Gas giant

How China Saved Santos

A sudden doubling of LNG imports pulled the Australian producer back from the brink.
Brendon Thorne/Bloomberg
SANTOS LTD
+0.11
At Closing, May 21st
6.36 AUD

It's barely more than two years since Australian oil and gas producer Santos Ltd. survived a brush with death. With crude prices slumping as low as $28 a barrel and net debt climbing to $6.6 billion, the company seemed on the brink.

Its price-book ratio -- which should typically be above one for an oil and gas producer -- slipped to liquidation levels south of 0.4. When a group of Chinese and Gulf investors showed up with a A$7.14 billion ($5.5 billion) offer in October 2015, this Gadfly argued they should take it.

You're the Top

For all Santos's attempts to cut costs, it's revenue growth that's driven its revival

Source: Bloomberg, Gadfly calculations

Note: "Operating costs" include all pre-Ebit expenses including cost of goods, depreciation and amortization, SG&A, impairments and hedging losses, and exploration spending charged to income.

Shareholders should be grateful that the board held its nerve. Thanks to China's surprise transformation from an LNG laggard to a leader over the past two years, the company now has an offer almost twice that level, at A$13.5 billion, in the form of a higher proposal Tuesday from Harbour Energy Ltd. The closely held U.S. company had initially approached the business in August with a bid about 30 percent lower.

It's clear what's changed in the past few years. Annual free cash flow peeped into positive territory for the first time in a decade at the end of 2016, and has since firmed further. As a result, analysts expect operating income to finally start covering interest payments in 2018, after years when debts were met by persistent losses.

The Right Direction

Interest bills that looked insupportable when Santos was losing money seem modest as profits loom

Source: Bloomberg, analyst estimates

Part of this recovery is internal. Operating costs at the biggest Santos units -- a domestic gas field in Australia's central Cooper Basin and the LNG export terminal at Gladstone on the east coast -- have fallen by more than a quarter over the past two years.

The Beast Awakens

China's LNG imports were desultory as the industry boomed in the 2010s. Then last year, they soared

Source: China Customs General Administration, Bloomberg

At the same time, look further down the income statement and much of that upstream benefit disappears. Mainly because of losses on commodity and currency hedges and purchases of product from third parties to fulfill contracts, overall costs have if anything been edging higher.

That means the real savior of Santos is external: A doubling of Chinese LNG import volumes over the past two years appears to have driven regional prices to a permanently elevated plateau.

Floating Free

The premium for Pacific LNG cargoes over U.S. piped gas surged in late 2017 as winter demand in Asia climbed

Source: Bloomberg

Note: mmbtu = million British Thermal Units.

Linda Cook, the former Royal Dutch Shell Plc executive who is Harbour's chief executive officer, sees that more bullish outlook for methane as long overdue.

"I've never been a believer in this theory that the LNG environment was oversupplied," she told Gadfly after Tuesday's announcement. Periods of oversupply "come and go, and each time they've been short-lived and in some places didn't actually exist at all."

I've long been of the view that gas has a bright future as renewables increase market share and put pressure on lumbering coal plants. With $7.75 billion in debt supporting the proposed Santos deal and an implied oil price of $71.70 a barrel according to Macquarie Group Ltd., Cook must be hoping that China's gas trade boom is only just beginning.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    David Fickling in Sydney at dfickling@bloomberg.net

    To contact the editor responsible for this story:
    Paul Sillitoe at psillitoe@bloomberg.net

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