The bars and lobby lounges of the Grand Papua Hotel are swarming with bankers.

Most are in their bespoke suits, one or two are in shorts and thongs to cope with the pressure and the heat.

They all sense that a billion-dollar deal window is closing.

"He was harassing me like nobody's business," says one senior PNG source, describing how an Australian banker from UBS had been tailing him and aggressively hurling instructions.

"In the end I couldn't stand it, I told him to 'F---- off, you are not my legal adviser'."

This was the atmosphere in which Swiss bank UBS struck a massively controversial deal to land the PNG government with a 10 per cent stake in ASX and PNG-listed company Oil Search. Those shares are seen now as an effective blocking stake to Woodside's ambitions to buy Oil Search, in one of the biggest deals currently in play.

The shares cost $1.2 billion, a staggering 8 per cent of the former Australian protectorate's GDP. The deal has also cost the jobs of the government's treasurer, petroleum minister and attorney-general, while sparking investigations by the Ombudsman and Public Prosecutor.

Despite the scandals, sackings and the official probes, the terms of the deal have remained confidential – until now.

Through a series of leaked documents and interviews Fairfax Media has reconstructed what UBS insiders describe as one of the "most amazing deals" the bank has ever done. Others, however, say the amazing part is that the bank was able to get away with it. They see a cash-strapped government getting stitched up.

How the deal was "bulldozed" through the board room

Source: NPCP board minute.

The shares are held by the government-owned National Petroleum Company of PNG. Its confidential board minutes, for a Sunday morning meeting on March 9 of last year, show that at the highest levels there was intense discomfort about the financial wisdom of the terms of the deal, a view confirmed in expert analysis.

The company's chairman Frank Kramer exclaims that the government has "bulldozed" the huge transaction on to his books, despite a lack of information and "irregularity in due process".

Two days earlier, a Friday, the Prime Minister's chief of staff had written to the company ordering it to "urgently consider and take all actions necessary" to make the deal happen.

Kramer "emphasised" that he did not believe the proposed transaction was "directed to the greatest advantage of the people of Papua New Guinea", as the board minutes record.

The rest of the shocked board unanimously agreed.

At the same board meeting of March 9, 2014 it emerged that UBS, through its lawyers at Ashurst, had actually drafted the resolutions that the board was meant to sign.

The revised minutes read: "UBS are only concerned about getting the NPCP Board's approval on the resolutions for the payment direction and therefore will [not] be the least concerned if the NPCP board wants to be frank enough to capture in the background/minutes its concerns about the inadequacies or otherwise of the premises on which it is going to approve the resolutions."

The Solicitor-General had only been asked to advise on the legality of the UBS fundraising plans on the previous Thursday, and noted numerous problems including the Constitutional requirement for parliamentary approval.

In the end, the board approved the deal on the basis that the NPCP would eventually own the shares outright once the UBS arrangement finished.

So what, exactly, about the deal had them so concerned?

UBS appointment questioned

For a start some observers questioned why UBS was even involved, saying it did not receive its mandate via an orderly appointment process.

The whole Oil Search investment process was originally designed to enable the PNG government to buy back a stake that it had sold to an Abu Dhabi sovereign wealth fund.

It was well-known among the PNG elite that the shrewd Prime Minister O'Neill, was desperate to hold a substantial stake in Oil Search, seeing it as the country's national champion.

Business leaders and officials who dined with him say it was a prominent topic of conversation throughout the second half of 2013, as the Abu Dhabi sovereign wealth fund was considering whether to convert its large PNG debt security into equity.

One of the early attempts to make this happen saw an intergovernmental committee, involving the Independent Public Business Corporation and the corporate advisory arm of the Bank of South Pacific, reject the "risky" and "expensive" UBS proposal, according to sources involved. They preferred low-risk and low-cost loan proposals, such as a joint proposal by ANZ and Barclays Bank.

But the PNG decision-making process was delayed, the Abu Dhabi fund opted to keep its Oil Search shares and, by February 2014, Prime Minister O'Neill was searching for another way. At this time, a separate investment banking "beauty parade" took prominence, managed by the Bank of Papua New Guinea.

The document appointing UBS as adviser

A senior advisor to the central bank, Jacob Weiss​, informed officials that he, not they, were advising Prime Minister O'Neill on the Oil Search investment, according to the officials.

Mr Weiss has a different recollection.

"I didn't play any role in it, I'm sorry," Mr Weiss told Fairfax, when reached by phone in Europe.

"I have nothing to say."

Others to assume prominence were Treasury Secretary Dairi​ Vele​ and his Australian consulting partners, Lars Mortensen and Nathan Chang.

Mr Chang defended his advisory role in the Oil Search investment process, but not the decision to appoint UBS.

"There was probably nothing wrong with the process that was followed," Mr Chang told Fairfax.

