Highlights
• Profit after tax for the six months to 30 June 2008, excluding significant items, was up 184% to US$133.3 million, compared to US$46.9 million in 2007. An after tax profit of US$131.1 million was also made on the sale of assets, profit to US$264.4 million, a record for the Company. The result was driven by higher oil prices, stable operating costs and a drop in the effective tax rate.
• Operating cash flow and EBITDAX (earnings before interest, tax, noncash items and exploration expense) were strong, increasing 48% and 64% respectively on the first half of 2007.
• Oil and gas production in the first half of 2008 was 4.34 million barrels of oil equivalent (mmboe), 9% lower than in the corresponding period of 2007. This primarily reflected natural field decline and the sale of the Company’s producing MENA assets effective from 1 May 2008. Oil production was 3.82 million barrels, with revenues based on oil sales of 3.75 million barrels.
• Revenue from operations was 53% higher than in the first half of 2007. This reflected excellent realised oil prices, with the Company’s high quality PNG crude continuing to attract a premium over the Tapis benchmark. Oil Search realised an average oil price of US$114.99 per barrel in the first half of 2008, compared to US$70.69 per barrel in the previous corresponding period.
• One of the key events to occur in the first half was the commencement of Front End Engineering and Design (FEED) activities on the PNG LNG Project in May. This followed the finalisation of the Joint Operating Agreement, covering the commercial aspects of the Project, and the Gas Agreement, outlining the fiscal terms to apply to the Project. FEED work is now progressing well on a range of fronts, including technical, marketing and commercial.
• During the period, a major Strategic Review was completed, with the objective of setting the Company’s direction for the next five years. A number of the Review’s recommendations, including the sale of a package of non-material assets in the Middle East /North Africa (MENA) and a corporate reorganisation, were implemented during the first half.
• The sale of the MENA assets realised a profit of US$132 million, demonstrating significant value creation by Oil Search in that region. The remaining assets in MENA are assessed to have material upside value that will be tested by drilling over the next few years.
• Over the first half of 2008, Oil Search spent US$143 million on exploration, evaluation and gas commercialisation and US$77 million on development, production and corporate activities. This expenditure was funded by the Company’s strong operating cash flows. At the end of June 2008, Oil Search had a cash position of US$400 million and remained debt free throughout the period.
On the outlook for the second half of 2008 and 2009, Mr Botten said the following:
AGL Asset Sale
“A key event expected to occur in the second half of 2008 is the sale by AGL of its PNG oil and gas portfolio. The AGL portfolio comprises interests in PDL 2 and PDL 4 which encompass the following oil fields:
• Kutubu (PDL 2) 11.9%
• Moran Unit (PDL 2) 5.2%
• SE Mananda (PDL 2) 11.9%
• Gobe Main (PDL 4) 66.7%
• SE Gobe Unit (PDL 4) 27.3%
In addition, AGL has approximately a 3.6% entitlement in the PNG LNG Project. The AGL portfolio does not contain the upside gas potential of the Oil Search licence interests, as it does not cover gas fields such as Hides, Angore and Juha, as well as other discoveries and exploration potential. Oil Search and its Joint Venture partners have pre-emptive rights which are pro-rata to their PDL 2 and PDL 4 licence interests (for Oil Search, 60.05% and 10.0% respectively). These rights may be used to match any offer by a potential purchaser. AGL anticipates that bids for the licences will be lodged in mid September, with the partners likely to be notified shortly thereafter. Following notification of the agreed sale price, Oil Search and its partners have 30 days in which to decide whether they wish to exercise their pre-emption rights on either or both licences, by matching the highest offer. The Company and its partners will consider their respective positions once the final sale price is known.
Apart from the price, there are a range of other factors which will influence whether Oil Search exercises its pre-emption rights, including:
• The intentions of its other partners
• Funding ability
• Implications for Oil Search’s ongoing business due to additional capital requirements, offset by the cash flows generated by the producing oil assets
• Impacts on the Company’s future earnings per share and cash flow per share
From our perspective, this transaction is likely to be positive for Oil Search shareholders. If AGL achieves a high sale price for the assets, it will be a clear demonstration of the market value of this asset base. The ‘look through’ valuation may lead to a re-rating of Oil Search’s share price. Additionally, the pre-emption right could represent an excellent opportunity to acquire a package of high quality producing oil assets, plus an interest in the region’s premier LNG development, should the purchase satisfy the Company’s investment hurdles.
