Behind many puzzling numbers one encounters in life, there lies a story.  Several weeks ago in an article about Benjamin Graham’s Seven Tests on Finding Safer Shares, we found an unexpected PE Ratio in the shares of Australian energy company, Oil Search Limited.

The PE for the ASX energy sector is 21.5, yet the PE for OSH showed an astounding 63.34.  That kind of Price to Earnings Ratio is usually associated with growth shares, yet OSH is a dividend-paying share in an established industry.  Indeed, competitor Woodside Petroleum (WPL) has a PE of 23.57 and the PE for Santos Limited (STO) comes in at 31.4.

What is going on at OSH to support such a lofty Price to Earnings Ratio?  There are different ways to dig into that question, but for the benefit of the newcomer to share market investing we chose a place far too few retail investors visit with regularity – the financial statements in annual reports.  

The numbers in the three financial statements present a picture of a reasonably healthy company.  Two entries there pointed to a potential answer.  OSH added almost 300 million in Exploration and Evaluation assets between 2008 and 2009, and raised 850 million in cash from issuing new shares.  Their financial ratios told us they did not need the money to handle debt or operating costs, so one could only assume the company needed the additional revenue to grow and expand the business.

Some retail investors in a hurry limit their search of an annual report to the financial statements themselves, ignoring the company’s statement of its current and future performance.  But therein lays the tale.

On Page 1 of the Annual Report, nestled in a text box appearing in the corner of a picture of a city skyline are three introductory words – Liquefied Natural Gas (LNG)

Newcomers to investing with little knowledge of the energy sector might not even know what LNG is, but to some experienced investors, it is the future.

Most – but not all – of what you need to know about the future of OSH is right there in that text box.  It tells us a partnership of companies has created a project called PNG LNG (Papua New Guinea Liquefied Natural Gas).  It tells us they will be ready to market this newly produced LNG in 2014.  It tells us there is a growth market for LNG in the Asia Pacific region and Papua New Guinea will become one of only 19 countries in the world with the capability to both produce and export Liquefied Natural Gas.

What doesn’t it tell us?  Well, you can read on in the annual report to learn what the officers of OSH have to say about this story.  However, just as is the case with the financial numbers, management statements always to try to present things in the most positive picture possible.  

Instead of taking management’s point of view about the growth potential of the PNG LNG project without question, a simple Internet search will yield opinions and analyses from more objective observers.

You will find press releases and industry websites with background information on the scope of the project.  Here are some of the areas where you will want to gather information:

•    Viability of LNG as an alternative energy source
•    Production and delivery capability of the PNG LNG group
•    Partnership structure
•    Competition
•    Market Demand

First, you do not have to be a petrochemical engineer to understand the basics of LNG as a marketable product.  Natural gas exists in wells, just like water and oil, and it must be brought to the surface through drilling technology.  Then it is transported via pipelines to production facilities where it is converted into liquid form, stored, and finally shipped to the customer.  LNG is already in use throughout the world.  It burns much cleaner than coal.

Second, you will learn this project has been a long time in stgelopment and all the necessary pieces appear to be in place.  You can find maps locating the well sources, pipelines, and production and storage facilities.

Third, the principal operator of the project is a subsidiary of energy giant Exxon-Mobil, the third largest corporation in the world.  Exxon owns 33% of the project while OSH owns 29%.  The third largest participant is Santos Limited, which may explain their above average PE Ratio we discussed earlier.

Fourth, industry websites suggest the potential for strong competition in this growing market, especially from the Middle-Eastern country of Qatar.  However, the PNG LNG project has a geographical advantage in terms of transport and delivery.  What’s more, it can be difficult to estimate true market demand for a newer alternative energy source.  There may be enough eventual demand for multiple suppliers.

Fifth, even in the event global demand for LNG slows, the PNG project already has four LNG customers in the Asia-Pacific region:

1.    Chinese Petroleum Corporation,
2.     Osaka Gas Company Limited;
3.    The Tokyo Electric Power Company Inc.;
4.     Unipec Asia Company Limited, a subsidiary of China Petroleum and Chemical Corporation (Sinopec).

China is choking in its own carbon emissions and is expanding alternative energy usage of all types.  Japan’s recent earthquake/tsunami disaster stgastated significant portions of its energy supply.  Note the third customer listed – Tokyo Electric Power – is the owner/operator of the crippled nuclear plants that will never produce another watt of power.

On the surface, the growth story for the PNG LNG project and OSH looks promising.  However, even with the participation and backing of industry giants, the willing cooperation of local government, and customers eager for the product, there is always something that can go wrong with the story behind any “story” stock.  Share market investing is about weighing the potential rewards against the potential risk that the story will not have a happy-ending.  

If you think the rewards outweigh the risk, you are not alone.  Right now, there are 17 Certified Financial Analysts following OSH.  Eleven have the shares rated as a strong buy or buy; four have rated OSH as a hold; two as underperform; and none has a sell rating on OSH.