This is an article by Ivor Reis from the subscription Eureka. It deals further with my recent post pertaining to the Santos deal.
By Ivor Ries
PORTFOLIO POINT: Santos is punished on the market after announcing a big deal, because it cannot tick the boxes for asset quality and equity.
It was not so long ago that when you announced a gas deal with a big international company your share price would go up. Those days appear to be over.
Over the past two days, Santos has been sold down by about 10% after announcing a 20-year offtake agreement with French oil giant Total. The message here is that it’s no longer enough to just be a “player” in the coal seam gas space. You need to be right at the top of the tree when it comes to assets, and you need to be able to get these projects over the line without having to give up too much equity. Santos wasn’t able to tick those boxes.
According to yesterday’s announcement, Total will shell out $860 million for 20% of the project which, on a transaction level, values the reserves on a 3P (proven, probable and possible) basis at about 73¢ a gigajoule.
Santos has been trying to sell an interest in this project for some time and the net result is well off the high-water mark. If we drill further into the detail of this deal, it’s clear that Santos was not in a great bargaining position. Of the $860 million paid by Total, Santos will come away with about $650 million. But somehow, perhaps because Petronas gave up another 5% in the deal, Santos has managed to forfeit a $545 million milestone payment from Petronas in the process.
So on the face of it, Santos has given up 15% of the project for about $100 million. Granted, it has secured a 20-year offtake agreement of about two million tonnes in the process, but Total is a producer and trader. It is not a customer and the gas still needs to be sold.
There is probably about another two million tonnes of gas per annum to be sold from Santos’ Gladstone LNG project and if yesterday’s announcement had said, “Look, we’ve sold all the gas”, then you would have seen a different response from the market. But what we are hearing from the gas companies is that when it comes to getting signed sales agreements the customers are playing hardball. Earlier this week I was at a briefing from a gas company, and the chief operating officer stood up and said: “It’s all about the equity.”
Asian customers are looking to secure equity in exchange for the offtake agreements, and those companies that need those agreements more desperately won’t be able to bargain as hard.
There are several things investors can take away from this. One is it used to be that Santos and BG were regarded as the front runners, and Origin and Shell were regarded as the back runners. Well, obviously Santos isn’t a front runner any more and is still is going to face some difficulties financing this project. Reports in the press are suggesting that a share issue of about $2 billion will need to be made as early as next month.
If you do the maths on the deal, Santos has sold the project at about $4.33 billion pre-capital expenditure or about $602 million for every one million tonnes of LNG per year. If we apply that yardstick to Origin, then the joint venture with Conoco-Phillips should be worth a bit over $8 billion, which is not as heavily factored into the share price.
So there is a bit of a new pecking order emerging with Origin and Woodside coming out as the two companies with the real quality suites of assets, and that is why they have outperformed. Origin will need to do a lot better than this transaction … but then again it’s not under as much pressure.
Origin has already sold half its stake in what are perhaps the biggest coal seam gas reserves in the region; Woodside has the North-West Shelf as well as Pluto and Browse coming on.
People tend to forget that the reserves held by Santos and Petronas are the smallest of the four projects up there. On a 3P basis, they are about half the size of Origin and BG’s, and that’s one of the reasons everyone was talking about consolidation between Santos and Shell to begin with.
As it stands, Gladstone still may be a single-train project and ultimately single-train projects might not stack up economically. So unless chief executive David Knox can come up with an extra gas buyer to take another two million tonnes off his hands each year, then the market is going to keep their share price under pressure.
