July 8 (Bloomberg) -- Shares of Oil Search Ltd., Australia’s third-biggest oil and gas producer, may be undervalued because its stake in a $12 billion Papua New Guinea liquefied natural gas project is worth more, Sanford C. Bernstein said.

“The current market price of A$5.40 recognizes only half of the project value or assumes an LNG price equivalent to a long-term oil price of less than $55 a barrel,” Neil Beveridge, an analyst at Bernstein, said in a report yesterday. With oil forecast to average $80 a barrel in 2010 and $100 in 2011, Oil Search’s target price should be A$7.30, he said.

Oil Search owns 34 percent of the project, the biggest partner after Exxon Mobil Corp., who is also the venture operator. Exxon and its partners, which also include Santos Ltd., may give the go-ahead to build the project later this year, the U.S. company said in June.

Binding sales contracts totaling 6.3 million metric tons per annum have been signed with Asian customers, a “key milestone” for the project schedule, Beveridge said in the report. LNG in Asian contracts is priced off crude oil, which is trading at about $62 a barrel.

Oil Search fell as much as 2.8 percent to A$5.14 in Sydney today compared with a 1.5 percent decline in the S&P/ASX 200 Index. The stock has fallen 11.2 percent in the last 12 months.

Cost of Supply

The venture has agreed to sell 2 million tons a year of LNG each to China Petroleum & Chemical Corp. and Taiwan’s CPC Corp. and the rest of the 6.3 million tons a year capacity to Tokyo Gas Corp. and Osaka Gas Corp., Beveridge said in the report.

Exxon said June 22 it had reached “commercial terms” with three Asian buyers, including Tokyo Electric Power Co. and Osaka Gas Co., for 4.3 million tons of LNG a year. Sinopec, as China Petroleum is known, said in May it is in talks to buy 2 million tons. CPC’s spokesman and vice president, Lin Maw-wen, said in June the company has started talks, without giving the volume.

“Although the increase in potential supply relative to demand has put more pressure on LNG suppliers to discount price, we believe PNG LNG will sell at close to oil parity with only a discount of 5 to 10 percent,” Beveridge said. This may result in a long-term price of about $12 per million British thermal units, he said.

The cost of supply for the LNG venture, estimated at about $3 per million Btu, may be 50 percent lower than rival projects in Australia because of the presence of liquids in the gas, Beveridge said. At the peak of production, about 22 percent of the output will be liquids such as liquefied petroleum gas and condensate, according to the report. “The liquids will provide a significant source of revenue,” the report said.

The venture plans a two-production-unit gas liquefaction plant near Port Moresby, the capital of PNG. The project has scope to add as many as two production lines, the report said.

Exxon has a 41.5 percent share in the project and Santos 17.7 percent. The PNG government has said it may take a stake.

LNG is natural gas chilled to liquid form for transport by ship to destinations not connected by pipeline.

To contact the reporter on this story: Dinakar Sethuraman in Singapore at dinakar@bloomberg.net.

Last Updated: July 8, 2009 00:54 EDT