Gas deals are like buses. You wait a whole year, then two come along at once.
Oil Search's $2.2 billion takeover of InterOil, with a lot of help from Total, comes the same week as Range Resources' $4.4 billion play for Memorial Resource Development. Prior to that, there hadn't been a gas-production deal worth more than $1 billion since Royal Dutch Shell's $79 billion takeover of BG Group in April 2015, according to data compiled by Bloomberg .
It's certainly not game on, but in every commodities crash there comes a time when rising optimism among buyers couples with enduring pessimism among sellers to result in M&A offspring. This week's twin transactions are a sign that major gas players are starting to look beyond their current predicament toward a more profitable future.
The deal is a complex one that takes Oil Search two statements and at least 700 words to explain -- more than this column. While Oil Search is technically the one doing the takeover, it boils down to Total buying about 60 percent of InterOil's assets in the highlands of Papua New Guinea, while Oil Search gets the remainder.
The French company will provide $1.2 billion in cash to fund the first stage of the deal, plus another $372 million once the key Papua LNG project gets the go-ahead. InterOil shareholders will also be compensated if the Elk-Antelope fields underpinning Papua LNG prove to have more gas than expected.
For InterOil, the transaction is vindication after years of being accused of all manner of skulduggery, up to and including outright fraud. While the company's always had its bullish backers such as, er, Shia LaBeouf, it's long been one of the energy sector's most heavily shorted stocks. Detractors have thinned, thanks to Total's growing commitment to Papua LNG, but they're yet to leave the building:
Oil Search gets to lift its stake in Papua LNG to an eventual 29 percent, matching its interest in the nearby Exxon Mobil-operated PNG LNG project. Thanks to Total's cash infusion, it will also trim about $300 million from net debt that had grown uncomfortably high -- Ebit in the 2015 fiscal year was only 1.6 times the company's interest bill, Bloomberg data show.
What about Total? The oil major has made no secret of the fact that it sees the drop in oil prices as an opportunity to bulk up in LNG. Stumping up a slice of its $25.4 billion in cash and equivalents for 22 percent of an undeveloped gas project shows Total is prepared to put its money where its mouth is.
Getting the first gas on ships will still require some $16 billion of capital spending, according to InterOil, at a time when the likes of Australia's Woodside Petroleum have been pronouncing the end of mega-projects. Macquarie Group analysts say demand will decline from Japan, the world's biggest LNG consumer, and there'll only be limited growth from Korea and Taiwan.
Don't forget, also, that the world is in a historic gas glut. Papua LNG needs a price of $6.96 per million British thermal units to break even, InterOil forecasts, well above current spot prices, which stand at about $4.20/mmbtu for LNG arriving in Japan and $2.18/mmbtu for benchmark U.S. domestic gas.
Still, those numbers probably overstate the challenges to Papua LNG of making a profit. Macquarie estimates Asian LNG will cost in the region of $12/mmbtu by 2019, and gas export projects take years to develop.
If you're predicting a future of persistent oversupply, it might be worth curbing your pessimism. Total just bet $1.6 billion there's light at the end of the tunnel.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Not including midstream projects like China Reform's purchase of a stake in PetroChina's Trans-Asia Gas Pipeline, or QIC's purchase of Australian gas-storage assets from Hong Kong utility CLP. WPX's purchase of RKI and LetterOne's bid for EON's North Sea assets included a mix of oil and gas.
The vast majority of LNG in the Pacific is priced on long-term contracts between producers and power generators. Spot prices reflect only the spillovers when supply and demand fall out of sync, so will be unusually low in the current glut and unusually high when the market is short. Still, as the global LNG market becomes more interconnected, there's a substantial risk that long-term contract prices start to converge with the spot market.
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