2nd UPDATE: Arrow Buys Entire Fisherman's Landing LNG Project

Arrow Energy Ltd. (AOE.AU) said Thursday it will take full control of the proposed A$2 billion-plus Fisherman's Landing liquefied natural project in Queensland state, potentially increasing its exposure to fast-growing Asian energy markets but placing further pressure on its balance sheet.

In a complex deal, Arrow will buy out smaller company Liquefied Natural Gas Ltd.'s (LNG.AU) interest in the project with a combination of cash, milestone payments, royalties and options over Arrow shares.

Arrow sold 30% of its coal seam gas acreage to Royal Dutch Shell PLC in 2008 but has been rapidly proving up its remaining reserves. Chief Executive Nick Davies reiterated recently that Arrow could have enough gas to help feed Shell's proposed LNG project in Queensland as well as the Fisherman's Landing project. "In my mind, the two have always been completely doable," he said in an interview earlier this month.

Arrow on Thursday provided a clear cost estimate of the full upstream, midstream and downstream components of a one-train Fisherman's Landing project of A$2.1 billion-A$2.2 billion. The first production unit is slated to produce 1.5 million metric tons of LNG a year.

The cost guidance seems quite optimistic compared to analysts' expectations, with Merrill Lynch recently estimating a two-train project could cost about A$5 billion to build.

A final investment decision for the upstream and midstream elements of the project is still expected by March 31., but a decision on the LNG processing plant may come later, pending an assessment of any "enhancement opportunities," Arrow said.

Arrow's investor relations manager, Andrew Barber, said such enhancement opportunities weren't about expanding the project's size.

"Down the track we'll obviously be looking at a second train, but these opportunities are more about finessing how the plant interacts with the pipeline and gas field development, now that we have an integrated project rather than a joint venture operation," he said.

The cost of the LNG Ltd. deal is difficult to work out because the terms of the transaction have many moving parts.

It involves Arrow reimbursing LNG Ltd. for costs incurred to date of A$45 million, and it paying a US$10 million licensing fee for using LNG Ltd.'s gas liquefaction technology at the first LNG train's completion, and US$10 million for each extra train.

Milestone payments comprise A$24 million when Arrow makes a final investment decision on the first train, another A$24 million when the project produces its first 1 million tons year of LNG, expected in late 2012, and A$63.5 million when it first produces 3 million tons.

LNG Ltd. will also get an option to acquire 12.5 million Arrow shares with an exercise price of A$3.50 and May 14 expiry date, giving it a potential 1.6% stake in the company.

The most complex part of the deal is the royalty payment plan.

LNG Ltd. said it will get royalties of about 0.9% on the first 1.7 million tons of LNG produced from the project each year, calculated on the difference between the oil price at the time of each LNG shipment and US$60/barrel.

For the next 1.8 million tons, it would get a 0.9% royalty based on the difference of the prevailing oil price and US$50/barrel.

LNG Ltd. Managing Director Maurice Brand said the company will have about A$85 million cash after the first payments from the transaction. With further milestone and royalty payments, he said the company will be well placed to actively market its gas liquefaction technology and pursue "other mid-scale LNG opportunities".

Brisbane-based Arrow confirmed Feb. 2 that it has hired advisers to examine funding arrangements for Fisherman's Landing, including sourcing more debt, issuing new shares, or selling down part of its interest in the project. Those arrangements haven't changed, Davies said Thursday.

Five separate ventures, including Arrow's and Shell's, are planning to build LNG projects at the Queensland port town of Gladstone, each to be fed with coal seam gas.

The unconventional fuel has never been turned into LNG for export before and Arrow is well placed to be the first, considering that it has a smaller project that's on a tighter timetable than its rivals.

Arrow's move to increase its holding of the Fisherman's Landing venture isn't entirely surprising. In January, it said it intended to take up to 100% of the project's first LNG train and 30%-49% of the plant's other infrastructure.

-By Ross Kelly, Dow Jones Newswires; 61-2-8235-2957; [e-mail]