UPDATE 2-Exxon starts engineering work on $11 bln PNG LNG plant

(Recasts, adds analyst's comment, updates share prices)

By Fayen Wong

PERTH, May 22 (Reuters) - ExxonMobil Corp (XOM.N), the world's biggest oil company, and its partners have agreed to begin initial engineering work on an $11 billion LNG project in Papua New Guinea, a key step in moving it towards final approval.

Major oil and gas producers are racing to complete the building of liquefied natural gas plants between 2011-2015, when supply is forecast to be at its tightest amid burgeoning global demand due to economic growth and environmental concerns.

Initial engineering work, also known as front end engineering and design (FEED), is expected to take about 16 months to complete. A final investment decision is expected in late 2009, with the first LNG deliveries expected in 2014, venture partner Oil Search (OSH.AX) said in a statement. Australia's Santos Ltd (STO.AX) is the other main partner in the venture.

Exxon last month forecast LNG, a cleaner alternative to oil and coal, would account for a third of Asia's energy needs by 2030.

"It may be only FEED phase and there's still final investment decision to be made, but the project has very robust economics so this is expected to be a tick in the box for them," said Andrew Williams, an oil and gas analyst at Credit Suisse.

"This project will also be important for Exxon in terms of its overall strategy in developing its LNG portfolio in Asia."

Analysts have said Exxon's project has a very good chance of being approved for development given its high rate of return.

Global oil and gas consultant Wood MacKenzie said last month the project has an estimated internal rate of return of 19 percent, compared with Chevron's (CVX.N) proposed Gorgon project of 12 percent and Woodside Petroleum Ltd's (WPL.AX) A$12 billion Pluto project at 11 percent.

The project's move into FEED phase will help Oil Search to commercialise its large gas resources in Papua New Guinea, and will increase Santos' exposure to the lucrative LNG market.

Shares in Oil Search, which gained as much as 6 percent, were up 2.7 percent at A$6.41 by 0341 GMT, while Santos' shares gained 4 percent to A$20.62, having earlier hit a record peak at A$20.87.

$11 BILLION PROJECT

The project, estimated to cost between $10-$11 billion, proposes to commercialise the Hides, Angore and Juha gas fields and the associated gas resources in the oil fields of Kutubu, Agogo, Gobe and Moran in the southern highlands and western provinces of Papua New Guinea.

The proposed two-train LNG plant will have a production capacity of 6.3 million tonnes a year.

Exxon's Papua New Guinea LNG project is likely to beat rival ventures in the Australian region to production given its economics and unity between partners, said Mark Greenwood, an analyst from JPMorgan Chase.

Australia has two operating LNG ventures, with another in construction and as many as 12 more proposed, including four planned coal seam gas-fueled LNG plants on the eastern seaboard.

Some analysts say Exxon's progress on the LNG project in Papua New Guinea was unlikely to have a negative impact on Chevron's Gorgon project off Western Australia, in which Exxon has a 25 percent stake.

"The projects are very independent and have their own feasibility metrics. Besides, a company like Exxon can certainly multi-task," Credit Suisse's Williams said.

The agreement for the project to move forward came after Exxon agreed fiscal terms on the project with the government, ExxonMobil said in an e-mailed statement.

Oil Search said the government agreement included a 30 percent tax rate and an additional profits tax, which will apply once a certain threshold level of return has been achieved.

The agreement also sets the terms for the Papua New Guinea government's equity participation in the project, which is capped at 22.5 percent.

Project operator ExxonMobil has a 41.5 percent interest. Oil Search has 34 percent, Santos has 17.7 percent. Energy retailer AGL Energy Ltd (AGK.AX), Nippon Oil Corp (5001.T) and PNG landowners own the rest.

AGL said on Thursday that, following the agreement, it now intended to sell its oil, gas and LNG project assets in PNG. It said it targeted to complete the sale by the end of 2008. (Reporting by Fayen Wong; Editing by Michael Urquhart and Lincoln Feast)