Frenzy of mergers in energy: Reporting season roundup

<p><strong>Lewis Jackson</strong>: Price of crude oil and natural gas has nearly doubled in the last year as the economic recovery takes hold. I'm joined today by Morningstar's Mark Taylor to talk through how the Australian energy sector went this reporting season.</p> <p>Mark, thanks for being here.</p> <p><strong>Mark Taylor</strong>: Thank you.</p> <p><strong>Jackson</strong>: Let's start at the at the sector level. What were some of the themes that you saw coming out of the earnings reports this year?</p> <p><strong>Taylor</strong>: Well, it wasn't so much to do with the earnings. It was more to do with merger activity. The earnings if anything, were pretty much along the lines as expected, but there was a frenzy of proposed mergers. You've got mostly in the hydrocarbon space, obviously, you've got Santos merging with Oil Search, Woodside merging with BHP Petroleum, Ampol merging with Z Energy, even outside of that space Seven Group acquiring Boral. So there seems to be a lot of interest or willingness to look at mergers. You have to look at what the underlying drivers of that are, you never know precisely what it is, but there must be something that sort of loosened up the doors as it were, and caused the prey to lose its nerve to the acquirers. I'm sort of thinking things along the lines of COVID-19 lockdowns, the oil price having been sent into turmoil early on in pandemics piece, with oil price halving before OPEC reigned in the discipline and brought some stability, and then subsequent increase in the oil price. But I think the downturn in the oil price initially might have been enough to spook some companies.</p> <p>And you've also got the ever growing concerns around carbon emissions and BHP wanting to go green and therefore get out of hydrocarbons altogether, is a theme. And then you've just got the common sense logic in combining assets where there's commonality and ownership. And it makes sense to put one and one together and create three if you can. Yeah, so that's probably the major underlying from my perspective, in terms of the energy space it's just the merger and acquisition activity.</p> <p><strong>Jackson</strong>: So with those big structural forces driving this merger activity, can you just quickly sort of at a high level, take us through your thoughts on those big mergers?</p> <p><strong>Taylor</strong>: Well, I think they definitely make sense. Australian oil and gas companies were always little fish in a pond with whales, and you need deep pockets, and scale to really compete on the international stage. So it makes sense to combine these companies and, the current circumstances created an opportunity, perhaps we've had some of the majors who, for whatever reason, are looking to their own backyards more, struggling with a few issues here and there that's caused them to become a little bit more insular looking. And this created opportunity in places like Australia, for the locals to look at getting bigger, and going places. So that's one thing. I think that's a feature.</p> <p><strong>Jackson</strong>: So Woodside was part of this merger frenzy looking just past the merger to its report, was there anything that stood out for you?</p> <p><strong>Taylor</strong>: Well, once again, I think the earnings season was pretty surprisingly well behaved and as expected. Woodside was sort of pretty much a good example of what happened across the sector. And it reported a 17% increase in underlying earnings. Marginally ahead of our expectations, net operating cash flow, very strong US$1.1 billion a bit ahead of expectations, and the interim dividend, also a bit ahead of expectations. So I mean, that sort of theme got repeated again and again and again. Despite solid results, the market didn't seem that impressed often on the day, share prices sort of coming off in response to those sorts of announcements but I think that's sort of a sign of the times where oil and gas companies and probably anything hydrocarbons is a bit out of fashion at the moment, but I don't think that will persist indefinitely, I think they'll come back.</p> <p><strong>Jackson</strong>: And what's going to be behind that comeback, as you talked about many of these names, had strong reports, but had been undervalued for some time, where is the change going to come from?</p> <p><strong>Taylor</strong>: I think it's probably going to be the realisation that hydrocarbons have to have a place in the energy, the primary energy mix. With all the will in the world, you can't bring on sufficient renewables even in the space of a decade, to meet the demand, and also the growth in energy demand through population growth, and rising living standards. So I think there's going to be a realisation that, we don't want to get rid of hydrocarbons, what we want to do is we want, especially in the interim is to encourage greener forms of the hydrocarbons So, replacing coal and oil where possible with natural gas. And with that natural gas prioritising those projects, or circumstances where there's potential for sequestering carbon in reservoirs, producing things like blue hydrogen, where you're making fuel and you're sequestering the carbon in reservoir, all sorts of things like that, companies are doing all sorts of things, but I think rather than looking at gas as the enemy, and thinking about it instead as a really effective and the fastest way probably to lower carbon intensity globally, with gas having half the carbon intensity of coal, for example. So I think, the market will get its head around that eventually, and they'll be seen as part of the, a very important part of the solution rather than rather than the enemy.</p> <p><strong>Jackson</strong>: And across the names that you cover, what companies are best placed to be part of that solution who's best positioned to take advantage of trends towards green hydrogen or energy demand in Asia?</p> <p><strong>Taylor</strong>: Well, most Australian companies are fortunately placed because they have the geographic proximity to Asia, fastest growing energy markets on the planet. So they're advantaged in that regard. They're also heavily gas focused, rather than liquids focused. So that means that they're ahead of the curve in terms of their relevance for a decarbonizing effort, if you will. And then amongst those, you've certainly got players who are perhaps slightly better positioned from a reservoir sequestration perspective. Santos very definitely with its Moomba and Undan-Bayu fields has a lot of scope for carbon capture and storage. But they're not by any means the only one though, most of the companies just by virtue of having produced hydrocarbons from reservoirs for decades, have this potential ahead of them. So I don't know that I'd particularly, point out one especially being advantaged. I just think that they're all fairly well positioned.</p>