What? Invest in oil? Don’t be stupid, the future is renewables.
Maybe so, but out in the real world, which still has to function day-to-day, fossil fuels still dominate the task of producing the energy we expect when we flick a switch, start a car or – hopefully, one day again – board a flight.
The International Energy Agency (IEA) still projects that 70%–75% of global primary energy consumption may be met through fossil fuels in the year 2040. People think that electricity is the main game, but it’s not; in primary energy terms, especially transport, fossil fuels still dominate. And will for some time.
Oil’s price trajectory was smashed by the COVID-19 pandemic, plunging by 80% in the first quarter of 2020, to US$12.20 a barrel – and, famously, into the negative, on one futures contract.
But through 2021, despite the occasional reverse, oil prices have pushed determinedly higher, on rising demand optimism, a major production outage in Mexico, and vaccine rollouts. Fuel demand is proving resilient to the latest coronavirus outbreaks, and producers – particularly the OPEC+ coalition, which means OPEC plus Russia – have been diligent in trying to keep prices high enough to support the revival of the global petroleum industry.
Oil is back on the rise, attempting to retake its July peak of US$78 a barrel, as it recovers in anticipation of an eventual global reopening. Gas prices are also on a bullish run. If oil prices can get above US$80 a barrel, there is at least technical (on a price chart) grounds for it to hit three digits, for the first time since September 2014.
Looking at the ASX oil and gas sector, there is plenty happening, with significant M&A (mergers and acquisitions) activity, and a lot of value implied in analysts’ consensus price targets for stocks. Here is a look at some of the best buying opportunities: all five of these stocks look to be very nice value, with nice potential upside for the majors (with the caveat that Woodside is about to trade ex-dividend), plus a bit more speculative spice available in Karoon Energy and Senex Energy – particularly in Karoon.
1. Woodside Petroleum (WPL, $20.28)
Market capitalisation: $19.5 billion
3-year total return: –14.8% a year
FY22 Forecast Yield: 6% fully franked (grossed-up, 8.6%)
Analysts’ consensus valuation: $27.07 (Thomson Reuters), $26.18 (FNArena)
Australia’s largest independent oil and gas producer Woodside Petroleum and BHP stunned the market in the middle of the month with the proposal to merge BHP’s petroleum assets with Woodside, creating a global top ten oil and gas producer, an international player with a significant presence in the Gulf of Mexico. The merged Woodside-BHP Petroleum will have production of about 200 million barrels of oil equivalent (boe), and reserves of more than 2 billion boe: it will be owned 52 per cent by Woodside shareholders and 48 per cent by BHP shareholders, and have a total market capitalisation of about $41 billion.
The BHP business comes into the merger with no debt; that means the combined entity will have a debt-to-equity ratio of about 12 per cent. Analysts think that implies that Woodside could fund not only the huge $16.2 billion Scarborough gas development (in which BHP was already a 25% joint venture partner), but other Gulf of Mexico developments, as well as low-carbon opportunities.
Analysts feel Woodside will benefit more from the merger than will BHP. Woodside could benefit from more than US$6 billion ($8.2 billion) in upside through synergies it can gain. Woodside vaulting into the top ten of the industry should benefit shareholders significantly over the longer term, and there is also the huge benefit of BHP Petroleum’s cash flow being harnessed to help maintain Woodside’s dividends – which is important, given that the stock is seen as a yield stock – as well as fill a short-term earnings gap at WPL until Scarborough gets off the ground.
In the short term, Woodside’s half-year result was a bit of a disappointment, with the combination of lower production guidance and higher costs. But longer-term, brokers are fairly bullish on WPL, with expectations of a share price pushing towards $30-plus as the potential upside of the merger is priced-in (assuming, of course, that it goes ahead.)
2. Santos (STO, $5.97)
Market capitalisation: $12.4 billion
12-month total return: –2% a year
FY22 Forecast Yield: 2.5% fully franked (grossed-up, 3.6%)
Analysts’ consensus valuation: $7.95 (Thomson Reuters), $8.00 (FNArena)
3. Oil Search (OSH, $3.71)
Market capitalisation: $7.7 billion
12-month total return: –23.7% a year
FY22 Forecast Yield: 3.7%, unfranked
Analysts’ consensus valuation: $4.73 (Thomson Reuters), $4.577 (FNArena)
Santos and Oil Search are also up to their eyeballs in oil and gas M&A, with a proposed $21 billion union proposed in July with fellow ASX heavyweight Oil Search. While smaller than Woodside/BHP Petroleum, the Santos/Oil Search tie-up would create “a regional champion of size and scale,” positioned among the 20 largest global oil and gas companies.
