Oil Search Ltd. MS report

[Gator]

Management briefings in conjunction with a comprehensive PNG site tour, which we attended, reinforce our bullish view of the company’s growth prospects and long-term value drivers.

2014 is a transitional year: The base oil business is mature but expected to remain stable. However, the onset of LNG production will drive a block-shift in production, costs, tax , interest, and cash flows. Construction is well advanced on a number of fronts and our belief is that production from train #1 will occur around mid-year, followed by train #2 around three to four months later. Commissioning and ramp-up phases span several months. Plateau production from two trains is unlikely until early 2015. Guidance for production and capex reflects commissioning risk and may be conservative.

New opportunities are emerging and will evolve during 2014 and 2015: 1) The Taza oil discovery in Kurdistan is potentially very valuable if upside oil volumes of 750 mbbls are confirmed, and an active appraisal program spanning the next 18 months has started. 2) The LNG expansion opportunity set has expanded to include trains #3 and #4. However, the timing, costs, and source of gas are uncertain due to the potential for gas to be sourced from any or all of the Hides gas field (the cheapest), P’nyang, or third-party suppliers. We anticipate these options will be resolved in 2014, but in all cases, OSH should benefit by being a resource and infrastructure owner.

A key challenge will be in managing the competing demands on rising cash flow between shareholders wanting cash returns and funding a more aggressive exploration and appraisal program ahead of cash receipts from LNG, which lag sales and won’t be significant until mid-2015. Funding levers are oil forward sales and short-term borrowing, with little headroom to pay for a good deal should one eventuate.

We retain our Overweight rating.
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