article 3 months old

Oil Search Vulnerable To Delays In PNG

Australia | Jul 17 2019

This story features SANTOS LIMITED. For more info SHARE ANALYSIS: STO

Oil Search is facing a nervous wait as the PNG government reviews the fiscal terms of the PNG LNG agreement.

-P'nyang gas agreement to be negotiated once government review completed
-Critical items need to be de-risked before stock can re-rate
-Timing critical in a competitive marketing environment

 

By Eva Brocklehurst

The PNG government has thrown a spanner in the works for Oil Search ((OSH)), creating uncertainty in an environment in which delays could be critical in obtaining the necessary capital to forge ahead with expansion plans.

The PNG government will review the fiscal terms of the PNG LNG agreement, signed back in April 2019, which may lead to more onerous fiscal terms. The new minister for petroleum has indicated the government is not looking to revoke the agreement, unless there is fraud or non-compliance.

Once this review is completed the P'nyang gas agreement will be negotiated. Morgan Stanley points out a P'nyang agreement is required to underpin the train-3 expansion and will also drive the timing for the Papua LNG project, given the integrated nature of the two projects. The company has confirmed that both agreements are prerequisites for downstream front end engineering design (FEED) entry.

Oil Search remains confident in the fiscal stability of PNG, Macquarie asserts, having provided briefings on the expansion of LNG projects to the new government during the June quarter. The broker continues to believe the market is overly cautious about PNG as it incorporates little value for the PNG LNG expansion and Papua LNG projects.

Uncertainty

2019 production guidance has been revised down marginally to 28-31 mmboe, which relates to the company's operated assets. Production costs guidance has been increased to reflect additional costs associated with earthquake-related damage.

2019 capital expenditure guidance is been revised down -8% to $555m at the mid point. This reflects revised timing for FEED entry for the PNG expansion and, UBS suspects, while the company continues to make progress on pre-FEED activity, there is a risk that PNG expansion could be delayed as other joint-venture partners allocate attention elsewhere.

While the current price looks attractive, the broker remains Neutral on the stock, given the uncertainty. Morgan Stanley agrees there are certain critical items that need to be de-risked before there is potential for a multi-year re-rating of the stock.

In this, timing is important, as there are a number of global LNG final investment decisions pending. The broker also cites concerns about the balance sheet, although has become incrementally more positive on Oil Search, given the de-rating versus peers over the last 1-2 years and the possibility that expansion plans become clearer in the next 3-6 months.

The best case scenario, Ord Minnett suggests, is a short delay in the project proceeding, while the worst-case scenario is where more onerous fiscal terms are imposed that test the viability of the project. Of most concern to the broker is the fact that these developments comes at a time when project returns are being tested by weak global LNG prices.

Prepared For Delays?

Credit Suisse suspects that, as an organisation, Oil Search has not been prepared for the era post the departure of former CEO Peter Botten. The broker suspects Oil Search may lack internal structures and processes to enforce disciplined decision pathways, as Peter Botten was far more central to its internal functioning compared with peers.

Hence, the company is going through internal changes at a critical point in PNG's political and project development and this presents a risk.

Credit Suisse does not rule out the new minister taking a tough approach to the review, given questions about the fair share of government tax take. Should the review of the PNG LNG agreement prove benign, the broker still envisages potential delays at P'nyang that could bear the brunt of political misgivings and, in turn, mean the site access agreements are re-negotiated.

Hence, a delay of around 6-9 months is a real risk and, if this eventuates, could mean the project is pushed back several years on the dictates of project sequencing and capacity limitations. Partner Santos ((STO)) may also seek to open up access agreement negotiations again for P'nyang, if the government extracts tougher terms, which could delay decisions further, Credit Suisse asserts.

Citi does not believe the review will result in a worse position for the JV. If the government needs to increase fiscal terms, for the optics of claiming more economic rent, then the P'nyang gas agreement provides a better path, as this has long-dated cash flows that won't affect the economics of expansion. Citi is more concerned about the timing, as delays are not helpful in a competitive marketing environment.

On another issue, Osaka Gas is reported to be pursuing arbitration with the PNG LNG JV over contractual price reviews, which Credit Suisse notes is the first time a Japanese operator has taken such a step. The broker suggests other buyers will watch this arbitration closely, maybe taking a view to piggy-backing on the result. Moreover, Oil Search may be the JV partner most exposed.

There are two Buy ratings on FNArena's database, with four Hold and one Sell (Credit Suisse). The consensus target is $8.13, signalling 16.6% upside to the last share price. Targets range from $6.96 (Credit Suisse) to $10.54 (Morgans, which has not updated since May and is a substantial outlier to the rest).

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Share on FacebookTweet about this on TwitterShare on LinkedIn

Click to view our Glossary of Financial Terms

CHARTS

STO

For more info SHARE ANALYSIS: STO - SANTOS LIMITED