Woodside growth warnings

WOODSIDE Petroleum's strong balance sheet and low development risk compared to Santos and its one-time takeover target Oil Search may not save it from a ratings downgrade from Moody's, even as JP Morgan believes its growth LNG projects – Browse, Sunrise and Kitimat – are "not viable" at current oil prices.

Woodside growth warnings

Moody's announced it had placed Woodside's Baa1 rating under review for a possible downgrade, having changed its outlook from stable to negative last month on the back of expectations that oil prices were not expected to shift a great deal in 2016 from their late 2015 levels.

However things have changed since then, as Brent crude has plummeted nearly 30% just since the start of the year, prompting Moody's to warn that prices could fall further amid a "substantial risk" of a delayed recovery, longer than the medium-term than many oilers expect.

"Oil prices have deteriorated substantially in the past few weeks and have reached nominal price lows not seen in more than a decade," Moody's said.

The agency's latest review for downgrade for Australian energy companies including Origin Energy comes as "weaker industry fundamentals have potential to warrant rating changes" for Woodside.

Moody's sharply reduced its oil price assumptions on January 21 in light of continuing oversupply in the global oil markets and demand growth that remains tepid.

Iran is poised to add more than 500,000 barrels per day to global supply while OPEC and many non-OPEC oil producers continue to produce without restraint as they battle for market share.

Moody's said the addition of Iranian oil to the market this year would offset or exceed expected declines in US production as high cost shale and tight oil is knocked out of the market.

"Increased production vastly exceeds growth in oil consumption, given modest growth in consumption from major consumers such as China, India and the US," Moody's said.

"Production now exceeds demand by about 2MMbopd, adding to already high global oil stocks. Our natural gas and natural gas liquids price assumptions are unchanged.

"Natural gas production in the US continues to increase while costs decline and producers generate cash returns at ever-lower prices, although in many cases these appear insufficient to service their debt."

Moody's warned that lower oil prices would further weaken cash flows for exploration and production companies and the upstream portion of integrated oil and gas companies, like Origin, which means financial ratios will deteriorate further and cash flow will sink deeper into the negative space.

"Most companies are unable to internally fund sustaining levels of capital spending at current market prices," Moody's said.

"While integrated oil and gas companies benefit from the profitability of their downstream operations, the upstream operations represent a much larger part of the capital employed and cash flow for most of these companies.

LNG worries

Initiating coverage on Woodside on January 13 with a target of $A28.50/share, JP Morgan also expressed concerns over the macro outlook, and warned that consensus earnings estimates could well reflect too-high oil price forecasts.

LNG markets are also likely to be oversupplied for at least the next four years, which puts pressure on the strength of oil-linked contracts.

Wheatstone is Woodside's key near-term growth project with the project due for first gas by 2017.

Beyond that, the oiler has a number of development projects - particularly Browse floating LNG, Kitimat LNG in Canada and Greater Sunrise, the latter of which is stuck in limbo as Woodside wants to go the floating LNG option, while Timor-Leste wants the onshore option, and there are ongoing diplomatic tensions between Timor-Leste and Australia over the precise location of the maritime border between the two companies.

JP Morgan said in the current market conditions mean none of these projects are economically viable without either higher prices or a reduction to capital and operating costs.

"In our view, Woodside's limited viable growth options means a lack of apparent catalysts for the stock to rerate, meaning the stock price will likely be determined by commodity prices," JP Morgan said.

Woodside slightly cut its guidance for total expenditure in 2015 to a still significant $US6 billion, which consists of $2.3 billion in capex, $3.2 billion for the acquisition of Apache's assets early in the year and $400 million for exploration.

However, JP Morgan warned that, in the absence of another cash acquisition, investment expenditure is likely to "come down significantly" going forward.

Woodside has commitments to spend on the Karratha Life Extension, the Wheatstone project in its final year of construction, and the recently approved Greater Western Flank Phase 2 extension.

Beyond that, JP Morgan warned that Woodside's organic growth projects are "likely not viable" in the current pricing environment.

"We expect [Woodside's] board to defer much of the commitments to these projects," JP Morgan said, referring to Browse, Kitimat and Sunrise.

On the upside, JP Morgan also said Woodside could reduce investment spending by as much as $4-5 billion to only $1 billion a year for the next three years, which would mean significantly more free cash flow despite weaker prices.

"We forecast free cash flow of -$3.1 billion in 2015 but even using spot prices, we expect Woodside to be cash flow positive for the next three years," the bank said.

"Under our base case price forecasts, we estimate the company's gearing will reduce from 21% in December 2015 to 15% by December 2016 and 6% by December 2017."


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