The Company has an excellent knowledge of both the oil and gas components of the sale and is therefore well situated to assess their value. We are, however, not compelled to participate in the sale process and will only do so if we see that the acquisition represents demonstrable value to our shareholders. The Company has a good record of strongly accretive and well timed acquisitions.”
PNG LNG Project
“FEED activities, which are expected to take some 13-14 months to complete, are progressing according to plan. A strong project team has been built up by the operator, ExxonMobil, with a number of secondments of key personnel from Oil Search and the other joint venture participants to the team. The quality of the project team is an indication of the high priority that ExxonMobil is placing on this Project.
Oil Search is playing a key role in the FEED process, with a particular focus on the delivery of gas from the oil fields and support for the operator, ExxonMobil, on a range of in-country matters.
The key deliverables from FEED over the next year include the following:
• LNG marketing. A short list of preferred buyers has been developed and discussions with these parties have commenced. The objective of the LNG marketing team is to secure preliminary commitments based on indicative terms by late 2008/early 2009 and sign firm offtake agreements by the time of the Final Investment Decision (FID), expected to take place in late 2009.
• Project Financing. A global roadshow has recently been completed which has confirmed a strong level of interest from a range of banks and export credit agencies to be involved in providing debt funding to the Project. The Project Finance team is targeting Financial Close by end 2009.
• Construction and procurement contracts. Work is underway with Eos on the upstream component of the engineering and technical aspects of the Project. EPC contracts for the downstream phase are expected to be awarded in the third quarter of 2009.
• Benefits Sharing Agreement. Discussions between the State and Landowners on the sharing of the many benefits that will derive from the PNG LNG Project are due to commence shortly. On the basis that an agreement is reached by early 2009, the Joint Venture is considering making a significant investment in early works, such as road construction, commencing in the first half of 2009.
• Licence issues. The process for securing all necessary licences and leases and environmental approvals has commenced. Oil Search’s share of FEED costs in the second half of 2008 and 2009 are expected to be approximately US$110 million.”
The Final Investment Decision remains on-track for late 2009, with first production expected in late 2013/2014.”
Other Gas Commercialisation Activities
“Following the signing of the recent MOU with the PNG Government, work has commenced on a number of studies focused on gas aggregation and establishing the optimal development of gas infrastructure in the Offshore-Forelands and the Western Corridor. Other planned activities include the finalisation of an exploration and appraisal programme of key fields and licences and a review of potential farm-downs/acquisitions to optimise Oil Search’s gas portfolio. In addition, a range of potential value-adding opportunities are being reviewed. These include LNG project optimisations such as debottlenecking, gas and oil field management and LNG expansions.”
Production
“As highlighted in the quarterly report, Oil Search expects 2008 full year production to be between 8.5 – 9.0 million barrels of oil equivalent (mmboe). This follows the sale of the MENA assets, effective from 1 May 2008, which has reduced Oil Search’s 2008 production by approximately 0.5 mmboe. Production in the second half of the year is expected to be similar to first half levels, with natural decline mitigated by the active development drilling and well workover programme currently underway.
Specifically:
• There will be a full six months’ impact from the UDT 8 development well at Kutubu and contributions from UDT 9 (recently completed) and UDT 10 (drilling ahead). These development wells are expected to more than offset natural decline from the existing producing Kutubu wells.
• Production from Moran is expected to flatten with the commencement of production from the Moran 14 development well, which is currently drilling ahead.
After a number of teething problems experienced by the refurbished Rig 101 and the new Rig 103, drilling performance is improving with the recent UDT 9 well drilled in less than half the time it took to drill UDT 8.”
Exploration Activity
“At the time of writing, the Cobra 1A ST3 well is drilling the primary Hedinia sandstone objective, having intersected encouraging indications of the presence of hydrocarbons in previous sidetracks. The results of this well will be known in the coming week.
