Queensland Government-owned retailer Energex surprised some market watchers by announcing that it had struck a conditional agreement to purchase 24PJ per annum of gas (rising to 60PJpa) starting from 2007. The gas will be used primarily by the proposed Comalco alumina refinery in Gladstone.

The Energex deal has thrown the PNG gas project a much-needed lifeline after other touted users of Highlands Gas chose to source their feed from other sources in recent months.

While the news has prompted Deutsche Bank to increase its NAV for Oil Search to 75c per share (previously 66cps) the company's analysts, John Hirjee and Andrew Woolley, are tempered in their assessment on what the deal ultimately means.

"For the project to move to FEED (front end engineering and design), it is still short a contract or two," they said. "While some momentum has returned we would not be carried away. We have been down this road before. Despite valuation increases, we still rate Oil Search a hold (at 87c)."

Comalco's alumina refinery is on schedule to start production at the end of next year using coal and coal seam methane gas inputs. The refinery's design allows for the coal-fired generation plant to be converted to gas

"We understand the initial supply from PNG will commence around 2007 with Phase 2 of the Comalco project expected to be commissioned in 2011," Deutsche Bank said. "We would expect the larger volumes of gas to be supplied around this point of time."

According to the broker, Highlands Gas needs a commitment of between another 10-61PJpa to move to FEED. It has existing customers in CS Energy (15PJpa), TXU 20-35PJpa and now Energex (24-60PJpa).

Deutsche Bank has not counted the estimated 25PJpa for McArthur River given the recent change in ownership and the question marks on the viability on the project.

Oil Search was trading at 84c in early trade today.