John Brookes Outage Limits Fourth-Quarter Production for No-Moat Santos

Business Strategy & Outlook:

Santos is the second-largest Australian pure oil and gas exploration and production company (behind Woodside Petroleum, ASX:WPL), with interests in all Australian hydrocarbon provinces, Indonesia, and Papua New Guinea. Well-timed East Australian coal seam gas purchases and subsequent partial selldowns bolstered the balance sheet and set the scene for liquid natural gas, or LNG, exports. Santos is now one of Australia’s largest coal seam gas producers and continues to prove additional reserves. It is the country’s largest domestic gas supplier. Coal seam gas purchases increased reserves, and partial sell-downs generated cash profits, putting Santos on solid ground to improve performance. Group proven and probable, or 2P, reserves doubled to 1,400 mmboe, primarily East Australian coal seam gas. Coal seam gas has grown to represent more than 40% of group 2P reserves, despite partial equity sell-downs. A degree of confidence can be drawn from project partners. U.S. energy supermajor ExxonMobil, the world’s largest publicly traded oil and gas company, is 42% owner and the operator of the PNG LNG project. The Gladstone LNG project was built and is operated by GLNG Operations, a joint venture of owners Santos (30%), Petronas (27.5%), Total (27.5%), and Kogas (15%). Petronas is Malaysia’s national oil and gas company and the world’s second-largest LNG exporter. French energy major Total is the world’s fifth-largest publicly traded oil and gas company, and Korea’s Kogas is the world’s largest buyer of LNG. Santos is in good company. Overall, a happier future for Santos is observed now that excess debt levels are addressed, aided via improved margins and earnings driven by Gladstone and PNG LNG. The company increasingly enjoys export pricing on its gas. In addition to Santos’ Gladstone LNG, several other third-party east-coast LNG projects conspire to drive domestic gas prices higher. As the largest domestic gas supplier, Santos can expect significant bang for its buck, with limited additional capital or operating cost required to capture enhanced prices. The group production profile is simplified with increased certainty in project life.

Risk and Uncertainty:

Material ESG exposures create additional risk for E&P investors. In this industry, the most significant exposures are greenhouse gas emissions (both from extraction operations and downstream consumption), and other emissions, effluents, and waste (primarily oil spills). In addition to the reputational threat, these issues could force climate-conscious consumers away from fossil fuels in greater numbers, resulting in long-term demand erosion. Climate concerns could also trigger regulatory interventions, such as fracking bans, drilling permit suspensions, and perhaps even direct taxes on carbon emissions, already in place in some jurisdictions. These ESG risks are based largely on industry risks that are already incorporated into base-case analysis. And natural gas is the predominant value driver for Australian E&Ps like Santos. Natural gas is less carbon-intensive than coal or oil, and stands to benefit from efforts to minimize emissions, at least in the medium term. This is because renewables like wind and solar, while growing rapidly, can’t hope to entirely meet global energy requirements for decades, if ever. Santos’ balance sheet is sound. Moderate leverage (ND/E) of 21% and maintenance of strong net operating cash flow is reassuring. Santos’ debt covenants have adequate headroom and are not under threat even at low oil prices. The weighted average term to maturity is around 5.5 years, with less than 23% due by 2023. Net debt/EBITDA at end June 2022 was 0.6. It is not expected the metric to deteriorate much, even including planned development project expenditure. On the investment side, Santos’ performance is rated as fair. The company let itself down on the capital-allocation side due to cost overruns associated with building the USD 18.5 billion Gladstone LNG project. Returns consequently worsened to low-single digits over the past eight years, well below its cost of capital. Some of this is due to Gladstone being built with expansion in mind, and any future growth will be somewhat more capital-efficient than for the current two LNG trains. Santos could probably expand to three trains, subject to securing natural gas feed and LNG offtake, with cost savings coming on the capital side from better utilization of existing tankage, wharfage, and surrounding infrastructure

Bulls Say:

Santos is a beneficiary of continued global economic growth and increased demand for energy. Aside from coal, gas has been the fastest-growing primary energy segment globally. The traded gas segment is still expanding faster.
Santos is in a strong position, with 1.7 billion barrels of oil equivalent proven and probable reserves, predominantly gas, conveniently located on the doorstep of key Asian markets.
Gas has about half the carbon intensity of coal, and stands to gain market share in the generation segment and elsewhere as carbon taxes are rolled out. Bears Say Mark Taylor, Senior Equity Analyst, 19 Jan 2023
Santos committed to substantial LNG capital expenditures, which will see the balance sheet geared in the medium term.
Much of the company’s perceived value is in coal seam gas to LNG projects that are yet to reach full capacity.
Landholder opposition to coal seam gas development could hinder production growth.

Company Description:

Santos was founded in 1954. The company’s name is an acronym for South Australia Northern Territory Oil Search. The first Cooper Basin gas discovery came in 1963, with initial supplies in 1969. Santos became a major enterprise, though over-reliance on the Cooper Basin, along with the Moomba field’s inexorable decline, saw it struggle to maintain relevance in the first decade of the 21st century. However, the stage was set for a renaissance via conversion of coal seam gas into LNG in Queensland and conventional gas to LNG in PNG

(Source: Morningstar)

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