IPIC deal a major PNG government achievement

WITH construction of the $US15.7 billion PNG LNG project now past the halfway mark, it is worth recalling the landmark PNG government IPIC transaction just as global financial markets came crashing down in late 2008.

At the time economists and commentators said the world was facing its worst prospects since the 1930s Great Depression.

Nevertheless in the midst of this financial collapse the PNG government in November 2008 raised $A1.681 billion for its share of the PNG LNG project through an "exchangeable bond" with the International Petroleum Investment Company of Abu Dhabi.

The deal has since been vilified in some quarters, led by the former PNG public enterprises minister Sir Mekere Morauta, who twisted some of the facts to suit his political agenda.

In fact in late 2008 it was one of the most laudable financial transactions undertaken globally.

It was an excellent deal regardless of whether the GFC was acting to the detriment of all such transactions.

Giant US financial institutions such as Lehman Bros had collapsed. Global player Citibank survived only because of US government intervention.

Around the world governments went to the rescue of major banks and financial institutions.

In that climate it was virtually impossible to raise project loans from financial institutions that normally fought tooth and nail to fund lucrative long-term commercial ventures.

Even all-powerful sovereign wealth funds, such as IPIC, faced mounting losses from global investments and were drastically cutting back on lending activities.

In spite of this climate, the PNG government's LNG project team led by then public enterprises minister Arthur Somare, who subsequently lost his parliamentary seat, concluded an incredibly positive transaction for PNG.

It underwrote government equity funding for the PNG LNG project, one of the most crucial steps in the lead-up to the joint venture's final investment decision in December 2009.

The IPIC transaction, which received prior approval from the Ministerial Economic Committee and the National Executive Council, brought international credibility not only to the PNG government but also to the PNG LNG project itself.

The transaction leveraged the PNG government's then 17.6% stake in Oil Search via the exchangeable bond to raise $1.681 billion.

It was adequate for most of the government share of the LNG project funding with awareness that more funds needed to be raised in the final stage of construction.

It was the only transaction that met then prime minister Sir Michael Somare's demand that such funding be sought without a) any sell down of government equity in the LNG venture and b) that it was done without raising public sector debt.

Other attempts by Petromin, Treasury and others to seek funding involved a watering down of government equity and were rejected by the NEC (Cabinet).

At the time, Oil Search managing director Peter Botten acknowledged that the IPIC transaction was important for the PNG government as well as the LNG project.

"Raising these funds removes uncertainty, as the project financing team commences discussions with export credit agencies and banks regarding the provision of a competitive financing package and as gas marketing negotiations reach an important stage," he said in a statement released to the Australian and Port Moresby stock exchanges.

"It also positions the project to achieve timely financing milestones in 2009."

Botten said by maintaining its full equity position in the project, the PNG government would "maximize the potential value for the state and the people of PNG of this long-term legacy project".

He told Oil Search shareholders that even though the transaction was concluded amid concerns about global recession, the transaction had priced company shares at $8.55, well above the prevailing price of less than $5.

It was a strong vote of confidence in the future of Oil Search as well as on the prospects for the LNG project, on which construction only began 14 months later.

Getting such a strong cash price upfront that could be used for project finance was one amazing feature of the deal.

The PNG government also convinced IPIC that PNG could retain dividend flows from Oil Search pending the eventual share-asset swap.

The high strike price was a major concern to the PNG Treasury. It made regular references to the potential funding gap in case the shares did not reach the "strike price".

With Oil Search shares below $5, the shortfall was a rather scary $750 million though at today's share price the gap has shrunk to less than $200 million.

The share price gains largely occurred as a result of growing confidence in completion of the LNG project and it is more than likely to surpass the strike price prior to the deal's conclusion.

In effect what the government achieved was to leverage an indirect interest in the LNG project for a more significant direct equity stake.

Like Morauta, the PNG Treasury has taken a contrary view of the IPIC transaction as can be noted from annual budget papers since 2009.

Treasury has constantly referred to the IPIC transaction as a high-risk loan, even though it was well aware this was not a loan.

The exchangeable bond effectively involved a future swap in shares held in Oil Search for immediate funding for a direct equity stake in the LNG venture.

For example, the latest 2012 budget talks of "the Independent Public Business Corporation's borrowing to fund 18.2 per cent of the state's share of the PNG LNG project".

It goes on to state that further increases in debt will be "imprudent" and adds that the government aims to keep public debt below 30% of gross domestic product.

It is a long way from the current budget estimate of 2012 public debt at 23% of GDP.

For the debt ratio to go from 23% to 30% would require additional borrowing of 2.4 billion kina which appears to make the 30% target a rather imprudent limit in the current climate.

The IPIC transaction preserved the national government's total PNG LNG project equity at the current level of 19.6%. It paved the way for the world's largest ever project finance for an oil or gas project and it did so without raising the government's public debt profile.

As originally envisaged, dividend flows should commence in the first full year of LNG production with company tax likely to commence in 2018.

Then there is the bonus of possible additional profits tax once returns reach a rather modest 17% level.

When the Somare government took office in August 2002 - about six years prior to the IPIC transaction - the Australian government refused to provide emergency loans to tide it through crisis proportion problems. It was incapable of even raising $A50 million from financial markets.

PNG has come a long way since the IPIC deal with every likelihood a commitment will be made to build a third - and more lucrative - LNG train within the next six months.


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