America, Qatar and Russia totalling >240 mtpa – 30 times greater than Scarborough.
All of these exporters are targeting the same market: China. As regular Energy Flux readers will recall, China is busy buying up US LNG to secure long-term supplies (Cheniere signed a fresh 20-year deal with a Chinese city gas company this week). China is underwriting America’s next LNG capacity boom. Will it also need Australian LNG?
Woodside seems to have missed the not-so-slow boat to China. A preliminary ‘heads of agreement’ signed in 2019 with Chinese independent energy player ENN for 1 mtpa of LNG from Scarborough appears to have fallen by the wayside amid the diplomatic spat between Canberra and Beijing.
Woodside CEO Meg O’Neill did not mention ENN in an analyst call this week. She said Scarborough is underpinned by three LNG sales and purchase agreements with Uniper, Pertamina and RWE for an aggregate 3.94 mtpa – less than half of the project’s 8 mtpa nameplate capacity.
There are two ways to look at this. If you believe global gas demand will outstrip supply in the 2030s and beyond, Scarborough’s spare capacity could be sold into spot markets at a premium to the rates achievable in long-term contracts.
If you see decarbonisation policies squeezing gas consumption and prices, revenue from those uncontracted volumes could come in well below the ~$5.80/MMBtu cost of supply for extended periods. In a structurally volatile market, that double-digit IRR cannot be guaranteed.
Woodside’s FID at Scarborough came hot on the heels of an unusual farm-out deal with private equity outfit Global Infrastructure Partners for a 49% share in the joint venture building the second liquefaction train at Pluto.
GIP will bankroll 49% of the $5.7 billion construction cost of Pluto Train 2 plus an additional $835 million slug of capex. But Woodside may keep this only if there are no cost overruns or delays – which tend to be colossal at LNG megaprojects. Essentially Woodside is taking on construction risk in return for up-front capital.
GIP is expected to use a combination of fresh equity from its latest fund plus debt from National Australia Bank. Dan Gocher, director of climate & environment at the Australasian Centre for Corporate Responsibility (ACCR) said GIP’s investment is “debt dressed up as equity”:
“Woodside is a consistent failure in delivering projects on time and on budget. In 2010-11, the cost of Pluto LNG blew out by AU$2 billion and was more than nine months overdue.”
In theory, GIP would repay Woodside if the Pluto expansion comes in under budget, but when was the last time any infrastructure development cost less than planned?
Engineering, procurement and construction (EPC) contractor Bechtel will build the 5 mtpa liquefaction train under a lump sum turnkey contract that might insulate Woodside from some cost overruns. However, only 90% of costs are contracted as “lump sum or fixed rate”, and Woodside has not disclosed the breakdown between these two categories. Unlike a lump sum deal, costs incurred on a fixed rate contract can still spiral out of control.
Bechtel is unlikely to have exposed itself to 90% of the construction risk because LNG projects have a notoriously poor track record in cost discipline. Other EPC contractors have been pushed to the brink of financial ruin by such deals; McDermott went into administration and Chiyoda begged for a bailout from Mitsubishi after the Cameron and Freeport LNG projects they were building in the US were caught out by acute post-hurricane Harvey labour shortages in 2018.
Emissions and litigation
Woodside is also on the hook for carbon emissions from the Scarborough gas resource. GIP extracted a concession entitling it to compensation if Scope 1 emissions are higher than anticipated.
Scarborough has very low reservoir CO2 compared to other Australian LNG projects (around 0.1%), but how easy will it be to reduce emissions if they come in higher than expected? The abysmal failure of the Gorgon LNG carbon capture project does not inspire confidence. And what happens to that 13.5% IRR if Australia’s voluntary carbon market becomes obligatory, and offset prices rise towards the global mean?
Furthermore, if key regulatory approvals are withdrawn then GIP can return the keys to Pluto and get a full refund. This is not an immaterial risk. Post-COP26, litigious climate campaigners are outraged at Woodside for proceeding with Scarborough and Pluto Train 2.
Maggie Wood, executive director of the Conservation Council of Western Australia, said the project is facing outstanding legal action, uncertain approvals and “one of the largest, coordinated campaigns of conservation, environment, and climate groups in Australia’s history”:
“We have demonstrated that there are a wide range of outstanding issues that could cause serious delays, increased costs or stall the development indefinitely. When you look at it closely, this deal shows that Woodside is willing to take on almost any level of risk to attract finance for this appalling climate-wrecking development.”
And it's not just ‘appalled’ climate activists challenging the investment thesis. Equity analysts were also left a rather perplexed by Woodside’s decision to plough ahead with such a large venture without selling down any equity in the upstream Scarborough resource.
Woodside owns 73.5% of the Scarborough joint venture, but the rest is owned by BHP – which is in the process of merging its petroleum division with Woodside (as scrutinised in this Energy Flux deep-dive). Post-merger, Woodside will own the upstream molecules lock, stock and barrel – and all the incumbent risks that come with holding proven, probable and possible (3P) reserves on your books.
Not fooling anybody
Speaking on this week’s analyst call, Woodside CEO Meg O’Neill was probed over the risks that her company is shouldering. Polite but firm queries ranged from the credibility of the reserves estimate at Scarborough to Woodside’s failure to sell down its holding in the Scarborough resource pre-final investment decision (FID).
Mark Samter of MST Marquee was particularly critical of Woodside’s approach to risk management, saying that on a market cap relative scale “this would be like ExxonMobil sanctioning a $100 billion project 100% owned”:
“I’ve never seen an LNG project anywhere in the world, or any megaproject of $10 billion-plus, where you have taken 100% of it to FID. The closest we got was to Pluto at 90% and history probably hasn’t judged that too kindly. What did the industry miss? Why didn’t they come in? How did you get comfort with the risks round that?”
O’Neill countered that GIP will still be exposed to upstream resource risk, then claimed Woodside thoroughly de-risked the project during the 18-month delay caused by Covid-19 restrictions. Analysts on the call were palpably jarred by her logic. Samter replied:
“Every word you’ve just said is a cookie-cutter of every LNG project that has been FID’d around the world in the last 15 years. They always [promise] 10-15% IRRs, they’re always largely lump-sum and yet they have all been disasters. I guess the proof will be in the pudding but it is just hard to reconcile why we should truly believe Scarborough is different.”
Critics might find themselves in the minority. Woodside’s share price bounced more than 5% in the days since the FID announcement, perhaps in relief to finally see a path forwards for Woodside. Quite where that path is headed is less clear.