Origin's track to LNG fortune

In his usual measured and methodical way, Origin Energy's Grant King is gradually improving the economics and reducing the risks of the massive $US20 billion Australia Pacific LNG export project.

Origin and its partner, ConocoPhillips, secured the $US14 billion final investment decision for the first phase of the coal seam gas to LNG project mid-year after locking in China's Sinopec as both their foundation customer and an equity participant.

Sinopec committed to taking 4.3 million tonnes of LNG a year for 20 years and took up a 15 per cent equity interest in the project. Subsequently, Japan's Kansai Electric Power agreed to acquire one million tonnes of LNG a year from the project.

Today APLNG and Sinopec signed another, albeit non-binding, heads of agreement under which the Chinese group will buy an extra 3.3 million tonnes of LNG a year until 2035 and increase its equity interest in the project to 25 per cent, reducing Origin and ConocoPhillips' stakes to 37.5 per cent each.

If the deal is confirmed, it would underwrite the output of a second train at the APLNG plant at Gladstone in Queensland and transform the economics of the project in the process.

APLNG's first train is expected to cost about $US14 billion, with the cost inflated because the consortium is putting in place the infrastructure for a two-train project. The second train is estimated to cost only $US6 billion as a result.

The project would, the partners have said, produce attractive returns even on a one-train basis because Origin will supply it with its lowest-cost gas. It will have to supply the second train with higher-cost gas, but that's offset by the far lower capital cost and the efficiency gains from operating the larger-scale plant.

Origin didn't disclose the terms of Sinopec's extra commitment today, other than to say they were consistent with the terms of existing LNG sales from the project and the deal signed with Sinopec in April.

It may have been preferable for Origin and ConocoPhillips to have unearthed a third cornerstone customer rather than increasing Sinopec's role, both to diversify the customer base and reduce reliance on Sinopec, and because the terms on which they contracted to sell the gas and on which they issued equity to the Chinese group reflected its status as their foundation customer. They had hoped to be able to get a better price for the gas and the equity from marketing the output from the second train to other potential buyers.

Ultimately, however, with a host of competing LNG projects under development – at least three and probably four of them based at Gladstone – and a prospective glut of LNG in the region in the latter part of this decade, the imperative was to secure contracts for the gas.

Sinopec's increased equity interest will also help reduce the risk and funding requirement for Origin and ConocoPhillips and perhaps alter at the margin the balance of Sinopec's interest in where it secures its own returns, which previously would have been weighted heavily towards the price at which it could acquire the gas. If the heads of agreement evolves into a firm commitment, it will have a significantly larger exposure to the equity returns from the project.

That enlarged equity interest will help Origin alleviate concerns about the scale of its exposure to the project and the funding associated with it.

A $1 billion underwriting of its dividend reinvestment program and the recent $800 million issue of hybrid securities, along with its existing cash flows and borrowing facilities, were sufficient to cope with the first train but there were some concerns about its capacity to fund its share of the larger development. That requirement has now been quite significantly trimmed.

A final investment decision on the second train is now scheduled for early next year, with the partners working towards a schedule that envisages first gas from the first train in mid-2015 and gas from the second train flowing a little less than a year later.