A PNG rattler unsettles the numbers
A major earthquake in Papua New Guinea (PNG) was the key feature of Oil Search’s March quarter 2018 activities. The step-down in production for the first quarter was significant, but fortunately not permanent. Guidance for 2018 was impacted by the PNG event with a downgrade. Moreover, revenue took a knock for the quarter, but higher realised energy prices limited the fall.
The company revealed a soft March quarter 2018 result, with production on a barrel of oil equivalent (boe) basis falling by 36% compared to the corresponding 2017 quarter, to 4.8 million boe. The following chart shows quarterly boe production:
Source: Oil Search (ASX:OSH)
Boe production for the quarter was negatively impacted by lower production across all of its product offerings. The PNG earthquake impacted on all of the company’s operations hosted in that country. The event broke what had been a very good operational run for the PNG liquid natural gas (LNG) facility (Oil Search’s interest 29%) from its commencement of production back in 2014.
The impact of the earthquake on the March quarter numbers was reflected in the 2018 guidance downgrade. The company is now forecasting 2018 production to be in the range of 23 million to 26 million boe, down from the previous 28.5 million to 30.5 million boe range. In 2017, the company produced a record 30.3 million boe.
March quarter LNG production fell by 33% when compared to the corresponding quarter in 2017, to 17,560 million cubic feet. The following chart shows quarterly LNG production:
Source: Oil Search (ASX:OSH)
LNG is produced by the company’s PNG LNG facility which was shut-in following a 7.5 magnitude earthquake that struck in late February 2018. ExxonMobil, operator of the facility did advise the market that PNG LNG recommenced production in mid-April 2018.The facility suffered less damage post a full review than had been first feared.
This event was clearly out of the company’s control and until this point the PNG LNG facility had delivered a good operational run. Design capacity of 6.9 million tonnes per annum has been exceeded, with capacity topping an annual run rate of 8.0 million tonnes. We expect this feature will continue post the PNG earthquake.
The production of natural gas for the reported quarter fell by 30% on the March quarter 2017, to 1,592 million square cubic feet (scf). The following chart shows quarterly natural gas production:
Source: Oil Search (ASX:OSH)
Natural gas is produced by the company’s Hides fields (Oil Search’s interest – PDL 3 – 36.4% and PDL 4 – 10% respectively) for use in the Hides Gas To Electricity (GTE) plant. As a result of the earthquake, there was a shut-in of natural gas going to the GTE plant. Electricity demand was, at the time of the earthquake, robust. Operations have recommenced.
The company has provided a change in natural gas guidance for 2018 to now be 0.6 billion cf compared to the previous 0.6 to 0.7 billion cf guidance.
Higher unit valued oil production unfortunately fell for the reported quarter by 49% when compared to the corresponding quarter in 2017, to 540,000 barrels. The following chart shows quarterly oil production:
Source: Oil Search (ASX:OSH)
As the company’s oil fields are located in the same region of PNG, the earthquake had the same material impact on production for the reported quarter. The company’s four producing oil fields all reported lower production numbers. Highlighting the company’s two key fields in Kutubu (Oil Search’s interest 60%) and Moran (Oil Search’s interest varies across the three Petroleum Development Licences (PDL) – PDL 2 60%, PDL 5 40.7% and PDL 6 71.1%) and they reported falls of 45% and 58% respectively when compared to the same quarter in 2017, to 393,000 and 137,000 barrels.
Oil production guidance for 2018 was also downgraded, and is now forecast to be in the range of 2.8 million to 3.1 million barrels, from the previous range of 3.3 million to 3.5 million barrels.
The softer operational outcome for the quarter was fully reflected in the revenue result, with a partial offset arising from higher realised energy prices. The following chart shows quarterly revenue:
Source: Oil Search (ASX:OSH)
Revenue was 14.2% lower compared to the corresponding quarter in 2017, at US$295 million. The operational outcome was the primary driver of the revenue result for the quarter, however higher realised energy prices limited the damage. The average realised oil price rose by a significant 28% on the same price for the March quarter 2017, to US$70.38 a barrel. Moreover, the average realised LNG and natural gas price also rose by more modest 24% over the same comparative period as oil, to US$9.19 per million British thermal units. We do expect that in the first half 2018 financials, when reported in August 2018, volumes will have had a negative influence and realised pricing a positive influence on the profit line.
We have a positive outlook for energy prices in 2018.
We expect the Organization of the Petroleum Exporting Countries to remain compliant with its production ceiling of 32.5 million barrel of oil per day. We are cognisant however, that US domestic oil production will breach beyond ten million bopd production to act as a constant headwind. US production currently stands at a 10.525 million barrels run rate at 6 April 2018.
On demand, we expect the synchronisation of global growth will bring with it higher demand for oil. We are forecasting West Texas Intermediate (WTI) to end the year in the range of US$70 to US$80 a barrel and Brent US$74 to US$84 a barrel. At the time of writing, WTI was trading at US$66.78 a barrel and Brent Oil US$72.13 barrel.
On the daily chart, the technical picture has improved significantly in recent months. Resistance at the January 2018 high of $8.10 has given way, and now stands as a new layer of support. Prices have also moved above the 50-day moving average (red line) and the 200-day moving average (green line). The May high of $8.64 stands as a target near-term.
From the snap shot of the key balance sheet metrics provided at 31 March 2018, the structure remained stable. Net debt climbed by a modest US$6.1 million from a year earlier, to US$2.9 billion. The constituents movements saw cash fall by US$320 million, while debt declined by US$313.9 million, to US$3.6 billion.
We expect to see a continued improvement in the company’s debt position going forward, as cash flows remain robust on rising energy prices.
We have no concerns over the structure of the company’s balance sheet from the synopsis provided in its March quarter report. Greater clarity around the company’s financials will be provided when the results for the first half 2018 are released on 21 August 2018.
Our primary interest in Oil Search (ASX:OSH) lay in the value represented in its PNG LNG operations. The 30-year plus facility will underpin the long-term value this company has the potential to generate, as well as fund ongoing exploration and development activities. Furthermore, the offshore region of PNG continues to add exploration blue sky, in a location with an excellent energy pedigree. Plans for further LNG trains at the PNG facility to increase capacity are being actively pursued.
With reference to the monthly chart, prices have climbed above a series of Fibonacci retracements (blue set of retracements) in recent months. A decisive break above the 38.2% Fibonacci retracement at $8.23 would improve the picture further, and bring the all-time high of $9.88 (horizontal solid-red line) into focus.
The March quarter result was not a good outcome, although not of its own making, for the company. There will be financial consequences, albeit a one-off, in 2018.
More broadly, Oil Search (ASX:OSH) holds a strategic asset in PNG LNG that can deliver long-term value and it now has the financial capacity and ground to deliver. The company is focused on a region in PNG that is endowed with energy that offers “blue sky” potential that can utilize existing infrastructure.
Consequently, we continue to recommend Oil Search (ASX:OSH) as a buy for Members with no exposure to the stock.
Disclosure: Oil Search (ASX:OSH) is held within the Fat Prophets Mining and Resources, Concentrated Australian Share and Global Opportunities portfolios.