Following the drilling of the NW Paua and Cobra exploration wells in PNG in the first half of the year, Oil Search’s exploration drilling focus in the second half of 2008 will move onto the Company’s highly prospective Middle East licences:
• Shakal, Iraq (OSH – 15%, Operator – Prime Natural Resources). The first well to be drilled in the Shakal PSC is expected to spud in the third quarter of 2008, on a seismically defined structure with potential recoverable reserves of more than 100 million barrels.
• Caliph-1, Area 18, Offshore Libya (OSH – 30%, Operator Petrobras). The Caliph-1 well, which is well defined by recently acquired 3D seismic data, is scheduled to commence drilling in the fourth quarter of 2008. The well will target a number of different plays, including oil in the Eocene and Cretaceous carbonate and gas in the Jurassic and Triassic. The Caliph structure has the potential to contain up to 1 billion barrels of oil equivalent. Other prospects
have been identified in the licence.
In addition to drilling, seismic activities are planned in both PNG and in Yemen in the second half of 2008.”
Oil Refinancing
“Final documentation is underway on a five year facility, secured against the Company’s PNG oil assets, which is expected to be completed in the next few weeks.
A very favourable response was received from the target banks, which included those in the Company’s existing syndicate plus several new banks. Due to this demand and the attractive pricing offered, the size of the facility has been increased from US$400 million to US$450 million. The pricing and other key terms offered on the new facility represent an improvement on the existing facility, with almost half of the facility amount to be provided without recourse to political risk insurance. The facility will provide a component of Oil Search’s equity funding for PNG LNG development costs and is expected to be progressively drawn down as construction expenditure occurs.”
• The Company is presently completing a highly successful refinancing of its existing oil business, putting in place a five year facility. A very favourable response was received from over 15 target banks, with strong demand and attractive pricing offered, leading to an increase in facility size from US$400 million to US$450 million. This was achieved with a market backdrop of generally tightening credit lines.
• Following the strong result, the Board has recommended the payment of an unchanged interim dividend, of four US cents per share, payable on 10 October 2008.
Commenting on the results, Peter Botten, Oil Search’s Managing Director, said:
“Oil Search’s 2008 first half profit (after tax, before significant items) of US$133.3 million was a record for the Company. This excellent result was driven primarily by higher oil prices: realised oil prices were up 63% on 2007 first half levels, boosting revenue for the half year to an all-time high of US$466.7 million. Much of the focus during the first half of the year was on the PNG LNG Project. A number of major landmark agreements were signed during the period, including a comprehensive Joint Operating Agreement between the Project participants in March and the Gas Agreement with the PNG Government in May. The completion of these agreements led to a decision by the Project Participants to commence FEED activities in May 2008. The move into FEED represents a major step forward in commercialising Oil Search’s large discovered gas resource base, of which around some 60% is dedicated to the PNG LNG Project. The Government remains strongly committed to the PNG LNG Project and has recently agreed the Ministerial leadership and co-ordination structure to ensure the Government deliverables for the Project are met in a timely manner. In addition, the Government recently announced that the licences covering the Angore field and South Hides, PRL 11 and 12 have been renewed.
Shortly after the end of the period, a Memorandum of Understanding (MOU) was signed with the PNG Government. The MOU provides a framework for the PNG Government and Oil Search to work together to commercialise the substantial discovered PNG gas resource that is not currently dedicated to the PNG LNG Project.
Production during the period was impacted by a number of factors, including a planned shut-down of the Central Processing Facility for maintenance work in the first quarter and a slower than expected rampup of the development drilling programme. In addition, all of the Company’s producing fields in the Middle East were disposed in the Kuwait Energy asset sale, with production from those assets ceasing to be recognised from 1 May 2008.
Despite continued upward pressure on the cost of services and consumables, the Company was successful, over the period, in keeping cash operating costs steady. As a result, the revenue gains fed straight through to the EBITDAX level, with earnings before non-cash charges and exploration expense increasing by 64% to US$411 million.
Oil Search generated operating cash flow of US$348 million over the six months and at the end of June 2008 had cash in the bank of US$400 million, including cash balances of joint venture interests. The Company expects to receive approximately US$205 million in late August, on settlement of the sale of a range of MENA assets to Kuwait Energy. This transaction, which was announced in April, generated a net profit of US$132 million for Oil Search. The proceeds will bolster the Company’s balance sheet considerably, facilitating the financing of Oil Search’s share of the PNG LNG Project.”