ExxonMobil's InterOil Offer a model for Bottom Fishing: Russell

ExxonMobil Corp's bid to buy a junior natural gas explorer in a remote Pacific country shows that rare corporate ability of planning a deal at the bottom of the commodity cycle that holds the promise of long-term returns.

ExxonMobil has offered at least $2.2 billion for InterOil Corp in order to obtain the smaller company's natural gas assets in Papua New Guinea.

In doing so, the world's biggest listed oil company has trumped an offer from Australia's Oil Search, which was backed by French major Total.

At first blush the logic for the deal may seem somewhat lacking, given the sole use of InterOil's gas fields would be to supply a liquefied natural gas (LNGLF) (LNG) plant, and the last thing needed in the current market is more of the super-chilled fuel.

Asian spot LNG prices <LNG-AS> ended last week at $5.75 per million British thermal units (mmBtu). While this is higher than the record low of $4 hit in April, it's still only about a quarter of the all-time high of $20.50 reached in February 2014.

The outlook for LNG prices is also constrained for the foreseeable future, as the market will have to absorb a surge in supply from eight new projects in Australia, five in the United States and the potential for more from new provinces such as East Africa.

So why would ExxonMobil bother buying InterOil's stake in gas fields in Papua New Guinea, especially when the Texas company already operates an existing LNG plant in the country?

It's that existing plant that holds the key, as the best option for ExxonMobil to expand its 6.9-million tonne a year capacity is to acquire sufficient reserves to justify building another liquefaction train.

InterOil's Elk-Antelope gas field holds at least 6.2 trillion cubic feet of natural gas, and further drilling should expand this reserve.

It is also high-quality gas and the cost of doing business in Papua New Guinea is less than in neighbouring Australia.

This means ExxonMobil's bid, if successful, could underwrite the expansion of its PNG LNG project on a timescale that may see it deliver its first cargoes just as the surplus of LNG is expected to disappear in the mid-2020s.

InterOil's board has switched to backing ExxonMobil's offer over the rival bid from Oil Search, although the Australian company has the chance to trump the counter offer.

It's unlikely that Oil Search will try to do so, because even losing out to ExxonMobil could see it emerge as a winner anyway.

This is because Oil Search is already a 29 percent stakeholder in the ExxonMobil-operated PNG LNG project, a share not too far behind the U.S. giant's 33.2 percent.

Any deal that boosts the prospects for PNG LNG will also be good for Oil Search.

In addition, the Australian company holds a 22.8 percent stake in the Elk-Antelope gas field, the target of ExxonMobil's InterOil bid.

If ExxonMobil succeeds in acquiring InterOil, Oil Search effectively becomes the junior partner in both the existing LNG plant and any potential expansion using the Elk-Antelope resources.

TOTAL WILD CARD

The big question for both ExxonMobil and Oil Search is what will Total do.

The French company owns a 40.1 percent stake in Elk-Antelope and is the operator, with InterOil the next biggest holder at 36.5 percent.

Total has outlined plans to build its own LNG project in Papua New Guinea, something that may prove impossible if ExxonMobil and Oil Search believe their interests lie with expanding the existing facility.

It's worth bearing in mind that even with Papua New Guinea's superior cost structure, a new LNG plant would struggle to be viable in the current environment of low prices.

It's possible that all parties could end up working together, but it may be more practical to find a way to buy out Total's position in Elk-Antelope.

The attitude of the PNG government will also be important, as it will have to be convinced that a brownfield expansion of the existing LNG plant is a better long-term bet than trying to build a second, greenfield operation.

As can be seen, there are many loose ends still to tie up, but ExxonMobil appears to be making a strong bid for quality assets with its eyes firmly on the long term.

If it all works out, this could be a great example of a resource company doing what commentators always say they should be doing, namely buying good assets at the bottom of the market and seeking ways to exploit them in a cost-effective manner.

Resource companies have correctly copped criticism when they do expensive acquisitions at the top of the commodity cycle, so they deserve kudos when they buy when the market looks bleak.
 

By Clyde Russell