Oil Search capex cut fails to quell market fears
Papua New Guinea-focused Oil Search is at risk of becoming a takeover target after an announcement of plans to slash spending by 40 per cent failed to stem a savage sell-off in its shares amid worries about keeping within its debt covenants.
The news of the reduction of about $US300 million ($500 million) in capital investment this year and a suspension of ongoing projects is the first of an expected flood of cutbacks and disruptions in an oil and gas sector crippled by the crash in oil prices.
Oil Search, under new chief executive Keiran Wulff, has also put on ice a process for the sale of a 15 per cent stake in its Alaskan oil project.
Shares in Oil Search, whose "crown jewel" is a 29 per cent stake in the high-quality PNG LNG venture, sank a further 7.9 per cent to $2.44 on Wednesday.
The stock has halved since March 6 – before the oil price plunge after a price war broke out between Saudi Arabia and Russia - and is down more than 70 per cent since January.
Investors are worried about debt servicing and the risk it may need to raise capital.
Oil Search wasn't the only heavy casualty, with heavy selling across the board leaving Woodside down 8.8 per cent and Santos down 12.3 per cent.
Bernstein Research analyst Neil Beveridge gave credit to Oil Search management for responding swiftly to the new price environment with an "appropriate" reduction in capex, but pointed to the risk that fresh equity would be needed.
"While free cash flow break-even has fallen to $U$32/bbl it will be impossible for Oil Search to fund growth at current prices," Mr Beveridge said."Either oil prices will have to rise, or an equity raise [will be] required. M&A seems possible given the quality of the assets, which should bring support."
Credit Suisse analyst Saul Kavonic this week pointed to Oil Search as an example of a potential M&A target for Woodside that could be preferable to proceeding with its $US11 billion Scarborough LNG project in Western Australia.
Woodside has previously sought to take Oil Search over, making a $11.6 billion approach in September 2015 that was soundly rebuffed. The PNG player now has a market value of $3.7 billion.
"WPL could now possibly purchase OSH and Perth Basin interests and achieve a higher return than Scarborough on the same money in our view," Credit Suisse told clients this week. It added that it was just using Oil Search "as an example" and that other assets in the region could present alternative or preferable targets.
All eyes on IC covenants Oil Search's drastic action will cut expected investment spending this year to $US440 million-$US530 million, from an earlier range of as high as $US845 million.
RBC Capital Markets analyst Ben Wilson described the range of cutbacks at Oil Search as "a prudent approach in what is a treacherous oil price environment characterised by uncertainty".
But Citigroup analyst James Byrne said investors weren't focused on capex, rather on Oil Search's ability to keep within its interest cover (IC) covenants for its debt.
"Slashing capex does not directly improve IC," Mr Byrne said, adding that he thought the further sell-off in Oil Search's shares was because it gave no clear guidance on operating cost reductions or explicit remarks on being comfortable it wouldn't breach covenants.
In his first comments since the oil price crash earlier this month, Dr Wulff said it was unclear how long the downturn and the share market volatility would persist, pointing to the combined impact of the global oil production increase with the impact of COVID-19 on demand.
"While Oil Search is fortunate to have world-class assets, these unprecedented times require us to take immediate and decisive steps to position us for a potentially extended period of lower oil prices and business uncertainty," Dr Wulff said.
He added that if lower oil prices persist into 2021, Oil Search would "focus on protecting the value of our core assets and limiting any other activities". As of December 31, Oil Search said it had drawn debt of $US2.94 billion related to the project financing it took on to help fund its share of ExxonMobil-led PNG LNG, as well as $US440 million drawn down from its $US1.2 billion of corporate facilities.
It has $US300 million of loans related to its Alaskan business due to expire in September this year which it intends to refinance well before then.
It pointed to a "limited number" of financial covenants that apply to the corporate facilities, the most significant being an EBITDAX/interest cover test of more than three times, calculated each six months over the prior 12-month period.
Citi said the earliest breach of that level could be at discussions with lenders in December this year, but possibly in June 2021 given the lag between declines in oil prices and their impact on LNG contract prices.
Oil Search noted that its cash flow break-even for 2020, including PNG LNG debt repayments, is currently in the range of $US32-33 per barrel of oil equivalent, a number that would drop with cost-cutting.
Brent crude oil was trading just below $US27 a barrel on Wednesday.