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Oil and gas explorer ConocoPhillips (COP - Analyst Report) announced its consent to build a second train at the $23.7 billion Australia Pacific LNG (APLNG) coal seam gas (CSG) to liquefied natural gas (LNG) project. The decision comes despite concerns over escalating costs and gas shortages in the country's coal seam gas sector.

The second train will have an annual capacity of 4.5 million tons and is expected to begin LNG exports in early 2016. It already has binding sales agreements with China Petroleum & Chemical Corp. (SNP - Analyst Report) or Sinopec and Kansai Electric Power Company.

The construction of the second train will take the total annual capacity of the project to 9 million tons, and Sinopec’s holding will increase to 25% from 15% in the APLNG. On the other hand, stakes of ConocoPhillips and partner Australia’s Origin Energy will reduce to 37.5% each from the earlier 42.5%.

The returns associated with the project are more competitive than the other LNG projects and will aid the company to deliver an annual production growth and an annual margin improvement of 3–5%. This will augment ConocoPhillips’ long-term output and cash flow.

The first train of the project received approval in July 2011. In November 2011, a binding agreement was signed with Kansai Electric for the sale and purchase of approximately 1 million tons per annum (MTPA) of LNG for 20 years starting 2016. The existing sales agreement was modified in January 2012, incorporating Sinopec to increase the LNG purchase to 7.6 MTPA.

The Australia Pacific LNG is running as per schedule. The sanction of the second LNG train comprises the further upgrade of the associated upstream gas gathering and processing infrastructure as well as the building of the second production train by Bechtel.

However, major areas of concern include operational disruption, labor and material cost inflation affecting project outlays, governmental regulations and severe competition from domestic and international peers.

ConocoPhillips holds a Zacks #3 Rank (short-term Hold rating). Longer term, we maintain an Underperform recommendation.

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