Origin hedging its gas bets an incentive for EIG

Origin Energy's APLNG’ Condabri Central gas processing facility.

The hedging of Origin Energy’s gas price appears to be a key factor when it comes to getting EIG over the line for a $15bn buyout proposal.

Origin told the market on Wednesday that after offering $9 per share late last year and now completing due diligence, Brookfield and EIG – through its MidOcean Energy entity – had come back with an $8.90-per-share offer.

The offer includes a component paid in US dollars, where investors will have to take on currency risk. But perhaps more interesting is that one of the conditions of the transaction is that Origin locks in oil price hedging contracts for the gas produced from its 27.5 per cent interest in Australia Pacific LNG in addition to what is normally the case.

Some consider taking on the oil price hedging as a big concession by Origin, as usually it is the buyer, not the seller who takes out the hedging contract in a mergers and acquisition transaction. Oil price hedging fees are expensive and whatever bank on the transaction is providing them, along with the interest rate hedging fees and the deal fees, is in for a windfall.

It’s a big cost that EIG will not have to stomach if it completes the buyout. If the oil price goes down, it will be a win for Origin, but if it goes up, Origin will lose. What this means is that the risk profile for Origin has now changed.

While Origin has not agreed to the price yet, it has given every indication that it will accept the offer, saying it has “potential to deliver significant value to shareholders, and accordingly, intends to continue to progress discussions with the consortium”.

It comes after plenty of speculation in the market in recent weeks that the deal could be off and that EIG was about to walk away.

EIG had certainly sounded out the market to source additional capital, according to various sources. But Origin hedging the gas of its APLNG asset is a big deal for EIG and important for gaining its support.

EIG Global Energy Partners is one of the few private-equity firms still investing billions of dollars in fossil fuel-related assets, as it bets on continued global demand for liquefied natural gas before the world can fully rely on renewable energy.

Yet banks would only provide the funding it would need to transact on a deal by having oil price hedging in place to limit the risk. It is why so few private equity deals happen in the energy space, with only a handful involving companies that have assets in the North Sea between Britain and Northern Europe.

When EIG bid $13.5bn for Santos in 2018, it wanted the target to take out a hedge on the price of its oil, but Santos refused to do so and so its banks were to carry out the hedging.

The deal never happened after Santos rejected EIG’s offer.

The risk profile was different with Santos, where EIG was borrowing a lot of money, and in what was a very different environment the chance at that time of an increase in the oil price was far higher.

The terms of the latest offer sees bidders receiving $8.90 per share for the first 100,000 shares – which looks after retail investors – and for shares above that threshold, they get $4.334 per share plus $US3.194 per share.