Almost unbelievably, the Waitsia Stage 2 gas project has suffered yet another cost blowout and schedule slip. No-moat Beach’s (ASX: BPT) share of capital expenditure increases by around a third to $600 million – $650 million against prior guidance of $450 million – $500 million.

We assume $650 million at the high end. First gas is now not anticipated until early calendar 2025 which represents another six-month delay. More construction quality issues surfaced during precommissioning activities and despite the late stage, additional unspecified remedial works are required. Prior rectification works included rebuilding compressors and replacing elements of pipework.

Despite this, we only reduce our fair value estimate by 4% to $2.40 per share from AUD 2.50, with the Waitsia commissioning delay and increased capital cost detracting approximately equally.

The fair value hit, which would have been $0.20 per share all else equal, is roughly halved by recent strength in the Brent futures curve. Brent crude has risen around 10% over the past month to about USD 90 per barrel. This strength sees our group fiscal 2024 earnings per share forecast lift 5% to $0.16, and limits the Waitsia-driven fall in our fiscal 2025 EPS forecast to just 6%, to $0.22.

Waitsia Stage 2’s cost blowouts and production delays were key factors in our previously reducing our Beach fair value estimate by 20% to $2.50. We’d highlighted delivery of Waitsia according to the then plan as the key likely catalyst for share price appreciation toward our fair value. Unfortunately, this has not happened.

The market has responded savagely, with Beach shares down 15% on the day of the announcement. Despite not being responsible for Waitsia’s woes—having only started in his role in February 2024—new Managing Director and CEO Brett Woods will be feeling it regardless. We think the market response is overdone, and at $1.60, Beach is undervalued, in 4-star territory.

Business strategy and outlook

Beach Energy produces oil, gas, and gas liquids from multiple wholly owned projects and joint ventures in the onshore Cooper, Perth, and Eromanga basins, and offshore in the Otway, Bass, and Taranaki basins. Beach merged with Cooper Basin joint-venture partner Drillsearch Energy in March 2016, which increased equity production to about 10 million barrels of oil equivalent.

This more than doubled to over 20 million boe following the purchase of Lattice from Origin Energy in 2018. Lattice’s scale enhancing incorporation, expanding Beach’s footprint across multiple basins and production hubs, resulted in an increase in earnings before interest, taxes, depreciation and amortisation (“EBITDA”) margins. But even with Lattice, our no-moat rating stands. Despite Lattice’s advantages, Beach does not have sufficient resource life beyond 15 years.

Beach's goal to double production and reserves in five years was achieved via the $1.6 billion acquisition of Lattice, rather than from organic growth. But the priority remains to expand output from existing reserves, mainly in the Perth and Cooper/Eromanga basins.

Beach also sees huge potential for unconventional shale gas in the Cooper and elsewhere. The new target is for 34-40 mmboe of production in the next five years.

Most recently a final investment decision was taken for the Waitsia Stage 2 expansion project. The Waitsia project has become an inaugural accessor of North West Shelf Project liquefaction capacity of up to 1.5Mtpa to 2029.

Beach’s 50% Waitsia Stage 2 gas expansion to 250 TJ per day (100% basis) is equivalent to around 1.6 Mtpa of LNG. Waitsia Stage 2 alone could increase Beach’s equity production by over 7.0 mmboe or around a third on current production levels.

Also implicit in Beach’s production growth target is improvement in facility reliability, renewed Cooper Basin growth efforts and Otway gas plant production increase by around 35% to around 57 PJ by fiscal 2023 from around 42 PJ in fiscal 2019.

Economic moat

Learn more about sustainable competitive advantages or moats.

We think Beach Energy lacks a moat. The company produces oil, gas, and gas liquids from numerous joint ventures in the onshore Perth and Cooper and Eromanga basins of central Australia and from offshore fields in the Otway, Bass, and Taranaki basins.

The goal to double production and reserves during a two- to five-year period was instantly achieved via acquisition of Lattice Energy from Origin Energy. Beach also sees huge potential for unconventional shale gas in the Cooper Basin, though oil major Chevron exited a farm-in deal due to the oil price collapse. But even with Lattice’s advantages, Beach does not have sufficient reserve life to justify a moat.

