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Edited Transcript of OSH.AX earnings conference call or presentation 20-Aug-19 12:00am GMT

Half Year 2019 Oil Search Ltd Earnings Presentation

PORT MORESBY Sep 7, 2019 (Thomson StreetEvents) -- Edited Transcript of Oil Search Ltd earnings conference call or presentation Tuesday, August 20, 2019 at 12:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Elizabeth White;EVP, Development

* Ian Munro

Oil Search Limited - Executive General Manager of Gas, Marketing & Exploration

* Keiran John Wulff

Oil Search Limited - Executive GM & President of Alaska

* Peter Robert Botten

Oil Search Limited - MD & Executive Director

* Stephen W. Gardiner

Oil Search Limited - CFO

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Conference Call Participants

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* Benjamin Wilson

RBC Capital Markets, LLC, Research Division - Analyst

* Daniel Butcher

CLSA Limited, Research Division - Research Analyst

* James Byrne

Citigroup Inc, Research Division - Research Analyst

* James Redfern

BofA Merrill Lynch, Research Division - VP

* Jon Scholtz

Macquarie Research - Analyst

* Saul Kavonic

Crédit Suisse AG, Research Division - Research Analyst

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Presentation

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Operator [1]

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Hi, and welcome to the Oil Search Limited FY '19 half year results. (Operator Instructions)

I would now like to hand the conference over to Mr. Peter Botten, CEO and Managing Director. Please go ahead.

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Peter Robert Botten, Oil Search Limited - MD & Executive Director [2]

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Yes. Thanks very much. You can do the rest, if you'd like, quite happy. Look, ladies and gentlemen, thank you very much for joining us for our 2019 first half results webcast. And it's a pleasure to be here. And thank you, whether you're joining in personal or through the worldwide web.

Because we're here, the first thing I'm going to do is to show you our disclaimer, and please read at your leisure. And the second thing to do is to say in the event that there is a -- some form of event or incident, there is a step-wise process going from a report and alert to a beep, beep. And if you get to a whoop, whoop, and I understand, interesting to know what the difference between the beep, beep and the whoop, whoop is and why a whoop, whoop is that you will evacuate this auditorium out through the back left-hand door at the back of the stage and follow the stairs down out to the forecourt and the junction between Bridge Street and this open space out the front of the building. So there are no test evacuations planned for this morning. So in the event that you do get a beep, beep or a whoop, whoop, please, on a whoop, whoop, go out through the back exit.

Today, we're going to provide you with a relatively short presentation on operations and finance and also what's going on in Alaska, and that will be done by myself; Steve Gardiner, our Chief Financial Officer; and Keiran Wulff, who's the EVP and President of Alaska operations. We also have on the panel, our -- Ian Munro, who's our EVP for Portfolio Management, Gas and Marketing. Ian is the one with the beard on the end. And Dale Rollins, who sits in the middle, he's EVP, President, PNG, recently arrived from Nigeria. And we also have EVP, Development, who's been looking after LNG in Beth White, who sits between the bearded one and Dale.

So today, we're going to give you a short presentation on what the results are about, what the status of our business is and then to open for questions, both from the floor and from the Internet.

Obviously, the first half results, I think, you could term as solid. Total production of 14.1 million barrels of oil equivalent was about 38% higher than the first half of '18, recognizing, of course, that the first half of '18 was impacted by the tragic earthquake that took place in February 2018. So we obviously had a relatively a disruption-free first half, and that resulted in a solid production base, 36% higher than in the equivalent period.

PNG LNG, again, produced an annualized rate of 8.6 million tonnes per annum. That was impacted a little bit by planned downtime in the first half, and we expect a stronger second half for a range of reasons with no unplanned -- or no planned downtime during that period of time.

Our net profit after tax was USD 162 million, which is up approximately 100%. And our dividend per share, given -- announced by the company today is USD 0.05 per share for the first half.

We have recently signed midterm LNG contracts in this market. We think it's smart, and I'll talk about that later, taking total contracted volumes for PNG LNG to about 7.9 million tonnes, leaving about just a bit less than 1 million tonnes open to spot.

In PNG LNG, obviously, has dominated -- Papua LNG has dominated our discussions and interest over the last 3, 4 months. The PNG LNG Gas Agreement was signed in April, and other key commercial agreements made progress right through the first half and effectively are all ready to align our joint ventures, align interest of the various commercial entities and all ready to go when the Papua and P'nyang gas agreements are confirmed and finalized with the PNG government.

We had a successful appraisal well at Muruk 2, which tested very good reservoir quality sands. And it proved that the Muruk 2 well was in continuity with Muruk 1, and that will have ramifications for resource base announcements later this year, early next year.

We also saw some very strong results out of the Pikka unit and the drilling program in last year's winter in Alaska. And also progress made with the record of decision, and progress on the land use agreements also encouraged us in making progress on the development of the Pikka unit in a phased and sensible way. Keiran will be talking about that later.

We did exercise the option to pick up the other half of the Armstrong Oil interests. And we also carried out a substantial realignment with Repsol to provide the basis of sensible commercial decisions on a way forward for the development and exploration across our North Slope portfolio.

In the organization, because we now have 2 significant and active business units, we optimized our organization and set up the organization with 2 business units and also a new area of technology and assurance, which, again, will focus on development and working the assurance processes for those developments -- significant developments over the next few years. It also had flow and effects to succession and others. Again, a very positive input into a new Oil Search responsible for development of the next phase of Oil Search's growth over the next 5 years.

Liquidity remains sufficient to support our growth opportunities in PNG and Alaska, and Stephen will be talking about that a little bit more later on.

Can't get away from the fact that Oil Search has been very much at the forefront of promoting investment in PNG to the world, and that has progressively gone very, very well over the last 20-plus years, building investor confidence based on predictable project delivery and stability. And this diagram shows our share price in black. And you can see since May this year, a decline in our share price, which is largely related to events in Papua New Guinea. Clearly, the last few months have tested the confidence of investors with financing and insurance cost rising, reflecting ongoing uncertainty about what's happening in Papua New Guinea. Also it is very much a bellwether of this sentiment and with uncertainty on the timing of Papua LNG development, substantial value has clearly been removed from our share price over the last 3, 4 months. Over $2.5 billion drop in value over that period of time, far and away more than the value of Papua LNG to us right now.

