Sandstone Insights: Woodside spends big on ammonia project

This article was written by Sandstone Insights on 6 August, 2024.

ASX code: WDS

Suggestion: Sell

Need to know

• Acquisition of OCI clean ammonia for $2350 million cash partly fulfils Environmental, Social and Governance (ESG) pledge on Scope 3 emissions
• Likely removes any chance of a higher dividend payout over the next two years as leverage rises
• Market unlikely to attribute anything more than book value to this deal, in our view

Addressing ESG concerns: Woodside's $2.3 billion clean ammonia investment

Still recovering from the shareholder-rejected Climate Transition Action Plan (CTAP) earlier this year, Woodside Energy Group has invested $2.3 billion in a project that should appease its ESG critics. The OCI clean ammonia project will significantly reduce Woodside's Scope 3 emissions, a measure only introduced in the CTAP this year.

For $2350 million, Woodside has acquired 100% of OCI Clean Ammonia Holdings in Beaumont, Texas. The project, currently under construction, expects its first ammonia production in late 2025.

Once Phase 2 is operational, the project will have the capacity to abate 3.2 million tonnes per annum of CO2e, reaching 60% of Woodside’s Scope 3 abatement target. This should garner praise from many investors who criticised Woodside for its apparent inaction on climate initiatives.

Financial implications and strategic acquisitions

Despite Woodside’s assertion that the project will achieve a required return on investment above 10% (a positive point), the acquisition will increase group leverage to about 20% (the top end of its 10-20% range). This will likely preclude any increase in Woodside’s dividend payout ratio for at least the next two years.

Woodside has made two acquisitions in quick succession (Tellurian LNG and OCI ammonia) that align with its Capital Allocation Framework but will put pressure on free cash flow in the short term.

Woodside’s Scope 3 emissions abatement target is to invest $5 billion in new energy projects and lower-carbon services by 2030. The target abatement is 5 million tonnes per annum of CO2e.

Investment view

Measuring the economic and environmental benefits

The OCI project aligns with Woodside’s ambition to find suitable investments to achieve its Scope 3 emissions target. The project produces ammonia using natural gas paired with carbon sequestration, significantly reducing the CO2 emitted in the process. It can theoretically be sold at a premium to standard ammonia in global markets, thus contributing to a payback on investment in under ten years - a key criterion for Woodside.

Challenges and opportunities in ammonia production

In the context of Woodside’s business, this investment is crucial to achieving its ESG targets. However, the opportunity cost is a delay in free cash flow that restricts higher dividend payments to shareholders.

Ammonia production is not a core business for Woodside, and investors are unlikely to attribute more than book value to it. Woodside lacks specific expertise in marketing ammonia, raising doubts about its ability to achieve the $120 per tonne green premium expected, compared to current ammonia prices around $400 per tonne.

Promoting LNG as a sustainable energy solution

We believe Woodside should promote its green credentials through its core liquefied natural gas (LNG) product. Shell’s CEO Wael Sawan recently stated that its LNG business is “currently the only credible solution that offers both energy security and decarbonisation of the energy system.” According to the Energy Information Administration, switching from coal to gas has helped the US reduce its carbon emissions from electricity production by 40% over the last two decades.

• ^{The information provided by Sandstone Insights does not constitute investment advice and does not have regard to the specific needs of any person who may receive it. No warranty is given as to the accuracy or completeness of the information and any person acting on it does so entirely at their own risk.}