Ask the analyst: Are markets ignoring Santos’ LNG business?
A reader asks whether the tendency of Santos shares to move with oil prices suggests a misunderstanding of its business.
Welcome to Ask the analyst, where Morningstar Australia’s equity analysts answer questions from myself and Morningstar readers. If you have a question about an ASX stock or industry in our coverage, please send it to [email protected].
Today’s question
Today’s question comes from Morningstar subscriber David. The crux of his question was as follows:
“Why does Santos trade like an oil pure-play with seemingly no regard to its LNG production? This seems strange when 1) its LNG production seems to grow even more once the Barossa project comes online 2) demand for LNG seems very strong and 3) LNG looks set to play a major role in the energy transition.”
We’ll get onto our ASX energy analyst Mark Taylor’s answer in a moment. But first, a quick overview of Santos’ business.
Australia’s other oil and gas major
Santos is Australia’s second largest oil and gas exploration and production pure-play behind Woodside.
Its major producing assets include the Darwin LNG terminal that is supplied by the Bayu-Undan gas field off the coast of Timor-Leste, the Gladstone LNG project in Queensland, and domestic gas operations in Western Australia and Queensland.
As David alluded to in his question, growth projects make up a decent chunk of the company’s value. Prominent here are the Barossa gas field, which is around 300 kilometres north of Darwin and will also use the Darwin LNG terminal, and the Pikka oil project in Alaska.
At the last update, Barossa was 95% complete and Pikka was 82% complete. Taylor estimates that Santos’ overall production could rise by up to 30% once both projects are producing at full capacity in 2027.
Why does Santos trade like an oil pure-play?
Oil doesn’t represent a big percentage of Santos’ overall production. This chart supplied by our analyst Mark Taylor shows that it is instead dominated by LNG and natural gas that is supplied domestically.
Figure 1: Santos production by product type, 2001-2024. Source: Mark Taylor
Despite this, most of Santos’ products are priced with reference to crude oil benchmarks and will see their prices move with it.
“Most energy commodity prices are at least loosely correlated to crude already” Mark says, “and most Santos LNG is sold under contract with reference to the Brent crude price.” Condensate, a major by-product from LNG production that is shown in green on the chart above, is also referenced against crude for pricing.
Taken together, Mark says that over 60% of Santos’ production now has prices that are chiefly dictated by the direction of oil prices. The other 40% or so, which is made up mostly of domestic gas, has also been going that way because domestic gas prices have trended towards parity with LNG.
When you look at profits per unit of production across Santos’ different oil and gas products, you can see that profitability per barrel of oil equivalent moves very closely with changes in the Brent oil price. Hence Santos trading like an oil pure-play.
Figure 2: Santos EBITDA per barrel of oil equivalent produced versus Brent. Source: Mark Taylor.
Santos still underestimated
Santos shares continue to trade materially below Mark’s estimate of Fair Value. He thinks this mainly reflects unrealistic expectations regarding the speed of any energy transition and what it may mean for oil and gas demand.
Absolute growth in hydrocarbon consumption over the past decade outstripped growth in renewable energy consumption by a factor of three to one, his research note on Santos points out, with growth in demand for natural gas especially strong.
Taylor is confident that demand for natural gas will hold up especially well as it supplants coal as a source of reliable (and far cleaner) base load power.
Other factors that might be holding Santos back, Mark says, include potential concerns over harsher taxes and regulation on oil and gas production. Investors might also be wary of hydrocarbon producers like Santos deploying capital into greener sources of energy with lower returns.
Santos shares closed May 19 at $6.33 per share, significantly below Mark’s Fair Value estimate of $10. At that price, the shares boasted a four-star Morningstar Rating.
