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BG banks on Brazil and LNG

With its LNG business expected to make nearly $2bn this year, BG's Brazilian operations are still making the headlines, writes NJ Watson

BG'S FARM-in deal with Kazakhstan's KazMunaiGaz Exploration Production (KMG EP) will please investors that the UK company is following an old maxim, to keep your friends close but your enemies closer.

BG is embroiled in one of several spats between international oil firms and the Kazakhstan government over energy projects in the Central Asian country (see p34). Kazakhstan is trying to reclaim shares in assets sold too cheaply to foreign investors over the past two decades through a mixture of administrative pressure and dubious tax bills.

BG is a 32.5% stakeholder in the Karachaganak Petroleum Operating (KPO) consortium, the country's second-biggest oil and gas producer – at 382,000 barrels of oil equivalent a day (boe/d) in 2009 – and the only one without state involvement. This position looked set to change, as KPO found itself subject to accusations of tax evasion and violations of environmental, employment and immigration laws. Timur Kulibayev, the president's son-in-law and a man with huge influence over the country's energy industry, said publicly during the summer that the state wants a 10% stake in the project.

But the situation seems to have changed since, at the end of August, BG sold a 35% stake in its White Bear gas-condensate prospect, in the UK North Sea, to state-controlled KMG EP. White Bear is close to BG's producing Everest and Armada assets in the northern North Sea. BG will continue to operate the licence, which includes a commitment to drill one more exploration well in 2011; KMG EP estimates its financial liabilities associated with the project at some $25m-30m.

The deal represents KMG EP's first international venture and its first joint endeavour with BG under an upstream co-operation agreement signed in 2008. The firm is excited: Kenzhebek Ibrashev, head of KMG EP, tells Petroleum Economist: "White Bear has very high potential. It's an important step forward." KMG EP is looking to gain expertise in natural gas production.

Andrew Neff, a senior analyst at IHS Global Insight, says BG's co-operation with KMG EP "is likely to be viewed favourably in Kazakhstan". The first sign that this may be the case came in October, when Kazakhstan's oil minister, Sauat Mynbayev, indicated a government u-turn by stating negotiations with the Karachaganak partners are not about the state securing a stake. "The parties are discussing how to improve the project," he claimed.

This, and comments from Ibrashev that KMG EP is looking at other projects in BG's exploration portfolio, provide the basis for ING oil and gas analyst Jason Kenney to highlight BG's Brazilian assets as "only part of the company's attraction". He points to BG's coal-seam-gas (CSG) acreage in Australia and its liquefied natural gas (LNG) operations as other positives in the company's portfolio (see p4) – BG predicts its LNG business will earn $1.8bn-2.0bn a year from 2010.

Yet BG's Brazilian operations continue to dominate the headlines. In early October, an eighth successful well on the Tupi prospect confirmed the light-oil potential of deep-water, pre-salt reservoirs in the Santos basin, and reaffirmed estimates that the Tupi area holds a massive 5bn-8bn boe of recoverable reserves. (Brazil's state-controlled Petrobras holds 65%, with BG 25% and Portugal's Galp Energia 10%.) BG estimates its net share of total reserves and resources in the Santos basin at over 3bn boe and expects its net production will ramp-up to more than 400,000 boe/d by 2020.

The Brazil finds are an important part of what BG predicts will be "a new decade of growth" for the company. It is forecasting production of 1.6m boe/d by 2020, which would represent compound average growth rate (CAGR) of 10% between 1997 and 2020; contracted LNG supply of 20m tonnes a year (t/y) by 2015, representing CAGR of 31% between 1997 and 2009; and production of 100,000 boe/d of shale gas in the US by 2015, through its alliance with Exco Resources. The company's total reserves in US shale-gas plays have risen to over 1.3bn boe, it says.

But investors appear unconvinced, with BG's stock trading at a reserves multiple of $2.51 a barrel, which is noticeably cheaper than other firms with Brazilian exposure, such as Repsol, at $6.28/b, and Galp, at $12.84/b. "BG Group offers a sound exploration-led growth outlook, which is undervalued by the market," says Kenney, who recently raised his target price on the stock to £14.50 ($23.00) a share from £13.00.

Near-term concerns include the hesitancy of the new Australian government to give environmental approval to BG's 8.5m t/y Curtis Island LNG project, based on CSG reserves in southern Queensland's Surat basin – although most industry observers expect this project to gain approval.

Power exit

Financially, the company's return on average capital employed and return on equity has almost halved from 2008 levels, putting a question mark over how effective management is in deploying its financial resources. A move to remedy this comes with a decision to exit from the electricity sector and sell off its power plants, with investment diverted into exploration, production and LNG, where there is faster growth. In September, BG sold its 40% stake in two gas-fired power plants in the Philippines to Korea Electric Power for $400m.

But there are signs that the discount its shares are trading at could soon narrow, if not disappear. BG's stock rose sharply at the beginning of October following Repsol's deal to sell 40% of its Santos basin assets to China's state-owned Sinopec for $7.1bn (see p36), which has focused investor attention on the value of BG's Brazilian assets. By mid-October, BG's shares were up by over 20%, at around £11.62, from a low hit in May.

Recent results are also encouraging. In July, BG reported a 19% year-on-year rise in second-quarter profits to $0.9bn, with revenues up by 18%, to $4.127bn.

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