Australia | Nov 02 2017
Oil Search is heading north to Alaska to acquire a stake in a prospective oil field. What does this imply for a business that has been centred on PNG LNG?
-Diversifies geographic risk, brings more oil to portfolio
-Will the company be able to fund commitments in both Alaska and PNG?
-Risk profile heightened, and Alaska will test the company's capabilities
By Eva Brocklehurst
Oil Search ((OSH)) has hit the surprise button, taking a stake in an Alaskan asset for US$400m. The company will acquire the interests in the undeveloped Nanushuk oilfield on Alaska's North Slope and is keen to stress that the acquisition diversifies its geographic risk away from PNG and brings more oil into the portfolio.
The acquisition comes with an option to acquire the remaining interest for US$450m by June 2019. The company has the right to on-sell the option to increase its equity. The assets consist of 500mmbbl of estimated crude reserves, located close to existing producing fields as well as underutilised infrastructure.
The transaction will be funded out of existing liquidity and Oil Search will become operator from June 1, 2018. Oil Search is acquiring 25.5% of the Pikka Unit and 37.5% of the Horseshoe block. Partners are Repsol and two private companies, Armstrong Energy and GMT Exploration.
The entry into a new country always carries heightened risk, UBS suggests, and as the stock is usually considered a pure play on LNG in PNG the market may remain sceptical until commerciality is demonstrated. The broker notes Woodmac estimates a break-even oil price of US$47/bbl for this play and a gross value of US$1.3bn for a 500mmbbl resource, which suggests a value net to Oil Search of $330m, below the purchase consideration.
Nevertheless, UBS points out that upside is considerable if Repsol's resource estimates are realised. Most of the appraisal drilling is scheduled for 2019 and, therefore, the broker suspects it will take some time for investors to judge the merits of the transaction.
At spot oil, Ord Minnett values the stake at US$584m and suggests, while the market may be concerned about the implications of the acquisition, it represents an attractive opportunity and should not impact on confidence in the timing of the PNG expansion project.
Impact On PNG LNG Timeline
Incorporating the transaction means gearing would peak in 2021 at 40%, signalling to Ord Minnett the company should still be able to fund its commitments for the PNG LNG expansion as well as the Alaskan operations.
Morgan Stanley disagrees and suspects the transaction will throw doubt on the timeline for the LNG expansion in PNG, where successful development offers material upside.
Credit Suisse will take more time to become convinced: why leave PNG and go elsewhere to operate a prospect on a timeline that is concurrent with an expansion in PNG that is supposed to already double production?
While the call on capital is a few years away the broker worries about the ability to do both, pointing out that keeping the debt on balance sheet means this will peak at an uncomfortable 46% in 2022 and that would be too high to sustain another dip in the oil price.
Despite the company asserting that there would be no delay to PNG expansion, Credit Suisse suggests a move like this is more logical were that to occur. The broker hopes to be proven wrong. The main challenge Credit Suisse foresees is that, assuming both assets progress to plan, Oil Search may need to raise equity.
Execution Risk
The acquisition metrics appear good, Morgan Stanley acknowledges, should a high-case resource be proven, and suspects the transaction was highly competed, given the size of the resource and its location in a region where there is significant oil and gas development.
The broker does point to the company's past investment in the Middle East over a number of years which was recently written down to nil, although agrees with Oil Search that this one is more of an appraisal/development opportunity. Still there is execution risk, given the location is on the other side of the world, and it will test the company's operating capability.
First production from this new acquisition schedule for around 2023 and Morgan Stanley's suspects this could ultimately be very well timed, given a view of strengthening oil markets.
In Citi's calculations the company has paid a full price for the discovery. The broker concedes upside could be proven in time and agrees investors need to question whether the risk profile for Oil Search has changed.
While value could be demonstrated in time and Alaska could be retrospectively viewed as good business the company's core competencies are in mature oil fields, LNG markets and landholder dialogue, the broker points out. Supply chain capabilities in a difficult terrain may not be well suited to the greenfield oil development in Alaska.
Citi also asks whether investors would not be better served by their own diversifying of commodity/region exposure?
While development will increase the risk profile in the near-term, Deutsche Bank believes the acquisition offers a diversified development and exploration option at an attractive point in the cycle.
Given the rally in oil prices, the broker suggests the company should be able to sell its stake at an attractive price if choosing to do so. Moreover, while there is concern about the company's lack of experience in the US there is widespread regional expertise that can be harnessed.
FNArena's database shows three Buy ratings, four Hold and one Sell (Citi). The consensus target is $7.80, suggesting 9.0% upside to the last share price. Targets range from $5.79 (Citi) to $10.46 (Morgans, yet to comment on the acquisition).
This stock is not covered in-house by Ord Minnett. Instead, the broker whitelabels research by JP Morgan.
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