Oil and gas

The Company

Oil Search (OSH) is one of the bestperforming stocks on the Australian Securities Exchange. Total production for 2013 was 6.74m barrels of oil equivalent, 6% higher than 2012. Revenue rose 6% to $766.3m, driven by a 19% increase in oil and gas sales, offset by a slightly lower realised oil price of $110.73 per barrel. Operating cash flow was up 87% to $366.8m, reflecting higher sales volumes, the timing of cash receipts and the low income tax paid. Net profit after tax in 2013 (including significant items) was $205.7m, up 17% from 2012. The company had total liquidity of $509.7m, comprising $209.7m in cash and $300m undrawn under a corporate revolving facility.

A 2013 final unfranked dividend of $0.02 per share was announced, taking the 2013 full-year unfranked dividend to $0.04 per share, which is consistent with 2012 dividends. The Papua New Guinea liquefied natural gas (LNG) project is now complete, and the Hides gas conditioning plant and the LNG plant site in Port Moresby were commissioned sooner then expected, in preparation for first gas exports. Construction has finished on the pipeline system linking the Hides production wells to the Hides gas conditioning plant and to the second train at the LNG plant site. LNG production is expected to double OSH’s 2013 output, increasing cash flows and strengthening its balance sheet in 2014.

OSH entered into an agreement with Pac LNG Group to acquire its 22.84% gross interest in petroleum retention licence (PRL) 15, which contains the Elk and Antelope gas discoveries. The current joint venture partners in PRL 15 include InterOil (75.61%), Pac LNG (22.835%) and others (1.55%), although InterOil has agreed to sell down its interest to France’s Total. Under the agreement, OSH will acquire Pac LNG’s shares for $900m, payable at completion, and contingent resource payments of $0.775 per million cu ft of gas for any certified 2C raw gas contingent resources within the Elk/Antelope fields greater than 7trn cu ft of gas, applied to OSH’s gross share before any government back-in. OSH has also entered into an agreement with the Pac LNG shareholders and other parties to undertake negotiations to acquire up to 100% of their interests in petroleum prospecting license (PPL) 236, PPL 237, PPL 238 and PRL 39, the latter of which contains the Triceratops gas discovery. The acquisition price for these licences still needs to be negotiated.

Company Strategy

OSH’s purchase of a 22.84% interest from Pac LNG gives it exposure to a potential LNG development. The Elk/Antelope fields were estimated to contain 2C contingent resources of 5.3trn cu feet of raw gas, including 75m barrels of associated liquids. The resource base was certified by Gaffney Cline & Associates in December 2013. The net recoverable raw gas attributed to OSH is 1.21trn cu feet.

The company will also be exposed to a potential upside from evaluating wells and exploring in PRL 15. InterOil plans to appraise three wells – including the proposed Antelope 4 well to be drilled on PRL 15 over the next 18 months – with the aim of providing gas resources to support a new LNG development. Other prospects and leads have also been identified in PRL 15, with an exploration well planned to be drilled in the second half of 2015. Along with the proven reserve, this diversified approach will strengthen a standalone LNG development within the next 18 months, which will add up to $2.41 per share to our OSH valuation.

OSH and its partners continue resource assessment and design studies for the P’nyang gas resource in PRL 3. The design studies will consider utilising P’nyang as a foundation for a third LNG train, and are set to complete by the end of 2014. OSH will apply for P’nyang development licence in 2015 and estimates a total 2C resource at P’nyang of 2.5trn-3.0trn cu feet.

OSH is looking to prove an additional resource within the existing reservoirs in Hides to support future LNG expansion. Work on updating its Gulf of Papua geological models based on the drilling data gathered during 2013 exploration is continuing. Further work will take place in 2014 to determine mature leads and prospects for potential future drilling campaigns.