Oil's revival accelerates deal flows

Summary: Rising oil prices are giving impetus to industry participants, with takeover deals pointing to a sector rebound.

Key take-out: Investors can expect more activity to flow as supply and demand forces take shape.

Deals, developments and discoveries have revived the Australian oil and gas industry, with the primary driver being the promise of strong profits from a rising oil price.

Not since the oil-price crash of mid-2014 has the sector looked healthier. Last week's return to profit and dividends by Santos capped off what has been a remarkable, industry-wide, turnaround.

The flip from a loss of $506 million in the first half of 2017 to a profit of $104 million in the latest six months to June 30 gave Santos an immediate 8.5 per cent share price boost to a 12-month high of $7.03, before easing back to around $6.80.

At its latest price Santos is trading slightly below a controversial takeover bid of $US5.21 a share ($A6.94) launched earlier in the year by US-based Harbour Energy.

The profit and dividend were good news but what sparked most investor interest in Santos was its first significant expansion move in five years. This is the $US2.15 billion acquisition of Quadrant Energy, majority owner of the promising Dorado oil discovery off the West Australian coast.

The Quadrant deal had been expected because the private-equity owners of the business were keen to monetise an investment made three years earlier when oil prices were lower. Apache Corporation was focussing on its US interests and selling what it owned in Australia, with Quadrant emerging from Apache Australia.

The acquisition of Quadrant was a natural expansion move by Santos because the two companies share ownership of a number of assets. But it is also likely that Santos moved faster than it would have preferred because of the interest being shown by other potential buyers in the assets, including the acquisitive Beach Energy.

Though still digesting its own company-making deal, the $1.6 billion acquisition of Lattice Energy at this time last year, Beach has retired a large portion of its debt and has been preparing for more deals. Quadrant was high on its takeovers agenda.

The seeds of a turnaround

To see the progression of the industry out of its 2014 slump to a time of rapid growth, it's necessary to look back to 2016 when Santos was selling, not buying.

It was almost exactly two years ago, when the oil price was around $US45 a barrel, that Santos found itself under financial pressure thanks to its heavy investment in three liquefied natural gas (LNG) projects.

Financial pressure triggered the sale of a parcel of assets in South Australia and off the Victorian coast to the small Cooper Energy.

One of the assets acquired by Cooper was an old BHP gas discovery in Bass Strait called Sole. While neither BHP nor Santos could not see how to make money out of Sole, Cooper could. A new platform is close to first production, with sales of gas from mid next year perfectly timed to capture high gas prices in Melbourne and Sydney.

Cooper was an early mover in the mid-tier oil and gas revival, though not as early as media and industrial equipment billionaire Kerry Stokes. He has been instrumental in the rebirth of Beach through a series of deals capped by the Lattice acquisition.

Cooper, Lattice and Quadrant are classic oil and gas revival situations, with projects largely neglected during the oil-price slump to less than $US40/bbl being revitalised as the price climbs back towards $US80/bbl.

Measuring the recovery

Deal flow is one measure of the oil and gas recovery. The other two measures are development and discovery.

On the development front there are early signs of a return to large-scale LNG investment in WA where conventional gas is much easier to produce and more profitable than the coal-seam gas, which underpins the LNG projects in Queensland.

An added advantage of WA's offshore gas reserves is that they are not connected to the east coast pipeline system. Changing government rules could see gas owners forced to redirect material earmarked for export into a price-controlled domestic market.

It's the ability to capture energy hungry markets in Asia with low-polluting LNG that has encouraged Woodside Petroleum and its partners to dust off plans to develop the long-dormant Browse Basin gas fields off the Kimberley coast and the remote Scarborough gas field deep in the Indian Ocean.

The Woodside return to growth saw its shares hit a 12-month high last week of $37.82, up 35 per cent on the year's low of $27.94 – before easing this week to around $36.80.

Discovery news has been topped by the Dorado field, which is relatively close to the Pilbara coast and almost certain to be developed by Santos. It will emerge with an 80 per cent stake in the field after it completes the acquisition of Quadrant.

The small Carnarvon Petroleum holds the remaining 20 per cent in Dorado, which is regarded as one of the best Australian offshore oil discoveries and could encourage other explorers back to the region after several go-slow years.

But Dorado also makes Carnarvon a plum takeover target, either by Santos, which would probably like full ownership of the discovery and the surrounding tenements, or by another oil company looking for a foothold in the oil and gas-rich region.

For investors the oil sector revival has been a slow-moving event, but one which has been inevitable since the oil-price crash of four years ago for the simple reason that oil and gas needs constant reinvestment to replace depleting resources – and that has not been happening.

The pressures pushing oil

The net result is that while oil remains abundantly available, the squeeze on supplies is tightening thanks to reduced investment in exploration and political pressure on Middle East producers such as Iran where US sanctions are starting to bite.

Australia's oil and gas sector is being aided by the rising oil price, which slowly feeds into the price of gas, and by the rising value of the US dollar.

At the latest price for Brent-quality oil (the European marker) of $US76.21 a barrel, and an exchange rate of US73.35 cents, the Australian dollar oil price has moved up to $103.89/bbl, which is more than double the local price in mid-2014 when an oil price of $US40/bbl and an exchange rate of US88 cents saw oil in Australia priced at $A45/bbl.

In terms of the overall resources sector it is oil which has returned to a starring role, thanks to the promise of a sustained upward move in the price.