Oil Search in PNG govt vice

After a steady climb in its share price and increasingly bullish expectations that its massive PNG LNG project was on the cusp of producing vast amounts of natural gas and a huge cash flow, Oil Search (OSH) stock has been on the skids in the past week.

Even this morning's announcement that major partner Exxon had secured the final $1.5 billion in financing to pay for the project cost increase, failed to stop a near 1% slide to $8.37.

The slippage can be sheeted home to government, not the wrangle in Washington over signing the Budget that has crippled the US economy and spooked markets, but the ambitions of the PNG government to secure its 14.7% stake over Oil Search.

Faced with financing the huge capital expenditure requirements for the project, in which Oil Search has a 29% stake and due to come on stream next year, the lowly rated PNG government was forced to raise finance over its Oil Search shares via convertible bonds issued to Abu Dhabi's state owned International Petroleum Investment Company (IPIC).

Due to mature next year, the PNG government now is keen to buy back the bonds early to retain its interest in the company. But at what price?

Various theories abound about what may happen ranging from an IPIC takeover of Oil Search, to it holding on to the stake and thereby creating a stock overhang, to a situation where a short selling strategy to turbo-charge earnings from the bond sale now are doing the rounds.

That uncertainty, after a strong rise based upon a perfect delivery of the current project in addition to assumptions of a successful expansion, has put the wind up many investors.

Priced at 63 times forward earnings, Oil Search has a premium built on the rapid ramp up in production and earnings through to 2015 (see Tim Treadgold's A gas giant in the making) and the uncertainty now has many looking to cash out.

Given its history as an explorer, many believe the company would be looking to exit the project once it moves towards full production.