Predictably -- predictability and stability are key to investor confidence with it. And without this, obviously, the business becomes much harder. And we are a significant, I would say, the largest investor in PNG. And when PNG wobbles, Oil Search will wobble as well.

Of course, we fully recognize and respect that any government has the right to review agreements. However, the joint venture with -- the Papua joint venture believes that the agreement that was signed earlier on in the year provides the state with significantly greater benefits quite rightly than the PNG LNG project. As today, PNG is the largest investor, we're obviously very sensitive to the -- this uncertainty and the uncertainty surrounding where Papua LNG Gas Agreement is going, and are working extremely hard to resolve and work with our joint venture partners and government to resolve any outstanding issues in a timely way, and I'll come back to that later on.

Obviously, safety is a core to any operations and, certainly, Oil Search is not -- is absolutely the same. And it's not acceptable for anybody to come to work at Oil Search and then go home, in any way, harmed, and that's true for our staff, but also our contractors. And you see in the first half this year a disappointing safety performance where, as measured by total recordable incident frequency rate, that rose to 2.5 incidents per million person hours. That is not an acceptable result for us, and we've undertaken a range of significant programs to refresh and focus on safety, right from the top, from our Board down into the organization. I should say that this is no excuse, but many of our safety incidents were actually on the seismic program, and we're doing an unprecedentedly large seismic program across parts of the Highlands and Gulf areas in Papua New Guinea, and that's a pretty dangerous place to go. And although we can work at it extremely hard, the incidents coming out of that are obviously concerning. But it is a challenging, challenging place to work.

Recently, we had a summit in Papua New Guinea, which was designed to focus on safety, not just for us, but all our contractors, our land owner companies and really reset the bar in terms of our expectations on safety performance.

In the space of process safety, we've had one Tier 1 and two Tier 2 process safety events. Again, in focusing on our older plants and the maturity of our facilities, we are reporting better, we're actually learning a lot and, after the earthquake, still fighting the battle to actually restore some of our operating facilities to a sustainable and reliable state of operations. The local drilling program in Alaska went actually extremely well, and there were no TRIRs or process safety incidents in our Alaskan assets. But more to come on safety and, certainly, a big focus for us in the second half.

With that in mind, I'll check -- I'll pass it over to Stephen, who can walk you through some of the numbers.

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Stephen W. Gardiner, Oil Search Limited - CFO [3]

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Thank you. Indeed, good morning, ladies and gentlemen. A pleasure to be here. I'll take you quickly through the financial results and our focus on capital management, in particular, and also an outlook for the full year.

As Pete has already mentioned, our performance in this first half really reflects as much as anything, the impact of the earthquake in the first half results for 2018. That noted, our sales volumes were up by 37% underpinned by strong PNG LNG production with the revenue also boosted by an 8% increase in average realized LNG prices. That translates to 105% increase in net profit and a 72% increase in operating cash flow, despite, as Pete has also mentioned, some unplanned oil production downtime and higher production costs in the first half, and I'll provide more details on the drivers behind that.

Our net debt, though, including lease -- excuse me, excluding lease liabilities, and they have to be capitalized under the new lease standard, reduced by USD 467 million over the last 12 months. Because of that and because of our focus on managing our balance sheet, our liquidity remains healthy at over USD 1.4 billion at the end of June.

Turning to our liquidity position. In the first half of this year, we generated around USD 600 million of operating cash flow, as already mentioned, supported primarily by a very good contribution from PNG LNG. Of that amount, USD 170 million was invested across the successful Alaskan appraisal drilling program, completion of the Muruk 2 appraisal well, acquisition of a very large seismic data program, oilfield development drilling and progression of LNG expansion activities. We also spent some money on implement -- ongoing implementation of our new ERP system. At the end of June, USD 174 million of PNG LNG project finance debt was repaid as scheduled.

Also at the end of June, the Alaskan Armstrong option was exercised and license -- alignment arrangements were agreed with Repsol. That will be settled over the next several weeks, and that resulted in a net cash outlay of about USD 386 million.

As previously flagged, the sell-down of some of the Alaskan equity acquired under the Armstrong option is now planned to occur closer to FID for the Pikka development. Accordingly, additional -- an additional USD 300 million of short-term bank credit lines has been arranged. Still waiting for a bank of PNG approval, which we expect shortly. That's to provide additional financial flexibility until we complete that sell-down process.

Turning to production cost. Although unit production cost declined compared to the first half of last year due to the recovery in production, in absolute terms, we did see production costs increase due to a number of factors. That included a higher maintenance spend on the PNG LNG facilities, ongoing earthquake remediation work across our own operated oil and gas projects that were not offset by insurance receipts. We spent about USD 17 million on those activities that we funded ourselves rather than from insurance recoveries in the half. We also completed a value-adding well workover program in the first half as part of our oil optimization activities. The earthquake repair work that were undertaken by the PNG LNG project in the first half wasn't offset by insurance recoveries, with additional proceeds of about USD 6 million covering work completed in the prior year, but with receipts are recovered from insurers this year booked to other income in our accounts.

As mentioned already, our capital management is a key focus area for the company and remains an absolute priority. We continue to assist our funding capacity and sources of liquidity, including the impact of various oil price scenarios and capital expenditure profiles as we move closer to the major capital and commitments on the development projects ahead of us.

Our liquidity position and balance sheet are in good shape, bolstered by the strong ongoing operating cash flow from the PNG LNG project and our oil operations and, hopefully, underpinned by oil prices that have started to stabilize and recover.

We've had a very encouraging initial engagement with prospective lenders for the expansion projects. So we've been out meeting them around the world, introducing them to the LNG expansion projects, and we're very comfortable that our aim of securing around 60% to 70% gearing at the project level can be achieved for those developments. At least, funding for the equity component of those projects to be sourced from our current liquidity position and free cash flow. Importantly, investment in future exploration activity that we have in front of us is largely discretionary. Certainly, spend that we can be wound right back if required.

We're confident that our financial ratios will remain comfortably within lender covenant limits during the development phase that's in front of us. And then post-LNG expansion with Alaska in production, we see free cash flow resulting in a very rapid deleveraging of Oil Search's balance sheet, aided by a full repayment of the foundation project debt for PNG LNG in mid-2026.

