Santos $30bn buyout will really be a battle for energy security in the national interest
As tensions across the Middle East hit breaking point, there’s little wonder Abu Dhabi’s state-backed oil company, its wealth fund, and private equity partner Carlyle were so keen to rush out their near $30bn offer for Santos.
Energy security is now the name of the game and Abu Dhabi should recognise it’s going to be geopolitics, not markets, that are set to determine the outcome of this bid.
With key LNG export operations in Darwin, PNG and Santos-pumped oil arriving in Donald Trump’s Alaska, the national interest test is going to be sky-high.
Abu Dhabi may have the cash, it simply hasn’t put much of substance, if anything, on the table to win over Treasurer Jim Chalmers, even if the bid scrapes past the Foreign Investment Review Board. But even that is looking less certain.
In fact, with a commitment to keep Santos’s Adelaide head office and long-term development of LNG, there’s politically no difference on what Santos offers today, except the prospect of losing fast-talking CEO Kevin Gallagher who is very good at throwing policy bombs but has one eye firmly on retirement.
Bidding under the XRG consortium, ADNOC argues the buyout should be considered no different from Santos simply moving from public to private markets. Still, global energy interests and Australia’s interests are rarely on the same page.
Santos chair Keith Spence is a career geologist who climbed the executive ranks, moving between Woodside and Shell then back to Woodside, and should know what’s at stake. He was at Woodside in 2001 when Peter Costello blocked the Dutch energy giant’s takeover offer. Then as today, the national interest was about gas.
There were three bumps from ADNOC to get to the indicative $8.89-a-share offer before going public on the bid. The opening salvo at $8.00, followed by $8.60 were so underwhelming the Santos board must have rocks in their collective heads, for being willing to take Abu Dubai’s last offer as “final” at face value.
Yet they have.
Despite the very real execution risks, new Middle East tensions putting a rocket under oil and Santos’s new projects coming online, the Santos board has already committed to back the buyout at $8.89 pending what ADNOC and friends turn up in due diligence. This price is barely a scratch above net asset value.
The final offer was pitched at a 44 per cent premium to Santos’s average trading price of the past few months, including a period of Trump-induced trade fears. Remember, just 12 months ago, Santos was trading at $8.00 – and that’s even before clarity about its development pipeline. The bull case among some brokers has Santos hitting as much as $11.60, although much needs to go right.
It almost makes you wonder how Spence’s Santos board didn’t learn from the mistakes of the Origin Energy two years ago, when the energy generator backed itself into a corner by rushing to endorse a $19bn offer from Canada’s Brookfield.
It was only a core of determined shareholders that saved Origin from itself, and consequently that energy player has since traded above its bid price. With the flow of dividends since, Origin’s investors are comfortably ahead for not taking the money, but the distraction was costly.
The difference here is Santos’s share registry is wide open. Passive funds like Blackrock and State Street crowd out the top, and this means there’s no Australian Super-style white knight waiting in the wings. Perpetual has a 5 per cent stake but can’t move mountains on its own, while industry fund REST has just 1.5 per cent.
This approach certainly gives the Santos board a quick win for their lack of succession planning around Gallagher, who is almost 10 years into the job.
Santos has certainly worked hard over the years to keep its reputation as a perennial underperformer. This is mostly on project execution problems, cost blowouts and wells coming up short. So should be no surprise that endless rounds of talks with potential suitors including Woodside and other private equity interest over the past decade rarely got anywhere.
Santos’s main problem was a gas producer, it was too short of gas and had to buy in other gas to fill the tanks to keep its Gladstone LNG project running. At the same time, a merger with Oil Search has delivered more operational complexity, with Santos having limited expertise to manage PNG projects.
Santos has spent much of its modern life, always being on the cusp of something bigger. This time it really is different.
It’s growth bets, the Barossa LNG project that hooks up to its Darwin export plant should start producing in coming months, while the Alaska oil and gas development should start pumping by this time next year – depending on how construction-friendly this northern summer is.
Combined, the two will deliver a significant jump in free cashflow, making a serious difference to dividends following years of heightened capex and project delays.
There’s enough certainty around cash generated from the projects that has given Santos the confidence to commit to a new capital allocation target, which aim to deliver between 60 per cent and up to 100 per cent in dividends or share buybacks.
The additional cash would also help pay down debt, which at nearly 25 per cent is not crushing, but is still on the top end of Santos’s preferred range
LNG prices have come off recent highs, however the global market is expected to remain in broadly in balance until the end of the decade. LNG demand is forecast to take off before the end of the decade as coal phases out of the global energy system, and much of this demand will be from Asian customers. The same buyers are looking for long-term partners, with Donald Trump’s US now blanketed in a layer of supply risk. An LNG ship from Santos’s Darwin fields to buyers in Korea or Japan takes just eight days. The same ship from the US, via the Gulf of Mexico, takes 23 days or 16 days from the Middle East.
Santos shareholders have worn the significant investment on these bets, particularly on the $US4.6bn Barossa project which also become caught up in a drawn out legal challenge on environment grounds, although Santos was right to fight it with determination.
Santos too has its cash cow in PNG LNG that even with low oil prices only need modest investment in backfill projects like Pikka to expand its life.
At the same time, domestic projects including ambitious Carbon Capture Storage targets at its cooper basin fields and the longer term option of bringing fields like the NT’s Beetaloo Basin and NSW’s Narrabri online, (albeit very slowly for the latter). Those offer potential to bring in lower cost gas to Gladstone, while building out much-needed domestic supply options.
The weekend conflict between Israel and Iran is clearly in ramp-up phase, and the surging oil prices are a reminder that how fragile energy markets are. Giving away another gas development for an uninspiring premium and a done deal, is short-termism at its best.
johnstone@theaustralian.com.au
