David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

Who'd have thought that with a global gas glut forecast till the end of the decade, two of Big Oil's largest beasts would be fighting over the rights to build a $32 billion LNG project.

That's what's happening in Papua New Guinea, where Exxon Mobil has trumped Total and Oil Search's $2.2 billion, $40.25-a-share takeover offer for explorer InterOil with a $45-a-share proposal.

The enthusiasm for these assets is at first hard to comprehend.

Gas prices have been slumping for two years
Source: Bloomberg; Bloomberg Intelligence
Note: Japan contract import price reflects only spot prices so will tend to be more volatile than Bloomberg Intelligence's average import price figure, which includes long-term contract prices.

Spot prices for LNG imports to Japan, the biggest importer, were running at $4.10 per million British thermal units in May. Bloomberg Intelligence's average import price estimate is probably a better measure of what gas producers can hope to earn but isn't much better, at $6.61/mmbtu in April. Papua LNG, the giant export project on which InterOil's value depends, needs $6.96/mmbtu just to break even.

Why get into a fight over a project that's set to lose money at current prices?

One reason is cost. Predicting long-term commodity prices is like trying to do the weather forecast for a date five years in the future, so for the most part, resource companies barely try. Instead, they attempt to benchmark themselves against competitors and ensure their production costs are the lowest, on the basis that the cheapest producer will always be the last to fall during a market slump and the best placed to profit when things rebound.

Papua New Guinea's gasfields are among the least costly in Asia Pacific. PNG LNG, an Exxon Mobil-operated project that started production in 2014, breaks even at around $8.29/mmbtu, according to Wood Mackenzie estimates. That leaves it in the cheapest half of LNG projects in the region, according to an Oil Search presentation in May -- but InterOil's Papua LNG project is much more frugal, close to the lowest quartile in Oil Search's ranking:

LNG breakeven prices

Those prices still look tough when you consider the current LNG market, but Exxon Mobil has another advantage.

Papua New Guinea's gas is located in the country's highlands, a somewhat isolated area all but unknown to the outside world until the 1960s. Getting it to consumers in Asia requires hundreds of kilometers of pipelines crossing the rainforest and seafloor, plus LNG liquefaction plants and ship terminals close to the capital Port Moresby. PNG LNG's facilities, which cost $19 billion to build, are already up and running. If gas markets remain in the doldrums, the best hope of cutting costs for both projects will be a deal to share some of those facilities -- and that's going to be a lot easier if PNG LNG's operator Exxon Mobil has a stake in Papua LNG as well.

Soft Share Shuffle
If Exxon wins the bid for InterOil, it would have a stake in both Papua New Guinea's major LNG projects
Source: Oil Search presentation
Note: For "Papua LNG, Total wins" and "Papua LNG, Exxon wins", equity-share figures are based on assumption of a 22.9% share for the PNG government, landowners and other stakeholders once the project is in operation. This share is excluded from the "Papua LNG" share estimate because the stakeholders haven't yet backed in their equity share. "Papua LNG, Exxon wins" chart based on assumption that Exxon acquires InterOil's stake.

It's hard to see Total and Oil Search straining too hard to block Exxon Mobil. Total's net debt-to-equity ratio would already be at slightly elevated levels of 31 percent if it puts up the $1.2 billion it's promised in order to fund its side of the InterOil deal. Oil Search, for its part, had proposed to offer 8.05 shares for each InterOil one, a ratio that likely would have to rise above 9.5 if it wanted to knock out Exxon Mobil's proposal. 

Should the Texans win this battle, Total will still be the biggest shareholder in Papua LNG. Oil Search will maintain its shareholding as well, even if it misses out on the extra equity and debt cancellation it could have won under Total's offer. Bringing Exxon Mobil on board will also mean that Papua LNG's $16 billion capital cost will be spread more widely, and hopefully reduced if some of those facilities can be shared.

Total and Oil Search have three days to put in a counter-bid. They have most to gain from standing pat.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. The volume-weighted average price of Oil Search's shares has been A$6.74 since its offer was announced May 20, according to Bloomberg-compiled data. That's equivalent to about $5.11 at current exchange rates. A 10 percent premium to Exxon's $45-a-share offer would require $49.50-a-share, which would suggest an exchange ratio of 9.7.

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