Finally, turning to guidance for this year. There's really no change to our guidance that was released in the June quarterly report update that we provided about 3 or 4 weeks ago. Our production guidance reflects an expectation of a stronger second half due to less schedule, and as Peter mentioned, hopefully, certainly, no unscheduled downtime and also some incremental production from the oilfield workover program that we completed in the first half.

Our unit cost production range in the area of $11 to $12 per BOE is going to be better than the first half result, again, due to higher production, but also lower earthquake repair cost and no well workover spend in the second half.

Our CapEx guidance, excluding the Alaska option and the license alignment payment due from Repsol, will be in the range of $500 million to $600 million or thereabouts.

At the second half, we're focusing on a number of activities, including pre-FEED spend on LNG expansion projects and the Pikka development, preparations for the next winter drilling program on the North Slope, continuation of seismic acquisition in both PNG and Alaska and commencement of drilling of the Gobe Footwall exploration well in the fourth quarter of this year. Also hopefully looking to entry and commencement of FEED activities for PNG LNG expansion and, of course, the Pikka development with Pikka early works activity also commencing and ongoing work on the PNG in Angore field.

We've also got a development well in the second half in the Usano field and a possible upgrade of the company's rigs and ongoing investment in our ERP rollout.

So that guidance is, really, though, of course, dependent on -- it could be in terms of LNG expansion and what they get to do in terms of the timing of FEED entry that Peter has already covered, and we'll go into more detail on.

So with that, I'll hand back to Peter. Thank you.

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Peter Robert Botten, Oil Search Limited - MD & Executive Director [4]

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Thanks, Stephen. And I'll move you on now to some of the production information, a little bit more flavor to what's going in -- on in our production business. Obviously, right now, we're working very hard to optimize our various activities following the earthquake to boost operated production from -- in the second half of 2019. PNG LNG undertook some significant scheduled maintenance in the first half, and we anticipate a strong second half from PNG LNG, but also from our oilfields, oil production, although impacted initially earlier on in the year with return to service issues following the earthquake and other unplanned outages indirectly, and some of which indirectly caused by earthquake, is now we hope largely behind us. And in addition, we've recently got access to Northwest Moran, and we hope to be able to bring Northwest Moran wells on progressively through the second half of the second half and into next year. We're also seeing -- we're back to doing workovers in Moran. We're also optimizing some of the Usano wells. And broadly speaking, we see value and reasonably significant value in optimizing our oil business through the second half, and that will continue into 2020.

With that in mind, as Steve said, our production guidance remains designed somewhere between 28 million and 31 million barrels of oil equivalent. And as I say, we expect a stronger second half versus the first half due to the reasons I mentioned above.

We do clearly see there's an opportunity in our oilfields to further refine and make those oilfields efficient. And of course, we're also looking at the development of a significant gas production capacity in our oilfields, which is also looking at some of our longer-term programs in the oilfields to extract maximum value.

As most of you would understand after something around 14 months of heavy negotiations, Papua LNG Gas Agreement was signed in April 2019 with the final signatures being placed by the Prime Minister at the time, Peter O'Neill, and the CEO of Total, Patrick Pouyanné. The gas agreement, through that negotiations, delivers a range of new benefits for the government and landowners and increases materially the value to the state of production from Papua. And some of the changes that were made was a commitment to up to 5% of gas production to a domestic market obligation, 2% production levy, some various mechanisms to defer some of the state's payment of past costs. And to come before us is a comprehensive negotiation on national content, planning to support local workforce development, business development, and that will be finalized before final investment decision. The states taken in Papua LNG is substantially better than PNG LNG. And quite rightly so, it's a more mature project. And the country is more mature. And it really does focus on the development of downstream industries, which hopefully will help diversification of the economy down the track.

Downstream, Papua upstream and pre-FEED activities have reached a very, very mature stage. And really, the FEED contracting is also very well advanced, and we're ready to award fee contracts, subject to the gas agreement's being finalized and confirmed, finalized for P'nyang and confirmed for Papua LNG.

Commercial agreements on the integration of Papua LNG and PNG LNG essentially are all finished and ready for execution, again, subject to the finalization of P'nyang and confirmation of Papua LNG. And we already have started initial negotiations on the P'nyang gas agreement.

In June, the new PNG government leadership team highlighted desire to review the Papua LNG Gas Agreement. And in early August, the government indicated it would, in principle, stand behind the agreement. More recently, the Minister for Petroleum has stated he wishes to renegotiate certain terms of that agreement.

The discussions between the state and Total as operator of Papua LNG are ongoing, as we speak, and further meetings are planned later this week and into next. The joint venture is working very hard towards resolution of this and confirmation of the agreement by the end of August, in advance of expiry bids for FEED activities. Those FEED bids expire sometime in September, and we really do need to get clarity before on what the gas agreement is before moving on.

Papua LNG and P'nyang gas agreements are key prerequisites for launching FEED and the FEED phase of the proposed 3-train development. And as I say, we're all working extremely hard to get what's needed to do -- done for moving these projects forward.

That's a short update on LNG market, and I want to encourage you to ask questions of Ian of this because he's been recently traveling Asia to underscore our knowledge base of what's happening in the market. But broadly speaking, we see ongoing significant demand increases for LNG across the region and, certainly, sustained growth of LNG offtake through to 2030.

Spot prices have really softened due to really an unseasonable mild North Asian winter or summer and new supplies, obviously, entering the market, but we still see the supply-demand balance being tightening as we go through 2020 into 2021 and '22 when supply will be tight, despite new LNG coming into the market, primarily from North America. After that, obviously, there is a wave of new LNG capacity that's being worked on. And by the middle of the next decade, again, back in balance and possibly oversupply in the back half over the next decade.

Engagement with buyers has really given us the confidence that we can actually do point-to-point sales and one of the few companies that will do point-to-point sales between Papua PNG LNG, Papua LNG and the customer. And there's, obviously, we believe, strong interest that our marketing team has found in the quality of our gas, the richness and the diversity of supply that buyers are seeking. We can really only get serious on the marketing, though, on the basis of moving into FEED and becoming absolutely understood about when and how we can deliver into the market.

