Company overview - Oil Search Limited is an oil and gas exploration and production company. The Company is engaged in the exploration for oil and gas fields and the development and production of such fields. The Company's segments include PNG Business Unit (PNG BU), Exploration and Other. The PNG BU segment is engaged in the development, production and sale of liquefied natural gas (LNG), crude oil, natural gas, condensate, naphtha, other refined products and electricity from the Company's interest in its operated assets for Papua New Guinea crude oil and Hides gas-to-electricity operations and from the Company's interest in the PNG LNG Project. The Exploration segment is engaged in the exploration and evaluation of crude oil and gas in Papua New Guinea. The Other segment includes the Company's ownership of drilling rigs, investment and development towards the Company's power strategy and corporate activities. The PNG LNG Project is a 6.9-million tons per annum (MTPA) integrated LNG project.


OSH Details

Strong production performance despite the maintenance activities: For Q2FY17, Oil Search Limited reported 4% decline in total production at 7.24 million barrels of oil equivalent (mmboe), due to planned maintenance activities at Oil Search’s operated facilities, as well as at the PNG LNG (Papua New Guinea liquified natural gas) plant. The average realized LNG and gas price for the quarter was US$7.93/mmbtu, 7% higher than the first quarter average, while the average realized oil and condensate price decreased by 8% to US$50.99/barrel.  Total production for the 1H2017 was 14.81 mmboe, similar to 2016 first half production, and the Company remains on track to deliver 2017 production within the 28.5 - 30.5 mmboe guidance range. Total revenue for the quarter stood at US$332.5 million, taking total revenue for the half year to US$676.2 million, 16% higher than in the first half of 2016. For H1FY17, production costs are expected to be in the lower half of the full year guidance range of US$8 - 10 per boe, while second half costs expected to be higher due to timing of major work programs.


Overall production and sales summary; (Source: Company reports)
 
Encouraging results from Muruk and further exploration potential between Hides and P’nyang: The drilling program at Muruk 1 in PPL 402 concluded during the quarter as third sidetrack Muruk 1ST3 was drilled to the south-west of the discovery well and proved the presence of a second gas bearing fault block. Further, production testing confirmed a superior quality reservoir with high deliverability, consistent with Toro reservoirs in the Central Fold Belt. Given these encouraging results, a comprehensive appraisal program is planned for the field. Seismic acquisition over Muruk and adjacent exploration targets is scheduled for the fourth quarter, while well site preparations for a Muruk appraisal well are targeted to commence in late 2017, for drilling in 2018, subject to Joint Venture approval. The Muruk gas discovery has de-risked several leads and prospects on-trend between Hides and P’nyang. Seismic acquisition, operated by Oil Search, took place along this trend during the quarter, with further seismic planned to be acquired, commencing in the fourth quarter after the rainy season. Additionally, preliminary processing results of the new seismic data have confirmed the presence of similar structures along the trend, and site preparation for the P’nyang South 2 appraisal well progressed, with the well expected to commence drilling in the fourth quarter of 2017. Recent work by Oil Search has indicated potential 2C resource upside in P’nyang, as well as the presence of several interesting prospects adjacent to the field.


Site preparations for a Muruk; (Source: Company reports)
 
Strong customer interest in new LNG offtake agreements: During Q2FY17, production net to Oil Search from the PNG LNG Project stood at 5.90 mmboe. The Project operated at an annualized rate of approximately 8.1 MTPA during the period, 3% lower than the level achieved in the first quarter due to scheduled maintenance in May, but averaged 8.65 MTPA in June, the highest monthly rate achieved since start-up. ExxonMobil continued marketing up to 1.3 MTPA from the PNG LNG Project. Further, strong interest has been shown from potential customers for the additional LNG volumes currently being marketed by ExxonMobil on behalf of the PNG LNG Project. Should contracts be secured for the full 1.3 MTPA being offered, this would take total contracted volumes to 7.9 MTP. Importantly, engagement between ExxonMobil (operator of both the PNG LNG Project and P’nyang), and Total SA (operator of Elk-Antelope) took place during the quarter to focus on the next phase of LNG development in PNG.
 

Production and sales data; (Source: Company reports)

Optimizing the cost of exploration activities: To support and optimize the cost of ongoing exploration activities in PNG, it has entered into formal and exclusive negotiations with High Arctic Energy Services to potentially exchange an equal share of the rigs that High Arctic has historically managed for Oil Search in PNG, under long-term agreements (Rigs 102, 103 and 104), for an equal share of High Arctic’s owned rigs (Rigs 101, 115 and 116). Under this arrangement, the rigs will be jointly owned by High Arctic and Oil Search, with High Arctic managing the joint company. It is estimated that potential savings in rig rates could be as much as 25% in the first twelve months, if the transaction materializes. The transaction, which is subject to several conditions precedent and respective company board approvals, is expected to be finalized by the end of 2017. In the interim, the current contracts for the operation of rigs 102, 103 and 104 by High Arctic are expected to be extended for one year at reduced rig rates.


