Oil Search Re-Rated Following Site Visit

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            [1] => ((DOW))
            [2] => ((STO))
            [3] => ((OSH))
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This story features DOWNER EDI LIMITED, and other companies.
For more info SHARE ANALYSIS: DOW
The company is included in ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

It was a long an arduous trek into the wilds of the Papua New Guinean jungle, but our intrepid gas analysts are happy they stuck it out. So far no one seems to have contracted any strange diseases, although that junior never did return after wandering off for a comfort stop. Is it just me or does this stew taste like chicken?

The feedback from the expedition would nevertheless be heartbreaking for the likes of Woodside ((WPL)) and Downer-EDI ((DOW)), both of which are desperately trying to deliver trains. Santos ((STO)), on the other hand, would have been smiling smugly.

For all the number-crunching a computer can accommodate, sometimes it's a lot more beneficial just to go out and have a look at an operation for oneself, meet with the protagonists, check out the holes in the ground etc and draw a more informed conclusion. That's exactly what several gas analysts did in setting off for a site visit to Oil Search's ((OSH)) enormous PNG LNG project. And what they saw, they liked very much.

It's been a long and somewhat tedious road for OSH investors these past five years. They have nothing at all to complain about, as the share price has headed steadily north, but fresh information is so thin on the ground you might as well watch paint dry. OSH dutifully publishes production reports every quarter, and every quarter gas analysts pull out the broken record. Forget about the production report, they say, all that matters for OSH is that PNG LNG is on track. The frustrating part is that that track is a helluva lot longer than the Kokoda one.

But the analysts have returned from PNG with a new spring in their steps, having met with the PNG Minister of Public Enterprise and other officials (the PNG people hold a stake in the project) and having toured the major existing facilities and greenfield upstream facilities. While Woodside struggles to find the gas to justify a second LNG train at Pluto, and a third seems like a pipe dream (pun intended) at this stage, and while the Queensland CSM hopefuls all watch the clock tick on final investment decisions, the market has long ago assumed PNG will have plenty of gas for two LNG trains.

Two trains may have been priced in to a sufficient extent, but the passage of time required to success and the potential for further expansion in the project has left OSH always a little undervalued in most analysts eyes. The market may not be prepared to be convinced until production is a reality, but six out of eight brokers in the FNArena database have Buy ratings on OSH given the potential upside.

RBS Australia actually prefers the similar but potentially more immediate value in Santos if the GLNG project ever gets the nod, so it is on a Hold rating. Credit Suisse put an new senior analyst on the job this month who immediately downgraded to Underperform, but having returned safely from PNG with a renewed appreciation she has decided to at least upgrade to Neutral.

The first thing analysts noted is that management now expects the first two trains to produce 6.9mtpa of LNG rather than the 6.6mtpa originally assumed. That's one thing about LNG trains – they tend to be assumed to be generic given most are built with pro-forma parts imported from offshore, but realistically there is no industry standard size. Qatar, for example, is in the process of building “mega-trains”.

[Note that a “train” has nothing to do with things that run on tracks and go toot-toot. My Downer comment was just a furphy. A “train” in gas terms is a production plant that produces LNG from natural gas through a step-by-step process of removing different impurities. Each process occurs at a “station” in the plant, hence the analogy.]

Citi believes the extra capacity could add 14c to OSH's share price while JP Morgan has offered 17c and Credit Suisse goes as far as 28c. But while this is good news, it's not the best bit.

To justify the construction of a train (a time consuming and expensive exercise) a project requires confident gas reserves of some 2.0-2.5 trillion cubic feet. Citi believes the Hides South prospective well is targeting 3.0-3.5tcf alone which is more than enough to underpin a final investment decision (FID) on a third train. It now appears a T3 is growing in focus for OSH with drilling set to commence mid next year, allowing enough time for the mandatory assessments.

JP Morgan suggests an end-2012 FID goal for T3 is a bit ambitious, with 2013 looking more realistic. However, OSH is apparently stepping up a gear given the PNG government's impatience. The government appears to now be adopting a “use it or lose it” policy which has already seen one well licence renewal rejected due to lack of progress. This should galvanise the joint venture into proving up its resource base more expediently, suggests Citi, meaning T3 and potentially a T4 will likely be developed faster than previously hoped.

On top of all of this excitement, OSH also suggests its actual production in 2010 will exceed prior guidance, albeit analysts had already taken that guidance as being to the conservative side.

The net result is that three brokers reporting on their OSH travels today have increased their earnings forecasts and shifted up their target prices a few percentage points (consensus now $7.71) with prospects shifting beyond T1 and T2 and on to T3 and T4.

So if you see an OSH investor who's nodded off in a corner, you may want to give them a poke.
 

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