Because of the change in spot term and dislocation between contract prices and spot, it really does validate PNG's LNG -- PNG LNG's strategy to execute midterm contracts. And as I said before, we've right now got on the contract term something around 7.9 million tonnes, leaving us relatively marginally exposed to the spot market.

Significant gas discovery was had at Muruk 2, Northwest of Hides, and it's certainly outstanding result that Muruk 1 and Muruk 2 is actually in pressure communication, and I lost that bet, let me tell you, because I didn't think it was going to be. But both wells talk to each other, and that's very good for proving up a resource base for future optimization of our gas stream into PNG LNG. We, obviously, had some very good test results there, and an updated resource base will be announced as part of our early 2020 resource up -- resource report. We certainly -- that was a good result, and it was very well drilled, highest well drilled in Papua New Guinea at about 11,800 feet up in the old measure.

In PNG, and in terms of exploration, as was -- we have been, as I mentioned, acquiring substantial seismic primarily now over the Gulf and in the Elk-Antelope region. And it's pleasing to see that there are a number of significantly sized prospects that could have similar characteristics to Elk-Antelope that have been identified in the Elk-Antelope area through this seismic phase.

In Highlands and Gulf, we're obviously leveraging seismic across that and looking at the optimal molecule to commercialize into our medium- and long-term gas strategy. The exploration is very much discretional. And our commitment to exploration will clearly be very focused on how we can commercialize what molecule and when. And certainly, again, a game-changer in Papua New Guinea is the offshore deepwater blocks #3 on this slide, which have potential for substantial gas resources, albeit higher risk than in more proven areas in the Gulf and Highlands. But I stress, this is very much being driven now by a road to commercialization of when we spend dollars and how with substantial opportunity to wind up or back our exploration spend, subject to where the commercialization focus is moving.

And with that, I'll pass it across to Keiran to talk about Alaska.

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Keiran John Wulff, Oil Search Limited - Executive GM & President of Alaska [5]

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Good morning, ladies and gentlemen. You'll have to excuse my cold, if I break into a coughing fit.

Look, we've had very significant progress in Alaska over the last 6 months and, really, since we've acquired the asset and taken over operatorship in March last year. We wanted to really understand the asset before we exercise the option with Armstrong. And we really want to focus on the resource base, just to take compliment -- confidence in exactly what the potential of the asset had. We wanted to get greater confidence on the farm -- on the cost and the development design. We wanted to understand the permitting and land access with the local communities, and we've been able to do that. Most importantly, we also wanted to develop an alignment with Repsol, who are very committed to this area. And we want to make sure that both Repsol and Oil Search had a common vision for this going forward.

What we've also been very successful about is building a world-class team in Alaska. And the attraction of the quality of the project in Alaska has been able -- to enable us to really get a super experience in both Alaskan and international experience team.

Now that combined confidence that we've developed over the last 12 months really gave us, excuse me, the impetus to exercise the option with Armstrong in June, and we did that. Whilst we did exercising the option and, as I mentioned before, a very important part of commercializing this development was to align with Repsol. And Repsol had -- have been, since 2010, spent over $1 billion. What the negotiations that we went through there was we set up a whole series of new joint operating agreements, alignment agreements, Oil Search remained operator, 51% equity holder across all of the leases. And as part of that transaction, Repsol transferred $64.4 million across to us or will be doing so. So it's been a very, very positive 6 months' exercise in the first half, and you're really dealing with a lot of those issues.

What it also allows us to do, before I move on, is start an independent sales process without the complications of what we dealt with when we first acquired the asset. We have a great -- a much greater understanding, and that process will start in the last quarter this year. The slide you're seeing is -- now is essentially where we're looking at the Pikka development. And we're moving towards a FEED decision on the Pikka development in December this year with an FID decision looking at the middle of 2020. The most important approval process for any development in Alaska is the record of decision, which is given by the core of engineers. And this is a 4-year process that was commenced by Repsol and Armstrong in 2015. It's a very, very comprehensive independent review, and it entails a lot of community engagement. And they also look at the environmental impacts of the project. When we took over, we actually slowed the process down. And we got, not in trouble, but we're asked why we did that. And what we wanted to do was to look at how we optimize the project, minimize the footprint, address the lot of the community concerns and also look at cooperation opportunities with adjacent operators. And whilst that was considered to be an interesting exercise at the beginning, it's now been proven to be a very, very worthwhile exercise. And our record of decision was received with the support of a local community.

What we've also looked at doing is updating the development design from the original acquisition case where we're talking about 120,000 barrels a day by 2023, we're now looking at an early production system, starting in 2022, at about 30,000 barrels a day tied into adjacent facilities. We're in negotiations with that operator, as I speak, and then that will be followed by a full field development and first production in 2024 from a new facility located, as you can see on the map. What this allows us to do is not only get early cash flow, but early learnings that we drive into the full project. Drilling in this development is a major part of the capital works, and what we're looking at doing is seeing how we can ensure that all of the wells are drilled optimally. And the lessons and learnings will be shared with the adjacent operator.

I'm conscious of time. This slide here, you can read at your leisure later. It really just go through the schedule and all of the activities that we're going through, but it really highlights that by the end of this year, we'll be going into a FEED decision. And that's leading up to the FEED decision is when we'll also release the upgrade and resources and our estimates on capital costs. You will just have to understand that we're in the process of organizing those in the middle of negotiations with the contracting parties.

In regard to my final slide, it really has been an incredibly active period since we've taken the operatorship in Alaska. And what it also has done is demonstrated to not only our stakeholders, but also to Oil Search our ability to take a challenging environment expertise and really positively make a difference in Alaska. We really are relevant, and we'll actually make a very positive contribution and seen to be very capable in Alaska. We've been -- as I said, we've been able to attract a world-class team. We've been able to land the joint venture to a common strategy that allows us to undertake an independent divestment. We've optimized the development design to look at 30,000 barrel a day facility in 2022 in full field development.

And we've also identified that with the data that we now have, which includes a reprocessing of the entire 3D seismic database, we don't need any further development drilling or appraisal drilling, rather, in the actual core development area. We have 10 wells that have penetrated the reservoir. We had 3D seismic. We have 5 tests that have all produced over 2,000 barrels a day. And when you compare that to most decisions, we have more than enough data to be confident that we have a very material and world-class development in the Pikka core area.

