Perpetual: Santos Is a Compelling Opportunity

by Vince Pezzullo – Deputy Head of Equities, Portfolio Manager

Santos is an oil and gas producer with assets in Australia and Papua New Guinea (PNG) and they have a development project in Alaska that was acquired as part of the merger with Oil Search Limited in late-2021. A key part of our investment thesis is the leverage that Santos has to domestic gas and export liquefied natural gas (LNG) markets as we believe these forms of energy are key to facilitating Australia and the world to transition to a lower carbon future.

The company has a strong balance sheet with a gearing ratio of 26% as at 31 March 2022 and is expected to deliver significant synergies, valued at US $90-$115 million from the Oil Search merger. Santos is also expected to significantly reduce its carbon footprint through the Moomba carbon capture and storage facility that is expected to be replicated at Bayu-Udan and Darwin LNG facility in the future.

A key driver of Santos’ share price is global energy markets and we have seen these tighten of late and oil and gas prices rallying. This follows the recovery from the COVID-19 demand shock that saw oil demand edge back towards the previous level of approximately 100 million barrels per day (mbpd). This was also combined with constrained investment in new capacity due to greater capital discipline from the industry, lack of new discoveries and ESG pressures. The disruption to supply from Russia’s invasion of Ukraine has tightened oil markets even further as countries and companies sanction Russian supply which makes up approximately 10% of global supply. Europe is also looking to diversify its sources of gas to decrease their heavy reliance on Russia. One of the ways it is looking to do this is through increasing LNG imports and Santos is a key global producer through its stake in the PNG LNG, Gladstone LNG, and Darwin LNG assets.

Another reason we view Santos as a compelling opportunity, is the asset sell-downs to improve the balance sheet even further and management minimising the risk of stretching the balance sheet through over-committing to projects in an inflationary environment when capital expenditure budgets are likely to come under pressure. Santos currently has a 42.5% stake in PNG LNG, which is higher than the operator of the project, ExxonMobil, who has 33%. It is expected that Santos will sell down its stake in PNG LNG to approximately 30%. Part of the rationale for the sell-down is to potentially bring in Total, another operator, into PNG LNG to align the interests of the parties in the Papua LNG project which is managed by Total and Santos who has a diluted interest of 17.7%. Santos is also looking to sell down its 80% stake in the Dorado, WA project around the time of the final investment decision for the project in late-2022. Another material asset sell-down decision is the Pikka project in Alaska. Santos currently has a 51% stake and they have previously targeted to reduce the equity interest to approximately 30% ahead of final investment decision in late-2022. Successful execution of all these sell-downs would see the company significantly exceed its target of US$2 – 3 billion in asset sales in 2022 , although we do expect the timeline to slip into 2023 given the complexities of negotiations with various stakeholders and counter parties. We would welcome these sales as it would significantly cut Santos’ capital expenditure, improve its cashflow and potentially lead to a re-rating of the stock.