"Whether or not it was a good deal, that's the state's call. We're obviously still up there. To be honest we copped a lot of flak over it. It puts me in an awkward position so I'm just going to let it go."

On 27 February 2014 it was Oil Search managing director Peter Botten who first announced that "the PNG government has entered into funding arrangements with UBS" to purchase a $900 million share placement, subject to the "unlikely" obstacles of "final regulatory and financing approvals".

Peter Botten, managing director of Oil Search, which rejected a takeover bid from Woodside Petroleum. Photo: Peter Rae

The dual PNG and ASX-listed company told the market that it would use the money to buy the privately-owned Pac LNG group of companies, which owned a share in the coveted Elk/Antelope gas fields.

Detail with devils

There are several strands to the deal that saw UBS deliver the finance needed to fund the PNG government's purchase of Oil Search shares.

These strands will all play a part in whether Prime Minister O'Neill will agree to sell to Woodside, and the documents show his break-even price is far higher – and complex to calculate – than previously understood.

The first and most straightforward mechanism was a $330 million "bridge loan", to be repaid by NPCP. UBS charged a start fee of 2 per cent, an extension fee of 1.5 per cent and interest rates that ratcheted up from about 7 per cent to 12 per cent over the course of a year.

Those terms would have led the Swiss bank to charge the PNG government entity about $33 million over the nine months to December, when it was refinanced. That translates to an effective annual rate 13.3 per cent, or about five times the rate at which banks like UBS lend to each other in Australia.

The high fees and rates might have been explained by repayment risk, if not for the unusually extensive security arrangements.

Those arrangements allowed for the "irrevocable" diversion of funds into a special Singapore bank account, where they would be available as required to satisfy loan repayments.

Specifically, they required NPCP to sign a power of attorney empowering UBS to stand in its shoes and garnishee "all" of the PNG government's expected revenue from its 19.6 per cent share in the massive PNG LNG project.

The project, in which Oil Search holds a significant stake, is expected to deliver total lifespan returns in the vicinity of US$156 billion.

Leaked board minute

Collared by the deal

The shares are owned by the PNG government, through NPCP, but are also subject to put and call options in a $900 million collar agreement.

UBS declined to discuss any details of the complex agreement, citing a risk of economic loss if its market positions were known.

But a full copy of the collar agreement was obtained by Fairfax Media.

Fairfax Media approached a leading risk advisory firm, Noah's Rule, to examine the document. The Sydney firm agreed to speak on record in order to facilitate informed discussion of a matter of public interest in two countries.

Co-founder Sean Russo says collar arrangements enable clients to effectively borrow against the shares they are acquiring, while surrendering some upside potential and hedging some downside risks.

They do this through a series of "put" and "call" options which, in this case, give UBS the obligation to buy Oil Search shares for a guaranteed price when the price is low and also a right to buy if the price goes high.

Sean Russo has raised serious concerns over the deal. Photo: Louise Kennerley

What is "unusual" about this $900 million collar contract – something that deserves to be read closely – is that the PNG government has given UBS the right to buy one-fifth of the Oil Search shares at a 10 per cent discount to the $8.20 that the government paid for them. This right applies regardless of the Oil Search share price.

"PNG has effectively 'forward-sold' about a fifth of the Oil Search shares for a price below what it paid for them, immediately guaranteeing a loss in the order of $18 million," says Sean Russo.

"Because PNG will always make a loss on 20 per cent of shares that has the impact of dramatically increasing the price at which it needs to sell the balance of the shares to come out ahead."

Derivatives experts emphasise that, to be fair, the different put and call options should be assessed together.

Surge needed to break even

Another unusual feature of the UBS collar arrangement, however, is that the average of all the call option prices is not far above the total cost PNG will pay for the shares.

The way the options are all structured, the Oil Search share price would have to rise by as much as 23 per cent above the purchase price of $8.20 a share before PNG begins to make any profit.

"After taking into account interest costs, and the inherent cost of the collar structure, it appears to us that PNG would make a small profit if the Oil Search share price was above $10.10 during the collar's expiry period, between March and June next year," says Russo.

Even more unusual, he says, is the fact that this elevated window of profitability quickly slams shut again.

"Paradoxically, due to other quirks in the structure, the PNG government would begin to lose money on the collar again if the share price rose above $13," he says.

In crude terms, at inception the value of the collar contract might have been worth perhaps $50 million on the books of UBS, depending on assumptions of volatility.

In reality, UBS would have quickly offloaded much of that potential upside onto the market place as it worked to manage its risk.

Did UBS gouge profits from its client? The bank doesn't think so, but declines to engage in the detail. What some of the bankers will admit, when pressed, is that it was a brilliantly creative deal.

An amazing deal?

For UBS the deal brought together not just PNG's ambitions but also those of Oil Search. Oil Search managing director Peter Botten was very keen to buy into Inter Oil's Elk-Antelope project, considered to have the best undeveloped gas reserves in PNG.

