santos' catch-22, page-5

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 its 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 yesterdays 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, its 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 yesterdays announcement had said, Look, weve 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: Its 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 wont 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 isnt 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 its 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 BGs, and thats 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.



Ultimately, the question of the true value of these companies hangs on the Chinese gas market, and all the signs there are very encouraging. The current rate of increase in gas consumption in China is equal to the total annual consumption on the east coast of Australia every year.

One of the things driving the gas market is that the authorities in Beijing are directing various municipalities to ensure that the majority of transport options are run on gas. There are some terrible problems with pollution and the more cars and buses on gas, the better.

Some subscribers may hold shares in Dart Energy, which was spun out of Arrow Energy after it was approached by Shell. Investors werent really interested in Dart, which was a grab-bag of gas assets spread out across India, Indonesia, Vietnam and China.

Because its right on the doorstep, so to speak, its been able to access those Asian markets more efficiently and has just announced an agreement to sell gas into the Shaanxi province in China. So over a period of two days, Santos has been sold down by 10% and Dart Energy has risen by about 14%.

Dart is going to be one of the lucky ones because there are probably a whole lot of other smaller coal seam gas players listed on the ASX that are not going to make out so well. Santos was supposed to be the white knight of some of those second-tier gas players such as Eastern Star Energy, Molopo, Westside and Comet Ridge.

They had gas, Santos needed gas and one day theyd come knocking. But, based on the multiples that have been paid by Total, they could revise their expectations on price by about 33% or more.