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BHP's shale for sale

The mining company will bow out of its US shale venture after pressure from activist investors

BHP Billiton's shale business has been in the crosshairs for months. Elliott Management, an asset manager and activist investor that has built up a 5% stake in BHP, has been agitating for management to cut the US onshore oil and gas business loose. It even set up a website, fixingbhp.com, where it argues the company has burned through some $23bn of investor money in its "ill-fated foray into US shale".

Now management is buckling to investor demands and says it will start shopping around its shale assets, which includes acreage in the Haynesville and Fayetteville gas plays and in the Eagle Ford and Permian tight oil fields. Andrew Mackenzie, the company's boss, played up the business, saying it has been free cash flow positive and profitable this year thanks to lower investment levels and a more efficient approach to development, no small feat at today's oil and gas prices.

But it's hard to argue that BHP's shale endeavor has been anything but a bust. The company made a big splash in US shale in 2011 when it plowed $20bn into buying up shale fields. The investment made BHP, a relative novice in the oil and gas business, a top-10 producer in the US. But the timing proved disastrous. Oil prices were more than $100 a barrel, natural gas was at around $4 per million British thermal units, and valuations had been inflated by a frenzy of deal-making. Since then, the company has written down the value of its shale business by around $13bn.

It wasn't just the financials that haven't worked out. Mackenzie revealed that a broader aim of the initial US shale investment was to use BHP's international scale and financial firepower to take shale global. That strategy has not worked out as other shale opportunities across Europe, China and Latin America have fallen well short of the early hype. "Following a global endowment study about two years ago, it became apparent to us that the opportunities to replicate US shale oil elsewhere did not exist," Mackenzie told analysts this week.

It is also more evidence that the shale business model is an uneasy fit for large mature resource companies. Investors in oil and mining majors value returns and stable dividend payouts over chasing growth. In shale, by contrast, volume growth rates rule over profits, more akin to a Silicon Valley startup than a global mining behemoth. Shale also requires a different mindset towards spending than other large oil or mining projects. The steep drop off in output from each well after just a few months of production also require constant drilling and investment. BHP would rather invest in projects against the price cycle, making its big capital commitments when prices, and costs, are down, and enjoying the payoff when prices rise. "One of the features of shale, which we have grown to like a bit less with time, and see as a bit more of a curse, is that the investments that are demanded there are quite pro-cyclical. You have to continue to invest to actually maintain the value of those businesses," Mackenzie said.

What can BHP expect to get for its shale business? Estimates range widely, and much will depend on future oil price expectations. RBC, an investment bank, estimates the onshore business is worth around $4.1bn, while analysts at Macquarie, another investment bank, puts the value closer to $10bn. Given that neither the oil nor US gas price looks likely to mount much of a rebound anytime soon, the lower end of that range seems like a more realistic expectation.

The Permian business will be where BHP Billiton sees the most value. Recent deals across the basin, probably the hottest oilfield in the world, have valued land there at between $20,000 to $40,000 an acre, making BHP's 93,000 acres potentially worth anywhere between $1.9bn to $3.8bn. One issue for BHP will be that its landholdings are fairly scattered around the Delaware section of the basin. It's prime real estate, but buyers would place more of a premium on continuous acreage, where longer lateral wells can be drilled and infrastructure development is easier.

Shale may not be the right fit for BHP, at least not in the eyes of Elliott and other activist investors, but the company's shale assets will find a welcoming home in the hands of smaller shale specialists.

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