"The negotiations are preliminary and incomplete, and no agreement has been reached in relation to the proposal," AWE said in a statement today.

While the two companies expect to be able to make a formal announcement by the end of this month, there was no certainty that an agreement would be reached or that a formal offer or proposal will be put to Arc's shareholders, according to AWE

The statement confirms a report in Sydney Morning Herald that AWE was considering a friendly $500 million bid for Arc that could create a mid-tier company worth about $2 billion.

The proposed acquisition of Arc will increase AWE's stake in the Origin Energy-operated BassGas development by 12.5% to 42.5% while its stake in the Roc Oil-operated Cliff Head field in Western Australia will more than double to 57.5%.

Arc and AWE first discussed a merger a couple of years ago. Arc last year signed a friendly agreement to buy Anzon Energy, but the deal was scuttled after Nexus Energy stepped in with a better offer.