What we've also identified is a number of very, very high potential prospects in close proximity to the facilities. And the decision of the joint venture going forward for this current season is likely, and we'll make that decision in September. But it's likely that we'll have a 2-rig, 2-well operation drilling 2 exploration prospects that have early commercialization options that can materially increase reserves in their own right.

As I said, it's been incredibly busy time for Oil Search, and we're very, very lucky to have the strong support of the state. Our partner, Repsol and also federal governments and also building strong support from the community for our program. In addition to the drilling program this year is also our intention to start early works to allow us to commence drilling in 2021 which means that we'll be building gravel, laying gravel to the NDB drill site. So it's a very, very active season, very positive in regard to the potential, but also leading to early production. So I might leave it there and give it back to Peter.

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Peter Robert Botten, Oil Search Limited - MD & Executive Director [6]

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Thanks, Keiran. And I'll move on, we're talking about the organization redesign and very much building the basis of the company for the future. The organization redesign was initiated in the second half of '18. So it's actually been around almost a year now, and we completed the initial part of that redesign and enactment in June this year. It really does lay the foundation to drive production growth and deliver on major developments in both PNG and Alaska. We will be responsible for significant operated development larger than we have done in the past. And the redesign and the capability building has been very much focused on our ability to deliver world-class projects in a world-class way. And those projects will have the capability of more than doubling our production base by mid-2020.

Now in the past, Oil Search just had one business unit, which is effectively Papua New Guinea. Now we have 2, a significant development that we operate in Alaska as well as major developments, too, with the LNG projects moving forward and a further optimization of both our gas production and liquids production through the expansion of PNG LNG and the development of Papua LNG.

And the organization redesign really has established a more streamlined leadership team with very clear accountabilities. It's also delivered, as our Chairman said at our AGM, it's been focusing on, since the middle of last year, succession planning and career development for our organization as a whole, especially the leaders in our organization.

We've established 2 business units, one in Alaska and one in Papua New Guinea, and there's a new chief operating officer in each BU to increase the focus on safe and reliable operations. We've also created a Technology and Value Assurance Group to really strengthen the opportunity maturation and provide project execution capabilities, enabling further value creation through the adoption of new technology. A completely new department, which will focus on, as I say, delivery assurance and the application of technology across our business -- our businesses in PNG and Alaska. With that in mind, we've got 2 new executive vice presidents and to lead both the PNG BU and the Technology and Value Assurance Group. Dale is on the front desk and Bart Lismont is sitting in the audience, are both pretty new in the organization but already making a significant contribution.

As we all know, I think Oil Search is a leader in being able to work with governments and work with communities in delivering not just sustainable economic growth in the country but also in the social space. And since the new government has been formed, again, strong relationships are built and have been built with the new government. And a common alignment about what's important in fitting in with the Prime Minister Marape's vision of the future of diversifying the economy, building substantial downstream opportunities and employment opportunities for PNG nationals. And as I say, diversification of the economy using the resources sector as a platform to bridge through to a new economic development down the track in this country. Now we remain a significant contributor to the social development of the country through health programs, infrastructure programs, women's empowerment, gender-based violence, youth engagement, especially education and training. And that continues and will -- and is very actively well received by the new government and by the people in the communities, most importantly.

We also see -- and continue to support progress on the distribution of benefits across a range of our own projects, both in the oil fields and in the LNG fields. And the benefits distribution has improved, and payments are now taking place the majority of areas. And it's important over the next few months that, that continues and the understanding of what these projects do bring and the efficiency of how benefits do actually get distributed is something that we'll continue to focus on in the second half.

We obviously continue to do infrastructure projects. We've just recently committed -- completed a 58-megawatt power station in Port Moresby in partnership with Kumul Petroleum, and that will provide the cheapest electric power based on gas from PNG. And that's due to commence operations shortly. We're also working on a biomass project and solar, supported by a number of parties, including the Australian government and the Pacific infrastructure fund, potentially. And of course, in Alaska, we're applying the same sort of approach to communities in Alaska as we have in Papua New Guinea with a very direct straightforward communication and one-off partnerships to help address some of the challenges that these communities face, and some of them are quite common with those we see in Papua New Guinea around (inaudible). We're also planning to release an addendum to our Climate Change Resilient report under TCFD guidelines early next year.

In summary, then, for the first half, production outlook is underscored -- strong production outlook is underscored by great PNG LNG performance and continued excellent operations led by ExxonMobil. And we're also, as I say, optimizing our oil business and improving our production in the second half from our oil business as we work through the final issues of earthquake and optimize our production through drilling a few more holes and doing some workovers. Approximately 90% of PNG LNG's production volumes are now contracted, which limits our exposure to the spot LNG market. We're very much ready to enter FEED on LNG expansion once gas agreements of Papua LNG and P'nyang are confirmed and finalized. We're ready to go when these documents are confirmed.

We did see positive results out of Muruk 2 and very much targeting a focused exploration program, which is, I suppose, complementary to our commercialization options for gas. But there's plenty of opportunity to find more gas, and encouraging results from the Elk-Antelope seismic really does give upside to what's going on in the Papua LNG area. We're targeting FEED for entry for the Pikka unit development by the end of 2019, and with that will come some material resource additions expected and to be announced early next year. We'll also be planning for a partial sell-down of our equity in Alaska in the first half of 2020, ahead of an FID. Hopefully, we could incorporate successful drilling results from the year-end campaign on the North Slope.

The organization redesign is very much now focused on delivering projects of major capital projects efficiently, effectively and safely throughout the organization. And that has been underscored by the quality of the people we've been able to attract to the organization. As Stephen said, we have sound liquidity underpinned by good cash flow generation from operations. And we have an ability to grow, and we're ready to do it.

So thank you very much. Thanks for your attention. We'll throw it open to questions. There's a very keen member in the front row. That's -- we will throw it open to you, the thing is yours. Okay.

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Questions and Answers

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James Byrne, Citigroup Inc, Research Division - Research Analyst [1]

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James Byrne from Citigroup. So with the PNG government wanting to attempt to renegotiate fiscal terms, you've been in Singapore recently to participate in those meetings. Is it too early yet for you to shed some light on the specifics of what they want to renegotiate?