The primary source of competitive advantage for resource stocks stems from maintainably lower costs than peers. We don't think Beach currently qualifies on this front. Pre-Lattice production was a meaningful 10 million equity barrels of oil equivalent per year, but operating costs are high in comparison with peers. Five-year average EBITDA margins of 45% to fiscal 2016 paled beside benchmark Woodside Petroleum's industry-leading 70%.

Beach has improved to plus 60% EBITDA margins but peers push 80% EBITDA margins.
Beach is Australia's largest onshore oil producer, and oil historically delivered much of its revenue, including an average 70% to fiscal 2016. But the three-year average oil revenue contribution to fiscal 2019 fell below 50% due to the addition of more gas producing assets.

Oil is more generally a high-margin business, but Beach is not a low-cost oil producer, given its development-intensive operations, small fields, and the requirement to truck product.

Beach became a more gassy business following the purchase of Lattice. The Cooper Basin has been in production for multiple decades, and many of the sweetest spots have already been tapped for oil. Oil economics are generally more favorable than natural gas, but Beach's competitive positioning within the oil segment itself is not particularly strong. We don't see Beach as having a moat.

Beach has equity proven and probable reserves of 255 mmboe and a further 195 mmboe in the 2C Contingent resource category. Average field based on reserves is around 15 years at current production rates, not sufficient for a moat. Additional equity contingent 2C resources are large, but still not moatworthy, given that a substantial portion comprises unconventional gas and gas liquids, which are not sufficiently progressed to rest production assumptions on.

Like most East Australian gas producers, Beach enjoys higher domestic prices than historically, given LNG export price pull. To a considerable extent, Beach already enjoys this, achieving a healthy average above $7.00 per gigajoule since fiscal 2019, and an average of $9.25 per gigajoule in fiscal 2023.

Beach is a partner in central Australian joint ventures with Santos and Origin Energy, including the Moomba gas processing facility, a 35 mmboe per year plant that chills off gas liquids for export and removes carbon dioxide. Moomba is definitely a moaty asset, and it is unlikely to be replicated by other central Australian gas proponents because of cost. While this certainly feeds into a cost advantage argument for Beach, its minority 33.4% stake weakens moat arguments that apply to majority owner Santos.

Built over decades, Moomba's gross historical cost is approximately $8.0 billion, including three fourths of the recent $700 million - $800 million incomplete refurbishment. We estimate Moomba's replacement cost in the vicinity of $4.5 billion - $5.0 billion. Moomba's position is pivotal to central Australian gas flows and is an important supply source for third-party East Coast LNG.

We don’t expect Beach’s economic moat potential to be undermined by material shareholder value destruction from environmental, social, and governance risks. ESG risks are based largely on industry risks that are already incorporated into our base-case analysis. And natural gas is the predominant value driver for Australian energy and production, E&P, firms like Beach. Natural gas is less carbon-intensive than coal or oil, and stands to benefit from efforts to minimize emissions, at least in the medium term. This is because renewables like wind and solar, while growing rapidly, can’t hope to entirely meet global energy requirements for decades, if ever.

Hydrocarbons’ share of primary energy consumption fell to 84% from 87% over the last decade, though in absolute terms consumption increased by 74 exajoules or 15% to 492 exajoules. Share was displaced by renewables, which increased to 5% of the total from 2%, or by 21 exajoules to 29 exajoules. In absolute terms, growth from hydrocarbons was more than triple that for renewables. And gas played the lead role, consumption increasing by 36 exajoules or 34%. We expect the trend for gas in particular to continue at least in the medium term as the most effective way to quickly reduce emissions meaningfully. Gas’ share of primary energy consumption increased to 24% from 22% over the last 10 years.

Further, E&P firms are doing more to defray emissions from their extraction operations. Beach targets a 25% reduction by 2025, preferring not to have a longer-term target. Another element of ESG risk for E&P firms includes potential loss of field access due to poor community relations. Beach Energy requires access to land in order to construct and operate infrastructure including pipelines and needs to maintain healthy community relations.