Significant remaining exploration upside in PNG; (Source: Company reports)
  
Forelands/Gulf:  In PRL 15 (Oil Search 22.835%), the deepening of Antelope 7 to test the Antelope Deep exploration objective was completed. Preliminary interpretation of the log data suggests that the penetrated carbonate has limited reservoir potential and is unlikely to be hydrocarbon bearing. The well was plugged and abandoned and the rig released. In May, Oil Search announced that it had entered into arrangements regarding the acquisition from ExxonMobil affiliates of a 30% interest in each of PPLs 474, 475, 476, 477 and PRL 39, located in the Eastern Foldbelt in the onshore Papuan Gulf Basin. The licenses are adjacent to the Elk-Antelope fields and contain the Triceratops, Bobcat and Raptor discoveries. As part of the proposed farm-in arrangements, Oil Search will undertake a seismic acquisition program over the license on behalf of the operator, commencing in the third quarter of 2017.

Capital expenditure: During the quarter, exploration and evaluation expenditure totaled US$44.9 million, including expenditure on Muruk 1 drilling (US$9.5 million), preparation for the P’nyang South 2 well (US$11.7 million), Antelope Deep (US$10.1 million) and pre-FEED on P’nyang and Elk-Antelope (US$5.6 million). Exploration costs of US$18.8 million of were expensed on the Antelope Deep well and seismic, geological, geophysical and administration expenses. Development expenditure for the first quarter totaled US$8.1 million, which included US$6.4 million for the PNG LNG Project and US$1.7 million for the PNG Biomass power project. Total capital expenditure is expected to be around US$380 - 480 million for FY17.


Capital expenditure summary; (Source: Company reports)

Increasing balance sheet flexibility and strong liquidity position:   In June, Oil Search had secured a new five years, non-amortizing, revolving credit facility of US$600 million, to replace its US$500 million corporate facility. Due to strong interest from the bank market and the attractive terms offered, the Company decided to increase the facility size by US$100 million. The 14-member bank group includes all four major Australian domestic banks, one Papua New Guinean bank and nine international banks and, together with the two existing bilateral facilities totaling US$250 million, takes the Company’s total available facilities to US$850 million, all of which remain undrawn. At 30 June 2017, Oil Search had cash of US$973.8 million and US$3.79 billion of debt outstanding under the PNG LNG project finance facility (compared to US$3.94 billion at the end of March 2017, following a scheduled principal repayment of US$153.3 million in June). With total liquidity of US$1.82 billion, the Company can fund all committed expenditures, including capital costs, scheduled debt repayments and dividends, through operating cash flows and existing cash, even if oil prices remain low for an extended period.


Cash and Corporate Facilities available; (Source: Company reports)
 
FY16 earnings driven by PNG LNG Project and fee from ExxonMobil:  During FY16, total oil and gas production reached a record of 30.24 million barrels of oil equivalent (mmboe), 3% higher than in 2015. The increase was driven by an excellent performance from the PNG LNG Project, which produced at an average rate of 7.9 MTPA during the year, compared to nameplate capacity of 6.9 million tons per annum (MTPA). The impact of higher production and sales on revenue was offset by lower realized oil and LNG prices, resulting in a 22% decline in revenue from 2015 levels. The Company continued to be successful in lowering unit production costs, which fell from US$10.08 per barrel of oil equivalent (boe) in 2015 to a very competitive US$8.50 per boe. Unit production costs have declined 30% since 2014, reflecting the successful implementation of a series of cost reduction programs and a higher proportion of lower cost production from the PNG LNG Project. The statutory reported profit for 2016 was US$89.8 million, boosted by the break fee received from ExxonMobil due to the termination of Oil Search’s bid for InterOil, with Oil Search realizing a net profit of US$18.7 million.


FY16 Financial summary; (Source: Company reports)

Recommendation: Despite the weak oil and gas price environment and ongoing expenditure on value-adding exploration and appraisal activities during FY16, the Company reduced its net debt position by nearly US$242 million. Given the strong balance sheet and healthy cash flows post expansion of its Papua New Guinea (PNG) liquified natural gas (LNG) projects, we give a “Buy” recommendation on the stock at current market price of $6.60


OSH Daily chart; (Source: Thomson Reuters)
 

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