Origin Moves Closer To LNG Reality

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This story features ORIGIN ENERGY LIMITED, and other companies.
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The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

– Origin's offtake agreement for APLNG with Sinopec has been ratified
– This goes a long way to de-risking the project
– More agreements may follow but risks still remain
 

By Greg Peel

“We have always seen the signing of binding Sales and Purchase Agreements (SPA) with buyers,” says Deutsche Bank, “as a significant de-risking event for proposed LNG projects seeking sanction”.

On Thursday, the Heads of Agreement signed less than two months ago between aspiring LNG producer Origin Energy ((ORG)) and Chinese gas buyer Sinopec was confirmed as a binding SPA for the delivery of 4.3mmtpa of LNG from the company's Asia Pacific LNG project from 2015. Sinopec also confirmed the acquisition of a 15% stake in the project. A move from HOA to SPA usually takes around six months in the industry, Deutsche notes, so such speed of conversion is an “impressive achievement”.

So what does it all mean?

Well we recall that the construction of a plant to convert natural gas into liquid natural gas for seaborne transport is a very costly and very time-consuming business. Given the capex required and the considerable risks involved, gas production companies need to first confirm sufficient gas reserves and then pre-sign long term sales agreements before being able to justify, or “sanction”, moving to construction of one or more LNG “trains”. To enter into a sales agreement, the buyer must also have confidence in the project.

Aside from signing sales agreements, it is common practice for buyers to take an equity stake in the project in order to subsidise the required capex, in exchange for some control over ultimate LNG pricing. Such investments alleviate some or all of the need for the gas producer to raise additional capital to fund the project.

At US$1.5bn, the price paid by Sinopec for its 15% stake in APLNG exceeded most broker expectations in A$ terms (given the exchange rate is against us) and appears favourable when compared to stakes acquired in Santos' ((STO)) Gladstone LNG project and others. This demonstrates the value of Origin's comparative gas resource base, suggests Credit Suisse. Half of that payment goes to Origin, which thus loses 7.5% of APLNG equity, and the other half to project partner ConocoPhillips.

Unlike LNG production in Western Australia, which sources offshore natural gas, APLNG will source coal seam methane in the Surat Basin in Queensland. CSM has been successfully exploited in the US and elsewhere before but these large-scale Australian projects remain unprecedented. This only adds to the risks of such costly, long-term endeavours.

Origin has been hoping to sanction APLNG, which means moving to final investment decision (FID) status, by mid-year. RBA Australia suggests that following the Sinopec agreement, reaching FID in the time frame now becomes a formality. Indeed, the deal is actually conditional on reaching FID, and also dependent on FIRB and Chinese government approval, though neither is seen as an obstacle.

Noting Deutsche Bank's statement at the top of this article, the Deutsche analysts have now “de-risked” their valuation of APLNG by increasing the chance of success in their model to 70% from 40% for a first train. Credit Suisse sees the metrics of the Sinopec deal as representing 60% of the analysts' de-risked discounted cashflow valuation for two trains. There is nevertheless still a question as to whether Origin will seek FID on one train or two.

Citi suggests the 4.3mmtpa contract with Sinopec represents the LNG production of one entire train. So it would be fair to assume FID on the first train is now a given. Origin hasn't said much about a second train lately, and Credit Suisse suggests the company may simply go to FID on one train “with a line of sight to a second train,” to use management's own words at the time of the SPA announcement.

Management also declared Sinopec is not the only interested party, and that there are other possible buyers sniffing around. RBS suggests negotiations with other parties are likely well advanced. The result may be further equity stake sales, which would mean Origin probably won't need to raise additional capital. Management has nevertheless warned not all interested customers are also interested in equity. As to whether the Sinopec deal is enough alone to prevent an equity raising on the market would depend on whether a potential hybrid debt issue could satisfy, RBS notes.

So it all seems like great news, albeit the risks do not end with such agreements. Deutsche foresees two potential issues.

One is LNG pricing. It is estimated the deal struck by Sinopec represents an 8% discount to equivalent pricing negotiated by the neighbouring two CSM LNG projects of Santos' GLNG and QGC's Queensland Curtis LNG. Sinopec can afford to negotiate aggressively given its alternative sources of pipeline gas, notes Deutsche.

The other is a simple one of costs. The standout feature of both the current round of quarterly production reports from Australian resource companies and the current general quarterly result season in the US is one of cost inflation. One only has to read the local papers to know that Australia is suffering a desperate skills shortage driven by the number of large-scale resource sector projects all under construction at once, so labour becomes a vital cost issue. There are now three CSM LNG projects at the port of Gladstone and Deutsche foresees labour shortages as a risk.

So it's not yet all beer and skittles for APLNG, or for any of the Queensland CSM LNG projects underway (not to mention all the WA natural gas projects). Funding remains an issue, as does the decision on a second train and the risk of capex blow outs in the long lead time to targeted first offtake (which in APLNG's case is 2015).

Of the four brokers in the FNArena database reporting on Origin this morning, only one (Deutsche) has increased its price target, in this case to $17.65 from $16.75. No ratings changes have resulted. Indeed, Deutsche is the only broker in the database with a Hold rating (not counting Macquarie, which is restricted) when everyone else has a Buy.

The consensus target is $18.04 which is only 6.8% above the current Origin trading price.

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