Australia | Jul 25 2012
– Oil Search production strong in June quarter
– Progress continues at PNG LNG project
– Gulf of Papua sell-down, exploration offer additional catalysts
– Broker ratings remain firmly weighted to Buy
By Chris Shaw
For the June quarter, Oil Search ((OSH)) recorded production of 1.8 million barrels of oil equivalent, its highest quarterly output since the final quarter of 2010. Revenue for the period was US$211 million, helped by the draw-down of some crude inventories.
In the view of BA Merrill Lynch, Oil Search's production in the quarter has the company well placed to hit the top of full year guidance of 6.2-6.7 million barrels of oil equivalent. This is important in the broker's view as it is helping to minimise cash erosion during what is a high spending phase of the PNG LNG project.
As BA-ML notes, the PNG LNG joint venture that includes Oil Search with a 29% stake and ExxonMobil as operator, is expected to spend US$5.9 billion on the project this year. This represents around 37% of the project's total budget.
With production for the quarter better than most in the market had expected, earnings estimates for Oil Search have been revised higher in some cases. As examples, JP Morgan has lifted its 2012 earnings estimate by 12%, while Deutsche Bank's numbers have risen by around 4% for this year.
But the quarterly report tells only part of the story for Oil Search, as the PNG LNG project remains the key to the longer-term future for the company. Here construction of Trains 1 and 2 continues to progress, while recent drilling at P'nyang South-1 exceeded pre-drill estimates and could help underpin volumes for expansion of the project.
Such an expansion would likely include a third train, with Goldman Sachs remaining confident such an outcome comes to pass especially given the recent success at P'nyang South. Macquarie agrees, noting additional gas could come from the Kutubu field as well. Further news on a third train is expected in coming months as reserve assessment is currently underway and joint venture talks with respect to development options are planned for the second half of 2012.
Oil Search has confirmed initial commissioning gas will be sent to the PNG LNG plant from the second quarter of next year, which to Macquarie indicates downstream progress remains on track. Recent PNG elections are understood to have had no operational impact on the project's development.
Elsewhere, Oil Search has seen competitive bidding as it looks to farm-down its interest in Gulf of Papua acreage. For BA-ML, the most likely outcome is Oil Search farms-down to around a 50% interest pre any government back-in. JP Morgan expects negotiations to conclude soon, which offers a potential short-term catalyst for Oil Search.
Other drilling also offers upside potential in coming months, in particular the Taza-1 well in Kurdistan. Oil Search has a 60% stake in this well and JP Morgan notes management suggests there is a 1-in-2 chance of success of a 300-500 million barrel find given nearby and on-trend discoveries in the area.
In PNG, Oil Search is to spud the Trapia 1 well in the current quarter, the target being one trillion cubic feet of gas in the Highlands area. For Credit Suisse, any success with this well would upgrade the potential for additional prospects and leads in the area and would therefore represent a positive surprise.
Further drilling at Hides is also expected later this year and in Credit Suisse's view would offer potential for valuation upside given the chance of a material positive impact on Hides gas volumes.
Changes to broker models post Oil Search's production report have had little impact on price targets. The consensus price target according to the FNArena database stands at $8.48, which implies upside of around 29% relative to current share price levels. Targets range from Deutsche Bank at $8.00 to BA-ML at $8.98.
This valuation upside underpins positive broker views on Oil Search, as the FNArena database shows seven Buy ratings and one Hold. This comes courtesy of JP Morgan, who sees better relative value in the likes of Santos ((STO)) and Woodside ((WPL)) despite Oil Search trading below valuation and offering a number of potential catalysts.
Absolute value underpins the Buy rating of Macquarie, who points out Oil Search is trading at a 33% discount to risked net present value at current levels despite a number of near-term potential catalysts for the share price.
While not in the FNArena database, both Morgan Stanley and Goldman Sachs have Buy ratings on Oil Search, the former as part of an attractive view on the oil and gas sector. For Morgan Stanley upside remains as Oil Search achieves full value through delivery of the PNG LNG project from 2014, while Goldman Sachs is also attracted to the near-term catalysts such as exploration and the farm-out of the Gulf of Papua interests.
Shares in Oil Search today are trading 0.5c lower at $6.595 as at 1.05pm, which compares to a trading range over the past year of $5.43 to $7.58.
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