Kevin Gallagher says Alaska is an opportunity to develop oil in a country wanting energy security
The company’s chief executive, Kevin Gallagher, had some explaining to do to an expectant market.
It was apparently hoping to see Santos pull out of its Alaskan oil interests and sell down a good chunk of its choice PNG LNG holding, with the prospects of bumper dividends and a bigger share buyback.
What the market got was the green lighting of the Pikka project in Alaska and only 5 per cent of PNG LNG on the block, reducing the expected $US2bn ($2.9bn) to $US3bn selldown and inevitably leaving less for investors.
There was also a reality check on Santos’ Dorado field in Western Australia, with that development on hold.
Credit Suisse analyst Saul Kavonic led the criticism.
There was “no mistaking a resetting of expectation and strategy in the results with significant disappointment versus expectations set by management only six months ago,” Kavonic said.
Gallagher told The Australian in an interview: “People keep asking me what’s changed since February? Everything. The entire world has changed since February.”
The Santos chief could not stress enough how war in Ukraine and sanctions had wrought commodity volatility, inflation and a structural shift in global policy to energy security.
“In terms of our major projects it’s really Barossa and now Pikka,” said Gallagher.
“In political issues, it is the challenge of global energy security and what that means to our markets, even the domestic gas market and the recurring (Australian Domestic Gas Security Mechanism) story and dealing with that.”
Gallagher acknowledged he previously made very clear to investors that, following the merger with Oil Search, his focus was to sell down Alaska.
However Alaska today presents an opportunity to develop oil in the US which is looking to up energy security. Alaska offers Santos diversity both in product and in geography, a pitch that gas-rich Oil Search – now merged with Santos – used when it bought into Alaska in 2017. As RBC’s Gordon Ramsay points out, it is rare to see 1 billion barrels of oil in a pro-development state.
Gallagher would not be drawn on whether Alaska was still a non-core asset. That is because he is still open to selling Pikka even after development is under way.
Analysts will need to become more acquainted with Pikka and Gallagher has promised to introduce his team members at the next investor day. But for Credit Suisse’s Kavonic, the risk is that market focus will shift to Alaska, and its poor optics around ESG putting off new investors.
Gallagher disagreed. “We are doing this because we believe this is a way in which we can deliver the highest value to our shareholders,” he said.
Gallagher added that Pikka was a low-risk project – no big vessels or LNG to build – and described it as the most final investment decision-ready project he had ever seen. It has contracts in place to underpin development costs of US$1.3bn, and 55 per cent of the project cost is fixed while the remaining 45 per cent is mostly labour.
“If we delayed any longer, we believe we would be destroying the value of the asset. We have done the FID to take it forward and we think it will become more valuable over time because we have done that,” Gallagher said.
In contrast, the FID on Santos’s Dorado project is delayed and Gallagher painted a grim picture around inflation, supply chains and issues with contractors – one of which had gone into Chapter 11 bankruptcy.
Pikka will be Scope 1 and 2 net zero from day one and the US has just passed legislation that offers incentives for carbon capture and storage, which Santos is already developing in Australia.
That said, Gallagher is still open to a sell down of Pikka. He insisted there was interest but that geopolitics had made it difficult to sell anything other than LNG projects at the moment.
Shares in Santos slipped more than 2 per cent on Wednesday and have dropped over 20 per cent since early June.
Given that the oil price is still over $US90 a barrel, Gallagher sees Santos as significantly undervalued and the current buyback as a good use of funds.
With a predicted 19 per cent rate of return on Pikka at a $US60 per barrel, MST Marquee’s Mark Samter wants to know why the board would not return more than 40 per cent of free cashflow to shareholders. If gearing fell to 15 per cent, the board might consider that, Gallagher said.
Risk of government intervention in Australia heckles the share price but Gallagher said – more important than whinging about his share price – it was overseas customers and investors who were at risk. “These are the same customers and investors we need for clean fuels in the future,” he said.
He told The Australian he was confident that any intervention would not take cargoes off Santos’s GLNG operation.
The Santos half-year result on Wednesday was a good example of how corporate strategy is morphing in response to geopolitics, including in its own back yard of Australia.