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Peter Robert Botten, Oil Search Limited - MD & Executive Director [2]

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Look, to be honest, I'm not going to shed any light on that. All I can say is that there's constructive discussions going on between government and Total as operator of Papua. And those discussions are ongoing, and I'm not going to compromise any of those discussions by opening up those issues in a public sense. There are ongoing discussions. And I think everybody knows where everybody is.

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James Byrne, Citigroup Inc, Research Division - Research Analyst [3]

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Okay. That's fine. But then let me ask this, I guess. So the ABC is saying that the Papua LNG JV doesn't want to budge. I've heard anecdotes that Patrick Pouyanné is a kind of guy that doesn't want to go back to the table once he struck a deal he think is equitable. Last week, we saw the PNG government was publicly very keen on trying to extract more economic rents. How should shareholders think about the risk that there's a sale mate because -- does the PNG government actually want to leave Singapore and lose face without actually doing what they say that they were going to do?

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Peter Robert Botten, Oil Search Limited - MD & Executive Director [4]

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Look, I -- again, I can't comment on that because I don't think it's constructive to get a positive outcome for shareholders on where negotiations presently sit. I think you saw 2 weeks ago, the Minister said something that they would back the agreement and make no economic changes to the agreement. In more recent times, he said something else. Again, I think that's a discussion point between the joint venture and government. I mean, clearly, we believe the agreement is a significant step-up on PNG LNG, and quite rightly so. And those discussions are ongoing, and I'm sure they'll reach a conclusion.

As I say, I think the important thing that the joint venture is saying right now is that we have bid some competitive bids to do FEED work on the table now. The validity of those bids will run out some time through September. And although we might be able to move them a little bit, we can't move them very far. But we really do want closure on this, and I think government does too. So I think constructive dialogue is underway. And probably have to leave it at that.

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James Byrne, Citigroup Inc, Research Division - Research Analyst [5]

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Yes. So the second thing that I wanted to ask about is the Osaka Gas arbitration that's in the media at the moment. Is that really around seeking an outcome on price? Or is there something more to it? Appreciate that this is commercially -- it's even diplomatically sane to talk to. But nonetheless, if you could help us on the public side, understand what's going on. I think that's going to be helpful.

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Peter Robert Botten, Oil Search Limited - MD & Executive Director [6]

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Indeed, and I'll pass it over to Ian to provide some color to that discussion.

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Ian Munro, Oil Search Limited - Executive General Manager of Gas, Marketing & Exploration [7]

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Thanks, Peter. Yes, James. I mean, I think you'll be aware that there are price review provisions in most long-term contracts, and the PNG foundation contracts are no exception. I think what I've said previously for this is the SPAs themselves are very bespoke and negotiated over a long period of time to cover a significant duration. Because of those bespoke terms, you can't really generalize. I mean, what I can say is that the current market has no impact on the discussions. The SPAs themselves drive the 2 parties to discuss what are comparable contracts in terms of duration lens into comparable markets. So that's the nub of it. We get a lot of theatrics, and we see a lot of commentators talking about market. But frankly, market is irrelevant. So that's the first point I'd make.

Secondly, most price review clauses in SPAs have the ability to try the party, buy or sell after flicking it to arbitration if they're not comfortable with where things are progressing. Arbitration is a lengthy process. If a party was to initiate that, he would kick the -- certainly kick the can down the road by several years. Again, all contracts are different and arbitrator may or may not be at a room on price, and any adjustment or subsequent negotiations may or may not be retroactive. So well, I can't talk specifically about that any of our due contracts. It's very much bespoke, and it will certainly play out over the next few years.

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Peter Robert Botten, Oil Search Limited - MD & Executive Director [8]

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Any more questions in the room?

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Daniel Butcher, CLSA Limited, Research Division - Research Analyst [9]

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Daniel Butcher at CLSA. I know you just want to sort of avoid a couple of questions about the details of your particular contracts, but maybe you could just elaborate on volume variance around the sort of foundation, 6.6 million tonnes in sort of an area of low spot prices like we are in this year, maybe next year? Could you sort of tell us how much build can flex down and whether there's a sort of make-up cost for the following years?

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Peter Robert Botten, Oil Search Limited - MD & Executive Director [10]

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Ian?

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Ian Munro, Oil Search Limited - Executive General Manager of Gas, Marketing & Exploration [11]

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Yes. So we have 6.6 million tonnes, obviously, contracted through 20 years with 4 foundation buyers. Again, without being specific, some of those contracts have downward quantity tolerance, nothing unusual and within the sort of specific norms. One contract has none. One has a little bit more. So buyers have the ability to flex downwards in those, which is entirely typical and we manage -- or operator manages any additional cargoes when they become available in summer or winter, and they would go on to spot. We haven't seen a tremendous downward flexing by any of the foundation buyers primarily because of the quality of the product, because it's at high heating value in a time where projects that traditionally have been heating. High-heating value suppliers into Asia are coming off plateau. We're seeing good take-up of our foundation contracts. The midterms have little, if any, flexibility over their 4-year duration.

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Daniel Butcher, CLSA Limited, Research Division - Research Analyst [12]

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Maybe I'll follow-up if I can. So it's actually a procure of Alaska timing. I know as you've previously had FEED as a 12-month process from mid-'19 to mid-'20 and now you're only allowing through, it looks like 6 or 7 months. Is that realistic to cut FEED back to almost half of its previous length with -- to your FID? And does this not also that Conocos is allowing sort of 4 or 5 years, Willow construction, you're allowing now 4, previously 3 for Pikka? Is that really scores over scoop the times are stretching out? And what will be the key risk factors around that in terms of the seasonality and building roads and so forth?

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Keiran John Wulff, Oil Search Limited - Executive GM & President of Alaska [13]

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That's a good question, Dan. The 6 or 7 months FEED process, we're already undertaking work that would be normally called FEED. Already, we're calling a pre-FEED, but there's a lot of work going on with our contractor WorleyParsons in Monrovia, in terms of the design as we speak. So it's not a formal start. It's probably the beginning of a more commitment to, I suppose, no regrets cost and you're leading to an FID decision in the middle of 2020. So whilst it is a 7-month FEED process, we really are in doing FEED work now as we speak.