Santos told the ASX on July 20 that it put a confidential merger proposal to Sydney-based Oil Search on June 25.
Oil Search rejected the initial offer, as it did not offer appropriate value for shareholders, but said it was open to further approaches. STO came back with a revised merger proposal that implied a transaction price of $4.29 per Oil Search share, which was a 17% premium to the OSH price at the time.
The proposal envisages Santos shareholders owning about 61.5% of the merged entity and Oil Search shareholders owning approximately 38.5%.
With its origins in the Cooper Basin, Santos has one of the largest exploration and production acreages in Australia and extensive infrastructure. It is already Australia’s largest domestic gas supplier, with major stakes in assets such as the Darwin LNG and Gladstone LNG plants, and aims to be a leading Asia-Pacific LNG supplier. The two groups are shareholders in the PNG LNG project, with Oil Search holding 29% and Oil Search 13.5%.
In March, Santos approved its $4.7 billion Barossa project north-west of Darwin, which it says represents the biggest investment in Australia’s oil and gas sector since 2012.
The merged group would own oil and gas assets in Australia, Papua New Guinea (PNG) and Alaska, with the jewel in the crown considered to be their combined 42.5% stake in the PNG LNG project, outweighing the 33.2% stake owned by Exxon Mobil, the operator of the project. PNG LNG is a great asset: it is one of the world’s lowest-cost LNG projects, with plenty of room for expansion, and it is right on the doorstep of the fastest-growing gas markets in Asia.
Some analysts think that Oil Search’s 51% interest in the undeveloped Pikka oil project in Alaska will be sold, in favour of a focus on the companies’ home region; others see the Alaska diversification as a good counter-balance to Oil Search’s over-reliance on PNG gas.
Oil Search also owns a share of another proposed LNG project, led by French major TotalEnergies, that targets first production in PNG in the second half of the decade. Analysts say there is plenty of potential value opportunities for Santos in this, possibly involving selling some of its PNG LNG stake to Total.
The market appears to view STO as the better-value approach into the merger, although OSH is also seen as offering value.
4. Karoon Energy (KAR, $1.20)
Market capitalisation: $665 million
12-month total return: 3.4% a year
FY22 Forecast Yield: no dividend expected
Analysts’ consensus valuation: $1.725 (Thomson Reuters), $1.78 (FNArena)
In 2019, Karoon Energy bought the $US650 million ($845 million) Bauna oil field off the coast of Brazil, moving it into the ranks of oil producers. The company had sat on hundreds of millions in cash for five years, since it sold a West Australian gas field in 2014 to Origin Energy, for $US600 million. Bauna has transformed the company, and there are now indications that production from the field could double from current levels by the end of the 2023 financial year, to about 30,000 barrels a day. This target comes from the company’s commitment in June to develop the Patola field, which it will feed into the Bauna infrastructure. Karoon also has potential projects in Australia and Peru. Analysts are bullish on the production increase target – and on the value in the current share price.
5. SENEX Energy (SXY, $3.05)
Market capitalisation: $561 million
12-month total return: –6.6% a year
FY22 Forecast Yield: 2.6%, 43.1% franked (grossed-up, 3.1%)
Analysts’ consensus valuation: $4.00 (Thomson Reuters), $3.78 (FNArena)
Natural gas player Senex Energy has big plans to boost domestic supply, announcing earlier this month that it will expand its natural gas production from the Atlas operation, in Queensland, by 50%, from the current output of 12 petajoules a year (PJ/y) to 18 PJ/y. The boost at Atlas is the next phase of growth to drive Senex towards its stated annual production target of more than 60 PJ/y by the end of 2025.
The company is also poised to press “go” on a production expansion at its Roma North operation from the current 9 PJ/y to 18 PJ/y, to be sold to the Gladstone LNG project. Senex is also planning a third expansion of the Roma North operation, to take it to 27 PJ/y.
The expansion plans come in the wake of a 140% lift in production in the 2020-21 financial year, to 17.3 PJ, with revenue more than doubling, to $109.6 million, and underlying earnings before interest, taxes, depreciation and amortisation (EBITDA) surging by 178%, to $54.5 million. FY22 production guidance was strong, with a mid-point estimating 21PJ–23PJ. Senex is kicking goals, and analysts think the stock is great buying at these levels.
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