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PTTEP savours Mozambique Cove takeover victory

Cove takeover will see Thai firm gain foothold in prolific gas play

Thailand’s PTT Exploration and Production (PTTEP) is poised to buy junior explorer Cove Energy and with it, a stake in the world’s most promising new gas frontier – offshore east Africa. The takeover, which comes after Shell bowed out of a bidding war, is strategically vital for Thailand as it seeks to diversify its energy supplies and increase imports of liquefied natural gas (LNG).

The ultimate prize for PTTEP is the 8.5% stake that London-listed Cove holds in Rovuma Offshore Area 1, off Mozambique, which is expected to feed a proposed LNG scheme. 

Since the start of bidding for Cove earlier this year, mean recoverable resource estimates within the block have jumped by 56% to 37.5 trillion cubic feet (cf) – largely thanks to the recent Golfinho discovery – with expectations that this will lead to an incremental LNG development of at least six trains.

While some analysts caution that PTTEP has paid over the odds for Cove, the fact that more gas has been found since talks began has sweetened the deal considerably. Besides, the state-backed Thai firm is prepared to pay a premium to beat Shell for gas reserves to fuel the nation’s growing economy.

And significantly, Cove could offer PTTEP a chance to acquire an even bigger stake. The Financial Times reported that Cove has first refusal on partners that sell down their shares, but when contacted by Petroleum Economist, a spokesperson for Cove said it would be unfair to the Rovuma Offshore Area 1 partners to comment on the report. 

Still, PTTEP’s £1.2 billion ($1.9bn) offer marks a 113% premium on the explorer’s undisturbed share price earlier this year. In contrast, Cove paid just $3.3 million for its stake in the licence. 

Shell made its 195 pence ($3.06) per share cash offer for Cove in February, before increasing the offer to 220 pence per share in April. Shell’s initial offer prompted the 220 pence per share counterbid from PTTEP, later boosted to 240 pence per share. This offer won the backing of Cove’s board.

PTTEP’s offer reflects the asset’s importance to both the firm and to Thailand, which produces most of its electricity from natural gas and has started importing LNG as supplies from the Gulf of Thailand are projected to start declining in the next decade.

But while the deal is strategic, analysts believe PTTEP may be underestimating the cost and scheduling challenges ahead.

Based on the resource estimates, the deal would value Cove at $3.6 per barrel of oil equivalent (boe), or $3.3/boe after removing Cove’s cash balance, according to Bernstein Research. Given global finding costs of $3-4/boe, at first glance, this does not appear to be unreasonable.

But based on estimates by both Bernstein and Cove for two- and three-train LNG blueprints, the valuations are significantly below the acquisition price of $1.9bn. In the six-train scenario, the value estimated by Cove is $1.6bn, which is lower than PTTEP’s bid. Of course, this excludes value in the other blocks held by Cove in Kenya and Tanzania, but in Bernstein’s view highlights the challenging economics of the deal.

Shell withdrew its offer for Cove on 16 July. However, PTTEP now needs the acceptance of investors holding 90% worth of Cove’s shares and approval from Mozambique’s minister of mineral resources.

Nevertheless, Shell's departure has fuelled talk that the company has found a new way to enter Mozambique’s offshore, possibly by buying a stake from another partner in the Area 1 consortium. Shell would bring with it significant LNG experience. Indeed, the partners and the government want a serious LNG player as operator of the project and Shell thinks it fits that bill, said Tony Regan, principal consultant at Singapore-based Tri Zen.

For the Anglo-Dutch supermajor, there is no shortage of other targets in the East African offshore, and it should be no surprise that Shell is said to be talking to Anadarko, which holds a majority 36.5% interest in Rovuma Offshore Area 1.

The other partners, Mitsui (20%), BPRL Ventures – part of India’s Bharat Petroleum (10%), India’s Videocon (10%) and the state’s ENH (15%), know Shell has the LNG experience and financial firepower to step in when the real capital expenditure is needed to develop the resource.

And it is quite plausible that some or all of the partners will be seeking to sell down stakes to help fund their share of future capital expenditure. But, in the wake of PTTEP’s bid, these firms will also be expecting a substantial premium. However, Rovuma Offshore Area 1 is not the only gas-rich concession in the region.

Other points of entry for Shell could include tie-ups with Italy's Eni, also offshore Mozambique, or with UK gas player BG Group and US supermajor ExxonMobil, which have discoveries offshore Tanzania. Smaller firms, such as Ophir Energy, are also active in the play.

The Cove bid clearly signals that Thailand is prepared to go all out to compete with the supermajors. To further demonstrate this, PTT, the country’s most valuable company, said in mid-July that it would invest up to $3bn in upstream and downstream projects in Myanmar (Burma). And with state backing, PTT can afford such deals.

Meanwhile, PTTEP aims to triple hydrocarbons production by 2020 with acquisitions making up a third of that target. The firm plans to boost output from 265m barrels of oil equivalent per day (boe/d) with an organic production target of 326m boe/d by 2015 and 600m boe/d by 2020.

Including mergers and acquisitions, PTTEP aspires to hit 900m boe/d by 2020.

Based on a three-train scheme, the Cove deal will add around 30m boe/d, or 5%, of the 600m boe/d 2020 target.

However, Neil Beveridge, a Hong Kong-based senior analyst with Bernstein, said it is highly unlikely the firm will hit these targets. PTTEP’s current reserves life stands at nine years and its proved developed reserves life less than five years.

Beveridge was sceptical about the firm’s recycle ratio, which over the past five years has averaged just over 100% – one of the lowest in its peer group. Effectively, it means it costs PTTEP as much to replace reserves as the cash flow they are deriving from those reserves.

He estimated that organic plus inorganic capital expenditure over the next five years will have to be $20bn in order to deliver on its production targets, buy Cove, and develop a three-train Mozambique LNG project. That compares to PTTEP’s own estimate of $12bn, which was released earlier this year and excluded the Cove deal.

Indeed, it seems PTTEP’s apparent willingness to spend on big-league deals to achieve its aggressive expansion targets bodes ill for the Bangkok-listed energy group’s private investors, but will be crucial to shoring up the nation’s energy supply.

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