In regard to the potential for delay, there is -- it's very seasonal, as you're aware of -- in Alaska, you have a very short operating season when you're operating a price and that's fundamentally why we want to lay down gravel commencing this year to commence our 2021 drilling program to support the early production in 2022. Daily production is really a simple tie into existing facilities nearby. It's not a significant sealift. There's no material retailing equipment required. So we don't believe that there's a significant risk if we actually are able to lay gravel down later this year. So again, it's sort of like a no regrets early commitment to some of the early works.

In regard to the full field development, we're very confident that we can meet the 2024 period. In regard to 2023, it would have been a stretch. We would have had to have a lot of things work going our way to -- in regard to the sealifts, and the probability of doing that was probably less than 50% of where we sit right now. We're sort of confident that we can meet our 2024 period. And given the fact that Conoco are moving to a full field development on Willow in 2025 or thereabout, we want to really be a year ahead of them. So we're not competing for yards and contractors. So we're confident that we can meet the 2024 period.

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Daniel Butcher, CLSA Limited, Research Division - Research Analyst [14]

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Sure. Maybe just one follow-up, if I can. Why 2 exploration wells and no horizontal appraisal well? Are you datasharing with Conoco? Are you just in line with information sharing with them for some of the plan in place to sort of improve the horizontal?

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Keiran John Wulff, Oil Search Limited - Executive GM & President of Alaska [15]

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Now that's a good question. Again, I can't talk about what the arrangement is with Conoco. It's confidential. So the -- we're just confident that we have enough data to be able to move forward in the core development area. You'd be aware that Pikka B was really an outstanding result from one frac. There's -- as I said, there are 10 wells, 5 wells with over 2,000 barrels a day. One of the important considerations in these appraisal wells is that we're saying that it's best to drill these development wells of gravel so you can actually clean them up with coal tubing and get the production going. So once you're able to do that, a lot of the risk of drilling these things so far with a short period to essentially play with them or get them flowing is something that we don't need to do, and we don't -- and we are confident we can do it off gravel in 2021.

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Peter Robert Botten, Oil Search Limited - MD & Executive Director [16]

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Thanks. Any more questions in the room? We might then go to see if there's any across webcast.

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Operator [17]

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(Operator Instructions) Your first phone question comes from James Redfern with Merrill Lynch.

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James Redfern, BofA Merrill Lynch, Research Division - VP [18]

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Just interested in terms of the various FEED tenders that were submitted, and they kind of expire in September. Just what is the risk of price increases if these tenants need to be resubmitted in the event that the Papua and P'nyang gas agreements aren't finalized in time? And I've got one more after that.

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Peter Robert Botten, Oil Search Limited - MD & Executive Director [19]

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Thanks. Look -- I mean, clearly, the market is tightening as more projects get sanctioned, and we're very -- obviously very keen to take up the competitive offers that have been presented to us. We started that exercise back in early June -- late May, early June, and I think it's quite likely that there'll be some further pressures on pricing if we do not move forward in a timely way. So I think all project participants, including government, recognize that as an issue and are working extremely hard to get certainty as quickly as we possibly can so that we can move forward and take advantage of what we think to be competitive and compelling bids.

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James Redfern, BofA Merrill Lynch, Research Division - VP [20]

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Okay. Just one more. Just -- if we assume that the discussion between Total and the PNG engagement made to successful, and P'nyang -- so Papua gas agreement is finalized next week or 2. How much longer after that would the P'nyang gas agreements be finalized? And would the terms be almost identical to the Papua gas agreement?

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Peter Robert Botten, Oil Search Limited - MD & Executive Director [21]

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Look, I've been in Papua New Guinea for 26 years and sort of predicting timing on Papua New Guinea stuff is quite challenging. And clearly, our first step is to actually get across the line with respect to confirming where we're going on Papua LNG. Actually, I think we're quite well developed in our thinking to address government sensitivities on Papua and -- sorry, P'nyang. And look, I can't predict exactly how long it might take to work through the government system. It has to be done properly. It has to be done comprehensively with bringing people along and not be seeing to be hurried.

But the discussions today have been very constructive on P'nyang. And -- but we one step at a time Papua LNG first before P'nyang, but I'd actually think once we get past the Papua LNG issue, and I'm confident we will in some for another. I think we're very much focused with ourselves and government on getting P'nyang across. And I think the thinking of that is very well advanced and inevitably, we'll have facets of what was agreed in Papua will be reflected in P'nyang. So the actual fabric of the discussion is already pretty well laid down.

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Operator [22]

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Your next question comes from Saul Kavonic with Crédit Suisse.

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Saul Kavonic, Crédit Suisse AG, Research Division - Research Analyst [23]

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A few quick questions for me. You mentioned that the access agreements between Papua and the PNG infrastructure are essentially completed. Are you able to give us a bit of color on what it essentially means? In particular, do you see no risk of those agreements is actually being opened up for negotiation again depending on P'nyang terms given the entrants into P'nyang can be a part and parcel of the access agreements which could package good companies like Santos?

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Ian Munro, Oil Search Limited - Executive General Manager of Gas, Marketing & Exploration [24]

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Yes. So Ian here. Thanks for the question. The -- you may recall the access agreement to get into the PNG LNG infrastructure and share the several billion dollars of cost and OpEx savings. It was pretty much completed 6 or so months ago. And that included everything you would expect in a time and processing agreement, including actual costs to be paid and when they will be paid to recognize the differences in ownership, to ensure that there wouldn't be a risk of reopening. The P'nyang joint venture agreed to allow Santos to farm in to the P'nyang field, such that those interests are pretty well balanced.

So look, we don't see any likelihood of that agreement being reopened. It was done and dusted sort of months ago. And there's been nothing that we've seen externally that really, I think, could flow on to this. And the fact that Santos will have a share and a balance and equally incentivized to see Train 3 move forward, that should see things move very smoothly.

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Saul Kavonic, Crédit Suisse AG, Research Division - Research Analyst [25]

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So just to be clear, if you were to see harsher fiscal terms in P'nyang, you don't see that therefore Santos getting something less than they originally thought, and therefore, would want to reopen things up again?

