Heard in Papua New Guinea: Oil Search Bargain

MELBOURNE Oct 17, 2006 (Dow Jones Newswires from the Wall Street Journal Asia)

Shares of Papua New Guinea-based oil and natural-gas producer Oil Search have been hit hard in recent months by uncertainty over its plan to pipe natural gas 4,000 kilometers to Australia's energy-hungry east coast.

Now, some analysts say the selloff, which has wiped more than A$1 billion (US$750 million) from the market value of the company, has made Oil Search shares a buying opportunity -- whether or not the pipeline goes ahead.

As well as having more than four trillion cubic feet of gas in Papua New Guinea's Southern Highlands, Oil Search has oil reserves of 96 million barrels in the same country and expects to produce about 11 million barrels in 2006.

"At today's stock price, you are getting all that gas for free because Oil Search is easily worth this price just for its exploration and oil production," says Morgan Stanley energy analyst Stuart Baker, who has a "buy" rating on the stock.

Deutsche Bank analyst John Hirjee, who also rates the stock a buy, agrees. "We definitely see value in the stock at these sort of price levels because there is not a lot of value, if any, imputed for the gas," he says.

Oil Search's shares, which trade on the Australian Stock Exchange, fell from a high of A$4.64 each in May to a low of A$2.99 in September. Yesterday, the shares rose 2.4% to A$3.43, well below Morgan Stanley's price target of A$4.20.

Macquarie Equities is even more bullish, with a 12-month share-price target of A$4.86.

Despite the stock's slide, Oil Search remains Australia's third-largest listed oil-and-gas company in terms of market capitalization, behind Woodside Petroleum and Santos.

The plan to pipe Papua New Guinea gas to Australia suffered a blow in August when the partners in the A$4 billion Australian leg of the pipeline, Australian Gas Light and Malaysia's Petronas Gas, said they had put the project on the back burner, citing spiraling costs and a lack of foundation customers.

Oil Search and its partners in the US$2.5 billion upstream Papua New Guinea gas joint venture, which include project operator Exxon Mobil Corp., of the U.S., are considering a proposal for a staged development that would cut the cost of the pipeline.

Many analysts now doubt the project will proceed, and gas customers in Australia are looking around for other suppliers.

Queensland's growing coal-seam methane sector, which now supplies 40% of the state's gas needs, is also putting pressure on the pipeline. Coal-seam producers in Queensland, the Australian state closest to Papua New Guinea, are accelerating their development programs and talking up their prospects of stealing customers from the ailing pipeline project. These companies extract coal-seam gas, usually methane, from natural fractures in Australia's abundant underground coal bodies.

Oil Search Managing Director Peter Botten says the pipeline is still the company's preferred growth option and the staged-development proposal looks promising.

"We are costing it out and working on a plan. I am reasonably optimistic that this is a way forward," Mr. Botten said in an interview last month.

Oil Search's plan has been to develop the pipeline first, selling 250 petajoules of gas a year into Australia starting in 2010 (one petajoule equals 0.95 billion cubic feet of gas). It will then sell 150 petajoules a year to petrochemical projects in Papua New Guinea and finally develop a 250 petajoule-a-year liquefied-natural-gas processing plant, starting production in about 2013 and with its eye firmly on the booming Asian energy market.

With gas prices in Australia low and construction costs rising, the company is undertaking a strategic review and considering a future without the pipeline. Oil Search has signed a memorandum of understanding with U.K. energy company BG International to look at exporting liquefied natural gas from Papua New Guinea.

A surge in prices and demand has seen the LNG export market take off in recent years. With LNG being sold at about A$6 a gigajoule, Morgan Stanley's Mr. Baker says it looks more attractive than piping gas to the Australian market, where it sells for around A$3 a gigajoule. "Targeting the export markets with LNG is a whole lot more sensible," he says. "The agreement with BG Group is a good start and I think it is something they should accelerate."

Oil Search says that at this stage any LNG development will be fed by gas that hasn't been allocated to the pipeline project. This means the company will need to start drilling and prove the resource of about five trillion cubic feet needed to underpin an LNG plant. Proving more gas shouldn't be a problem, with the Papua New Guinea government estimating the Southern Highlands could hold as much as 50 trillion cubic feet.

The company is also working to diversify its portfolio of assets and has exploration programs under way in Yemen, Egypt and the Kurdish section of Iraq, as well as another potentially huge but high-risk target in the southern part of that country.

Damian Graham, a fund manager at Macquarie Private Portfolio Management, says there is a lot of negative sentiment in the market over the Papua New Guinea pipeline deal, but fundamentally Oil Search still looks attractive.

"It is just a question of how they commercialize that gas; that is the unknown," he says. "As a long-term investment it remains quite attractive. But if you assume the pipeline is dead in the water, then the question is, what is the short-term catalyst on the stock?"

Macquarie Private sold out of the stock just before Australian Gas Light's announcement sparked selling in August. But Mr. Graham doesn't rule out buying shares at some stage.

"I think that they looked very attractive around A$3 the other day, so if you do see any more negative news on the stock, that potentially could be another buying opportunity," he says.

Copyright (c) 2006 Dow Jones & Company, Inc.


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