Origin digs deep for gas dominance

With the $24.7 billion Australia Pacific LNG project still under construction, Origin Energy’s Grant King could be forgiven for waiting for the $1bn-a-year of free cash to start flowing from that coal seam gas-fed export project before contemplating any other significant investment.

That he hasn’t says something about his confidence in APLNG, which is scheduled to produce its first LNG in the middle of next year, and his commitment to maintaining the remarkable growth of Origin since it was demerged from Boral in 2000.

Origin has a 37.5 per cent interest in APLNG, alongside ConocoPhillips of the US (37.5 per cent) and China’s Sinopec (25 per cent). APLNG is one of the three big coal seam gas-fed export LNG projects on Curtis Island, off Gladstone in Queensland. BG Group’s project is scheduled to begin production later this year while the Santos-led GLNG project (its partners are Petronas, Total and Kogas) should also be up and running next year.

Rather than wait for the APLNG cash to start flowing, King today announced Origin would pay up to $US800 million to buy a 40 per cent interest in two Browse Basin gas exploration permits off Western Australia from Karoon Gas. Karoon, experiencing something of a cash crunch, has been seeking to sell up to half its interest in the Poseidon discovery, while retaining a meaningful exposure to it.

King, however, insisted Origin was only interested if all of Karoon’s interests were available, both to make the exposure meaningful in the context of Origin’s scale but also to ensure a degree of negotiating leverage with Karoon’s partners in the permits. Coincidentally, Poseidon’s operator is ConocoPhillips (40 per cent) while China’s PetroChina owns the remaining 20 per cent.

The presence of ConocoPhillips would presumably provide a degree of reassurance to King, both because of the pre-existing relationship between the two companies in APLNG and ConocoPhillips' decades of experience in LNG. Both ConocoPhillips and PetroChina have pre-emptive rights over the Karoon interests, so Origin will have to wait to see whether its proposed acquisition can be completed. PetroChina paid about $US370m for its 20 per cent interest in the permits last year.

Although comparisons of its deal with Origin’s are complicated by the structure of the deal Origin has struck with Karoon, it would appear Origin is actually paying a slightly lower effective price for an asset where time has also slightly reduced the level of uncertainty and therefore risk. PetroChina will inevitably look closely at whether or not it wants to exercise its pre-emptives.

The question mark over whether or not the pre-emptives will be exercised helps explain why Origin has foreshadowed a $1bn equity raising, partly to fund the acquisition, but won’t proceed with that issue until sometime after the release of its results in August. In the meantime, should the deal complete, Origin will finance it using some of the $5.6bn of undrawn debt it has in place for its share of the APLNG funding.

The deal with Karoon -- $US600m down, with further payments of $US75m if and when there is a final investment decision, another $US75m payable on first production and a final payment of up to $US50m at that point if Poseidon’s reserves reach certain thresholds -- underscores King’s confidence in APLNG’s economics and his willingness to pursue new sources of growth beyond APLNG.

At this point Poseidon is a prospect rather than a project but there appears to be confidence that the permit areas contain at least 3.25 trillion cubic feet of gas. From Origin’s perspective, at the base $US600m commitment, it would be acquiring an interest in that gas at about $US2.68 per barrel of oil equivalent.

The presence of ConocoPhillips and PetroChina would give Origin confidence that the gas is there and that buying into the fields would be significantly cheaper and far less risky than spending the same amount on greenfields exploration offshore.

Poseidon has other risk-reducing characteristics. It could be developed via a pipeline to ConocoPhillips Darwin LNG plant, about 800 km away, or by using floating LNG technology. While FLNG is usually associated with Shell, ConocoPhillips has been developing its own technology.

In any event, there are development options for Poseidon which would again help reduce the risk to Origin, which would be very conscious of the cost blow-outs that have been occurring in Australia’s offshore LNG developments and the potential of FLNG technology to contain that risk.

Piping the gas to an established plant at Darwin would also be an option with reasonably defined costs; one that could also bring the potential for domestic sales into play. There is a lot of potential optionality in the development of Poseidon, something King has demonstrated his liking for in the past.

If Origin completes the deal it will have an exposure to a major gas region where currently it has none, as well as a significantly expanded long position in gas. With its LNG interests it will get a big exposure to Asia Pacific markets where demand for gas is growing rapidly.

With a final investment decision on Poseidon (if that point is reached) probably not occurring until the last couple of years of this decade and, if the project gets a go ahead, production not starting until the middle of the next decade, that gas would create a new post-APLNG growth phase for Origin.

For Karoon, the deal -- regardless of whether Origin acquires the interest or the pre-emptives are exercised -- is something of a life saver because it was burning through its cash reserves at a disconcerting rate.

Its prize asset is its exploration interests in Brazil’s Santos Basin, which have got analysts very excited. While it hasn’t been able to retain an interest in Poseidon -- its preferred strategy is to do early stage exploration and then cash out its finds while retaining some residual exposure -- it will now have the funds to support its program in Brazil as it heads towards development.