The return of Santos

It’s been a very long time, perhaps as much as 30 years, since Santos last held the title of Australia’s premier oil and gas company but judging by the latest share-price movements, the once deeply unloved Santos could be heading back to the top.

Since the start of 2019, a significant difference in share-market performance has developed between the petroleum producers widely seen as the leaders of the sector, Woodside and Oil Search, and two re-emerging stocks, Santos and Beach.

As all four are totally exposed to the price of oil (which also determines the price of natural gas), a comparison is valid and could provide investors with food for thought as the stock market shows two companies performing strongly and two struggling for growth.

Both Woodside and Oil Search, which have big investments in the production of liquefied natural gas (LNG), are battling headwinds in their efforts to expand, problems which should be ringing warning bells for investors.

Woodside is being confronted by difficulties in meeting the demands of partners in two Australian LNG joint ventures and a separate African oil project. Oil Search is being buffeted by the return of resource nationalism in Papua New Guinea.

Their problems can be measured using the oil price and stock prices with both Woodside and Oil Search not even matching the oil price since the start of the year with their shares up by 6 per cent whereas oil, after a roller-coaster eight months, is up 7.5 per cent.

Santos and Beach have done much better, rising by 36 per cent and 73 per cent respectively, gains which reflect stronger profit growth and confidence among investors that the outlook for both is more promising than Woodside and Oil Search.

Production data and a stock-market capitalisation comparison is also starting to show the gap closing with one of the most interesting recent developments being a win for Santos in quarterly oil and gas output for the first time in decades.

Through a combination of a strong quarter for Santos and maintenance outages at Woodside facilities, the numbers for the three months to June 30 were 18.6 million barrels of oil equivalent (a combination of oil and gas) for Santos and 17.3 million barrels for Woodside.

Woodside should quickly reclaim its production lead as big projects such as Pluto LNG return to full capacity, but the June quarter results were a warning for investors that the long-term leader is entering a period of uncertainty and that could soon be reflected in profitability unless development logjams are broken.

In terms of size, as measured by stock-market value, Santos is closing the gap with Woodside and whereas it was once less than one-third the size of its rival, Santos has risen to be half the size of Woodside ($15 billion v $30 billion) with the latest measure of Santos meaning it has also moved comfortably past Oil Search ($10 billion) whereas three years ago Santos was smaller than Oil Search.

Beach too is rising rapidly, from being a small business struggling to survive it has been resurrected under new management and an injection of capital which has funded a significant expansion phase to be valued at $5 billion.

Investment analysts are starting to take note of Woodside’s growth problems as the company’s management tries to muscle the development of the Browse gas fields (needed to keep the 30-year-old North West Shelf operating at full capacity), the Scarborough gas fields (needed to expand the Pluto LNG project) and the SNE oilfield off the coast of Senegal where a small partner, FAR Ltd, is disputing the sale of a stake in the project to Woodside by the U.S. oil major, Conoco Phillips.

Different joint venture ownership structures have led to difficulty in aligning the interests of all participants, a situation starting to heat up with Woodside chief executive, Peter Coleman, warning last week that JV issues could delay investment decisions.

“I think its time for a number of our partners in the joint ventures to move beyond self-interest and start to look at the bigger picture,” Coleman said. “There is a prize here and we need to be careful that we don’t lose it.”

That warning shot aimed at its partners in joint ventures that Woodside leads reflects an intensely competitive global LNG industry with multiple development options opening for big oil companies such as Shell and Chevron which will be comparing Australian LNG projects with those emerging in Africa and North America.

Oil Search is in a similar position, trying to align the interests of joint venture partners in the Papua LNG project in Papua New Guinea just as a new government in that country demands the renegotiation of a development deal signed with the previous PNG Government.

Credit Suisse, in a research note published after Oil Search last week, reported higher oil and gas production in the half-year to June 30, and a 105 per cent profit rise, said that the result was “overshadowed by politics.”

A stand-off between PNG and partners in the Papua LNG project threatens to see oil and gas licenses cancelled (at worst), or a long delay in expansion plans (at best) with the net result being a sell recommendation from Credit Suisse on Oil Search which has the gloomiest outlook of the major investment banks towards the stock.

Woodside is also facing a cautious investment banking community, led by Citi which is deeply concerned about the company’s growth options, telling clients after the release by Woodside of its half-year result that there had been “no material updates on growth” and that Coleman’s unhappiness with some of his LNG joint venture partners was of concern.

“We think tensions are boiling over into the public domain and the timeline (for new projects) is therefore not without risk,” Citi said.

Piling on the pressure at Woodside is a demand from the Australian Government that the Browse gas fields, discovered more than 40 years ago, be developed as soon as possible or be at risk for forfeiture under rarely used use-it, or lose-it, rules governing oil and gas reserves.

Santos is in a different position, and one that long-term followers of the stock might struggle to recognise because it is no longer the sick man of Australian oil, burdened by South Australian Government over-regulation and an excessive focus on the oil and gas fields of the Cooper Basin in the north of SA.

Multiple expansion moves, acquisitions and diversification has changed the face of Santos, along with promising and easy-to-develop oil discoveries such as the Dorado oilfield off the coast of WA.

Citi said last week after the release by Santos of a reasonable half-year profit of $411 million that it rated the stock more highly than Woodside or Oil Search.

“We continue to like Santos on the basis of its balanced portfolio, a balance sheet that can afford growth aspiration, and limited LNG repricing or contracting risk; a stark contrast to the likes of Woodside and Oil Search,” Citi said.

Other banks agree. Morgan Stanley said the “action plan” of Santos chief executive, Kevin Gallagher “keeps delivering”, and UBS said Santos’s vision “remains clear with focus on growth and costs.”