Squeezed Santos makes a sensible decision

Santos had no choice but to slash costs to ensure its near-term financial stability. Its priority will to be avoid a punitively dilutive equity before its LNG plants begin gushing cash.

Santos’ David Knox has, sensibly, responded to the sharemarket pressure exerted by a tumbling oil price and imploding share price, while Origin Energy’s Grant King has tried to pre-empt a similar onslaught. The immediate market response might not have been positive but a response to the escalating pressure from the markets was critical.

Santos has seen its share price more than halve in the past three months as the crude oil price has cracked. A credit rating downgrading hasn’t helped but the underlying cause of the sharemarket meltdown has been the combination of Santos’ debt and capital expenditure commitments.

Santos had to pull a planned $700 million-plus hybrid issue that might otherwise have provided a safety valve as it heads into the last leg of the $US18.5 billion Gladstone LNG plant its consortium is building.

Origin, which leads a consortium building another of the Gladstone LNG plants, has a more diverse portfolio of businesses than the upstream businesses Santos focuses on but has still since its share price slashed by about a third and was the obvious next target for short sellers and pessimists to attack.

As discussed earlier this week, Santos realistically had no option but to respond to the mounting pressure on its share price by carving into its spending. Only a week ago, in announcing that it had abandoned the planned hybrid raising, the group said it would review spending despite having access to $2bn of cash and finance facilities.

Today Knox announced that Santos would cut its planned capital expenditures from $2.7bn to $2bn -- about $1.5bn less than last financial year -- which effectively substitutes for the hybrid raising.

He reiterated that the group had no need to raise equity as the market has been speculating and short-sellers may have been hoping, but did say that it would consider asset sales provided fair value was realised.

The PNG LNG project, in which Santos has a 13.5 per cent interest, is producing at full capacity. The Gladstone GLNG plant is expected to be operational and generating cash from sometime in the second half of next year, which is the key milestone Santos needs to reach to ensure its financial stability. There are long-term contracts in place for that LNG.

Origin has responded to the fears that have mounted as the oil price has fallen by extending the maturity, reducing the interest rates margin and increasing the limit of its existing loan facilities. It has extended the terms of the facilities by 16 months to December 2018 and 2019, taken 30 basis points out of the margins and added $750m to the existing $6.7bn of funding.

It has also tried to reassure investors that the economics of its Gladstone project are robust, saying that its GLNG project will have free cash flow available for distribution to shareholders at oil prices above a cash break-even price of about $US40 to $US45 a barrel of oil equivalent once it is fully operational.

With the project scheduled to start up next year and Origin expecting to get about $900m-plus of distributable cash from it from 2017, the stretching out of the maturity of the facilities ought to remove any meaningful near-term financial pressures unless there is another major and protracted leap downwards in the oil price.

For both companies, even at current oil prices, once the projects are up and running their capital expenditures will tail off and their cash flows will surge. Origin’s $900m a year estimate of free and distributable cash flows is based on the current forward curve for oil prices.

With both projects so close to completion and the potential returns over the long term so significant, even if oil and gas prices are depressed today, the priority is to get the plants into operation and generating cash while responding to the immediate impact of the diving oil price.

That means cutting costs, rationing discretionary capital expenditures and getting access to as much liquidity as possible to keep the market calm and to avoid a punitively dilutive equity before the LNG plants begin gushing cash.

That would be the option of last resort and one that both Santos and Origin would hope has been averted by their actions and statements today.

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