He was prepared to pay much more upfront than France's Total had paid because of his greater confidence in underlying gas reserves. And if he played his cards right, he could out-muscle the French oil giant Total, bring in ExxonMobil, and give their hugely efficient PNG LNG project new possibilities of scale.

"Given the fact we've acquired a significant stake in what could be a world class LNG development, one in the highest quartile of returns in a low price gas market, we're very comfortable with our position," says Botten, noting favourable drilling results.

And online scuttlebutt about what the target company may have done with the funds? "As far as I'm concerned it's rubbish, if you believe the blogs you'll believe anything," he says, noting his company's commitment to world class governance.

O'Neill wanted into Oil Search, Oil Search wanted into Elk & Antelope, but neither of the two close friends had cash. Other banks, including Citi, were offering bridge loan and collar arrangements to raise the cash for the state of PNG. And of course they were willing to help Oil Search raise capital by issuing new shares.

But nobody had worked out how to connect those two objectives – issuing Oil Search shares to PNG at the usual placement discount – without disadvantaging ordinary Oil Search shareholders. By February last year, every serious banker in Australia had been crawling over this billion dollar prize, but none of them could make it work.

The star-studded UBS banking team refuse to discuss the detail of the deal or how they got the PNG government to agree to it. It must be frustrating, however, that the public has no opportunity to comprehend the magnitude of what they achieved.

The collar arrangement had necessarily left UBS needing to sell Oil Search shares to hedge its exposure. Normally, it would sell into the general market. The genius of the UBS solution, however, was that they worked out how to offer those those shares directly to Oil Search shareholders at the same price as the placement to the PNG government, so that no-one was disadvantaged.

Best deal ever done

A team of 20 or perhaps 30 of the best minds at UBS worked around the clock for a frantic fortnight as they worked the numbers and lined up the people. While they'd been talking with Botten, he was not their client. The pay-off had to come from the government of PNG.

"We were the only one who joined the three objectives of facilitating the Oil Search financing, giving the government what it wanted, and allowing outside shareholders into this deal," says the banker.

"The reason that this is seen internally as one of the most amazing deals UBS has done – why internally it is celebrated – is that we found a way to allow Peter Botten to finance his Elk & Antelope investment. This has never been written. It was only we who dreamed this up. Twenty of our best minds…"

UBS is now prepared to acknowledge the elegance of its solution.

"We are very pleased to have been able to provide a tailored solution to the PNG government to enable them to not only maintain their significant investment in Oil Search, but also to provide them with downside protection," says a spokeswoman.

Full minutes of special board meeting March 2014

What was obviously an act of brilliance to the sharpest minds in Australia's top-ranked banking team, however, has received a more mixed reception among outside specialists who have reviewed the deal.

Australia's nearest neighbour, and former protectorate, has struggled to convert its abundant mineral wealth into basic infrastructure, health and education services.

While the PNG LNG project has pushed GDP to expand by a quarter in the past two years, welfare measures are going backwards. The Australian arm of UBS can credibly argue that nobody else could have structured that deal with that client on better terms. It can rightly point to the fact that the PNG government wanted a strategic stake in PNG's largest taxpayer.

But did it make sense from the perspective of the 7.7 million citizens of PNG?

Serious questions remain

Robert Wyld​, co-chair of the International Bar Association, says it is "extraordinary" that UBS would approve such a huge, complex and costly deal for this particular client, given the bank's recent history of investigations and fines by international regulatory agencies.

"There are serious questions about this transaction – what did it involve, how and where did the money flow and to who and what was the commercial drivers behind this deal for the PNG people," says the leading Sydney lawyer.

"Where is the commercial logic? You would think that anybody at the highest levels at UBS would have known they were dealing with an incredibly high-risk government with an incredibly high-risk prime minister."

And while Prime Minister O'Neill battles cascading corruption investigations, he also has a fiscal problem. The gas revenues are starting to flow but prices have fallen.

In some ways, the structure of the collar arrangement has rescued the PNG government from the full force of the unexpected fall in prices for oil, gas and Oil Search. A plain vanilla loan would have left them in worse shape.

"Given the recent weakness in the oil price, this protection has clearly been shown to be valuable for the PNG government," says the spokeswoman for UBS.

The price of oil has halved taking gas with it.

Measured in local terms, however, it looks like the government would have notched up a half billion kina book value loss. And the benefit of hindsight does not change the calculus of whether the PNG government should have been buying the Oil Search shares at all.

Sean Russo, the principal at Noah's Rule, points out that once the contract reaches the expiry period of March-June next year, the government will still have to find a way of refinancing the shares.

He says: "If they refinance they will probably likely need to enter into a further collar structure and the costs associated with that will only increase their losses."

The only way is down.