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Ian Munro, Oil Search Limited - Executive General Manager of Gas, Marketing & Exploration [26]

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Look, I think when parties do these deals, they look at a wide range of parameters: oil pricing, costs, timing and fiscal. We're all adults and as we go in, we'll look at a wide range of potential outcomes. So I would imagine that, that would not be an issue.

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Saul Kavonic, Crédit Suisse AG, Research Division - Research Analyst [27]

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All right. Can I also ask a question on the PRL 15 Elk-Antelope licenses? Can you confirm when those licenses come up for renewal or expiry? And if the PNG government has the ability to take back the licenses at that point if Papua has not proceeded FID yet?

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Peter Robert Botten, Oil Search Limited - MD & Executive Director [28]

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Beth, you haven't said anything yet. So I'm going to pass it over to you.

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Elizabeth White;EVP, Development, [29]

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Look, the Papua LNG joint venture has done a lot of work on these licenses and it has been completing that work in accordance with the license conditions. We still have tenure and the license continues for quite some time, and there would be the ability to extend beyond that. But of course, we're looking to move this into -- move these projects forward and acquire a PDL over that license.

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Peter Robert Botten, Oil Search Limited - MD & Executive Director [30]

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To be specific, I think the licenses go out to the second half of 2021. So there's substantial flex for mining, and they can be renewed. But again, it's a question of moving forward far faster than that, I think.

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Saul Kavonic, Crédit Suisse AG, Research Division - Research Analyst [31]

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And lastly, I want to ask about, in the report, talk of the Papua Gas Agreement being fair all things considered. Why is that your view given that the FEED provide a relatively low government take compared to international LNG mark -- benchmarks despite being a relatively high-return LNG project?

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Peter Robert Botten, Oil Search Limited - MD & Executive Director [32]

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Look, I think you'll find over the next couple of months that they'll be very much a transparency from the projects about what benefits are actually received. There are many analysts out there and academics that actually don't count the full benefit of benefits that are actually provided by the project. And specifically, they don't count equity that comes to the government from the project. And I know there are a number of analyses out there recently done by and used that don't count that. And I think there are also some -- others in the market that don't actually count the full value. So I think with that in mind, I think it's important that the project gets out on the front foot and actually can enunciate where the value is and where the benefits go. And I might also say, highlight where -- what benefits have come out of PNG LNG and where they've gone.

So I think it's quite legitimate that people will ask and should ask, "Is this a balanced and fair agreement?" I think state take has been significantly improved for Papua over PNG LNG and is significantly above 50%. It's a balance. And you -- again, most important thing to do is to get some transparency around the regime, gets some transparency around where the benefits are and where they've gone and tell the people and let them decide. I don't think it's particularly fully informed market as it seems right now about that specific issue, but it is an important part. And I know that project participants are very well aware of that, and we'll be very active in communicating that out to the people primarily in Papua New Guinea over the next few months.

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Operator [33]

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Your next question comes from Jon Scholtz with Macquarie.

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Jon Scholtz, Macquarie Research - Analyst [34]

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Just a quick one on the timing of the insurance receipts. Could you just -- I mean, is the recovery expected in the second half? And the actual recovery, do you expect full 100% or will it be the full $17 million that you expect to be recovered from there?

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Stephen W. Gardiner, Oil Search Limited - CFO [35]

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Thanks, Jon. Look, as part of the insurance recoveries, we've got certain assets that were insured and certain assets that were self-insured. Those assets are typically sort of the smaller value assets, but because of the effect of the earthquake of very large area, they've actually got accumulated to quite a large cost. The things like some of our camp facilities, roads, some of the gathering lines, et cetera. And so we're spending money on doing a lot of repair work on that and having to fund that ourselves. We're also required under the accounting standards to take a very conservative view about applying insurance proceeds. So we have to have absolute certainty of recovery. We're still in discussions with our insurers at the moment.

As I think you might be aware, these -- the process of actually finalizing an insurance claim for something of this magnitude and complexity takes many, many months, and we're still working through that process. So we have adopted a very conservative process of booking proceeds. We still hold a large amount of proceeds in our balance sheet that are yet to be released. Finally, the larger exposure we have on our own assets are 2 key assets, which is our refinery that was badly damaged and a bridge across Hegigio Gorge. We haven't commenced work on those yet, and we expect a very large insurance payout for those when those works are commenced.

The second part of the question, in the second half of the year, we see a much lower spend on the earthquake related work anyway. And we do see some recoveries booked against that. So for the second half, we'll certainly see a much lower impact on earthquake on our operating cost structure.

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Operator [36]

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Your next question comes from Ben Wilson with Royal Bank Canada.

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Benjamin Wilson, RBC Capital Markets, LLC, Research Division - Analyst [37]

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Another quick question just for Stephen. Stephen, can I just confirm or assume that the big step change in your current payables is associated with that net strong option exercise?

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Stephen W. Gardiner, Oil Search Limited - CFO [38]

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That's correct. So we booked the acquisition of the assets at the half year, but obviously, we're making the payment as due at the end of August to Armstrong. And so we're carrying that in the balance sheet.

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Benjamin Wilson, RBC Capital Markets, LLC, Research Division - Analyst [39]

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Yes. And a likewise question. The lease liability is split -- a recognition of your lease liabilities are split or contained within your borrowings across current and noncurrent borrowings as we see it in your balance sheet, is that right?

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Stephen W. Gardiner, Oil Search Limited - CFO [40]

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It's correct. So we have provided an appendix to the release that we put out that shows the impact of the introduction of IFRS 16, the new lease standard. It's increased our borrowings by about USD 280 million through the capitalization process and our assets by about $240 million. But when we report our net debt, we've been consistent with other participants in the industry and focusing on our true borrowing debt that's due for repayment and focusing on that.

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Operator [41]

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There are no further phone questions. I'll now hand back to the room.

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Peter Robert Botten, Oil Search Limited - MD & Executive Director [42]

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Thanks very much. And thanks very much, anybody -- everybody, for coming along. And I'm sure, over the next few days, further questions will be asked and pass through the various ways of asking us things. I know we've got a series of meetings and other interactions with investors over the coming few days, and we'll look forward to also progressing to great clarity about where we're at with Papua in the relative short term. Thanks very much for attending.