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BG buoyed by Brazil

BG Group's attempt to buy Origin Energy has overshadowed a solid financial performance and significant reserves growth thanks to exploration success in Brazil

BG Group grabbed the headlines recently with its hostile bid to acquire an Australian company involved in the growing business of producing natural gas from coal seams. This rather overshadowed the company's widely admired financial results, as well as large oil and gas discoveries in Brazil in which the company has a share.

That is hardly a surprise: bids always make for good copy – and BG's attempt to acquire Australia's largest coal-bed methane (CBM) company, Origin Energy, has been no exception. The CBM industry – which involves producing gas from coal mines or seams – is relatively well established in the US, accounting for about 10% of the country's gas supply. Elsewhere, however, it's in its infancy – the global average is just 2% of supply.

But with the price of gas rising sharply, interest in CBM schemes has grown. Earlier this year, BG and Queensland Gas agreed to build a plant to liquefy coal-bed methane and export it to Asia. And then in May, BG appeared to have agreed a A$13.8bn ($13.2bn), or A$15.50 a share, deal to buy Origin Energy. But Origin's management then withdrew its support for the deal after Malaysia's state-owned Petronas paid over $2.5bn for a 40% stake in Australian energy group Santos' planned Gladstone liquefied natural gas (LNG) project. Based on the terms of that deal, Origin argued, its own CBM reserves should be valued at A$16bn.

This forced BG, which rejects Origin's valuation, to go hostile with its bid. It suggests that Origin probably lacks the financial capacity to proceed with the venture and may struggle to manage such a large project. It also says that working with a joint-venture partner will not remove the significant risks associated with a project that is unlikely to see "sustained revenues" until 2015 or 2016.

Many analysts say these are valid points, although the market does not appear to agree: Origin's shares have risen as high as A$16.42 – well above BG's offer of A$15.50 a share. BG will have to raise its offer to win support from Origin's board – by as much as 13%, says Merrill Lynch.

Even before it found itself entangled in a hostile bid and facing the prospect of stumping up more cash, analysts were divided on the merit of the deal. BG's original offer was already at a 50% premium to the market price. In addition, Origin contains several businesses that do not easily fit BG's operating model.

But what the Origin saga has certainly done is to detract from the company's improving financial performance and highly significant offshore Brazilian oil and gas discoveries.

Drilling, not mining

On 13 June, BG's partner, Brazil's Petrobras, announced yet another oil and gas discovery in the deep-water Santos basin. The latest exploration success, Guara – in a basin that one operator has referred to as "the new North Sea of the south" – is the second discovery in the BM-S-9 concession area. BG holds a 30% interest (operator Petrobras holds 45% and Spain's Repsol YPF owns 25%).

The first discovery, known as Carioca, was announced in early September; Petrobras says it won't quantify the field's reserves until it drills a second well next year, but Carioca's resources are thought to be very large indeed. The head of Brazil's upstream regulator blurted out in April that it could contain as much as 33bn barrels of oil equivalent (boe), which would make it one of the largest fields ever discovered.

Although Petrobras immediately distanced itself from those remarks, the firm's chief executive, Jose Sergio Gabrielli said last month that the conditions in these wells "are very similar to those at Tupi", another Santos basin field and, with estimated recoverable reserves of 5bn-8bn boe, the biggest discovery in the Americas since 1976 (although it may be overtaken by Carioca when new data are available).

The Santos basin discoveries, where BG now has interests in seven concessions covering a total 7,450 square km, have put a spring in the firm's step; at the end of 2007, its proved, probable and unbooked reserves were up by 26% over 2006 at 6.69bn boe.

The discoveries in Brazil are also forcing up analysts' valuations of BG, making it even less likely that BG itself – which has often been talked about as a possible take-over target for Shell – will be bought by a larger company. David Stedman of Daiwa Institute of Research raised his valuation of BG shares by some 10% at the end of April, to £14.50 ($28.75). At press-time, the shares were trading at just below £12.00.

BG's rising valuation is certainly supported by revenue and profit figures. In the first quarter (second-quarter results were due out at the end of July), BG reported net income of £0.789bn, which was up by 76% from the year-earlier period and some £100m-120m above analysts' expectations.

As well as the higher oil and gas prices – exploration and production operating profit rose by 50% over first-quarter 2006 – the company attributed the rise to the extraordinary margins it earned by diverting LNG cargoes to Asia. Very tight market conditions in Asia-Pacific, especially for Japan, saw BG divert 90% of its LNG cargoes to this region in the first quarter, which, together with an increase in volumes sold overall, produced a 226% year-on-year increase in LNG earnings before interest and tax.

Ironically, it is exactly the attractiveness of the Asia-Pacific LNG market that is pushing BG into the hostile bid for Origin.


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