When the COVID-19 pandemic slammed the global economy, in early 2020, one of the most stunning developments on the financial markets was the plunge of the oil price – on one West Texas Intermediate (WTI) futures contract, at least – into the negative in April 2020.
Many investors were prepared for lower oil prices as the extent of the COVID-induced economic slowdown hit – the market was already chronically over-supplied – but negative prices were definitely not expected.
Speculators holding the contracts for the delivered oil had nowhere to put it, and as the deadline for futures contract expiry of April 2021 loomed, they had to pay other market players to take those contracts off their hands.
Nobody knew how to deal with a negative oil price.
One thing is for sure: if you had said that in two years’ time, the price would be back to US$100 a barrel, you would have been laughed out of the room.
But here we are, with oil demand increasing and supply under pressure, Brent crude is trading at US$93.64 a barrel – its highest since September 2014. (“Dated Brent,” or physical cargoes of crude oil in the North Sea that have been assigned specific delivery dates, has already pushed above US$100.) And there is every indication that oil will push higher, with the market very tight, and geopolitical concerns roiling prices.
And while crude pushes toward $US100 a barrel, LNG (liquefied natural gas) is trading in Asia at prices five times higher than five years ago – and 15 times their COVID lows in April 2020.
Clearly, the major geopolitical issue right now is a potential invasion by Russia of Ukraine, and the possibility of Russia being hit with sanctions by the world, and prevented (for however long) from selling oil and gas to Europe. (Its second-largest customer, China, would probably not back sanctions. However, this could backfire a bit on Europe, as Russia supplies about 40% of Europe’s needs.)
Some analysts say we could see oil prices at US$120 a barrel in this case.
There is also a geopolitical issue that could potentially dampen the oil price: the US and Iran could be nearing a nuclear deal, which could mean about 1.3 million barrels per day of Iraqi oil re-entering the market quite quickly, increasing supply.
Then you have to add in the fact that a sustained lift of oil into three figures would probably require aviation to get back to something approaching normal, to build-back jet fuel demand.
As usually happens in any commodity, higher oil prices could cure themselves, by incentivising upstream investments and helping to push more supply into the market. Norwegian research firm Rystad Energy says there is evidence that this is already happening in the US shale oil sector.
Pre-COVID, global oil demand was running at 99.6 million barrels per day (bpd) demand in 2019. In 2020, it slumped to 89.3 million bpd. The International Energy Agency (IEA) expects world oil demand to rise by 3.2 million bpd this year, and reach 100.6 million bpd, as restrictions to contain the spread of COVID ease.
Before the pandemic upended forecasts for oil demand for both the short and long term, Rystad Energy had expected the maximum world oil demand to hit 106 million bpd in 2030. The research firm now expects global oil demand will peak at 102 million bpd in 2028, before falling below 100 million bpd after 2030 – and then halving in the period to 2050.
However, the world will still need oil for a long time – and investors can still make good returns investing in producers.
On the ASX, I think Santos stands out at present among the oil and gas stocks. Here’s why.
Santos (STO, $6.80)
Market capitalisation: $23.7bn
Three-year total return: 3.1% a year
FY22 estimated dividend yield: 3.1%, fully franked (grossed-up, 4.4%)
Analysts’ consensus price target: $8.92 (Thomson Reuters, two analysts), $8.95 (FN Arena, one analyst)
Stronger energy prices certainly showed up in Santos’ results, after the company – which is currently bedding down its $21bn merger with PNG-based rival Oil Search, which made it a Top 20 global oil and gas company – more than tripled its underlying profit in 2021 (Santos uses the calendar year as its financial year), to $US946 million ($1.32bn). Revenue surged 39% to $US4.7bn ($6.5bn), on the back of a 60% surge in Santos’ average oil price to $US76 a barrel, and a 45% jump in its average realised LNG price to $US9.25 per 1,000 British thermal units (mbtu). Santos paid a dividend of 8.5 US cents, up 70% on 2020.
LNG demand is at record highs due to the role of natural gas as a reliable and lower-carbon fuel. Santos’ 2021 LNG sales volumes were only 4.7% higher for the year, but the revenue from selling that gas surged by almost 65%, to US$2.2bn.
Santos improved its free-cash-flow breakeven point to US$21 per barrel in 2021, down from US$24 per barrel in 2020. (For every US$10 a barrel higher than that, there would be about another US$450 million in free cash flow.) The company expects a conservative average oil price of approximately US$65 per barrel in 2022, saying it expects to generate sufficient free cash flow to fund all of its forecast major growth projects at that price.
The company lifted 2021 production by 3%, to 92.1 million barrels of oil equivalent (boe, a measurement that counts gas output as well), and has guided the market to expect 2022 production to increase to a range of 100 million boe–110 million boe, as Oil Search’s PNG LNG production is added. Santos has 4.9bn boe of resources and reserves.
In fact, the 2021 result only counted three weeks of the merged company trading as one business, with Santos helpfully informing the market that the combined assets would have generated more than $US2.3bn in free cash flow for the year if Santos and Oil Search had been merged for all of 2021.
Santos has told the market to expect assets sales of about US$2bn–$3bn, saying it has had early interest from buyers to purchase a stake in its Papua New Guinea LNG project, which it wants to sell-down from 42.5%, and it has a broader range of oil and gas projects potentially on the block, across PNG, Alaska and Western Australia. As broker Macquarie puts it, PNG LNG is clearly the largest and most important deal to get done, and it’s a good time to sell, given high oil prices and Europe having confirmed gas-fired power as an ESG-positive energy transition source.
Santos operates three carbon capture and storage (CCS) hubs at its production facilities, which support the decarbonising of natural gas, and enable the production of clean fuels including hydrogen and ammonia. The company says this offers it a strategic competitive advantage, enabling:
- Emission reductions for Santos’ liquids, pipeline gas and LNG products;
- Hydrogen production from natural gas;
- CCS services to existing and new customers; and
- carbon removal services through direct air capture technology.
While this is an important part of Santos’ presentations around ESG, the reality is, in terms of ESG investing, that the transition to a low (or zero)-carbon future means – unless you are investing on the basis of ideology – will quite simply require much greater use of LNG.
In share price terms, however, Santos has struggled in recent years: the stock is up 1.3% in total return (dividends plus capital growth) in the last 12 months and 3.1% a year over the past three years. Analysts, however, are quite bullish on STO, and it easily looks to be the best way to play the oil boom among the majors.
Thomson Reuters collates the views of 14 analysts covering Santos and gives a consensus price target of $8.92, which, if borne out, would give a very attractive return on the current price of $6.80. Six analysts’ work feeds into the FNArena consensus price target, of $8.95. And don’t forget there is a dividend return, too, with both Thomson Reuters and FNArena expecting 4.4% grossed-up, which is not to be scoffed at as a contributor to total return.
Santos Limited (STO)
There are several other ways to ‘play’ oil and gas on the ASX.
One is the synthetic (that is, using futures) exposure to the oil price offered by the BetaShares Crude Oil Index ETF – Currency Hedged (synthetic) (ASX code: OOO), which is an ETF that aims to track the performance of an index (before fees and costs) that provides exposure to West Texas Intermediate (WTI) crude oil futures, hedged against currency movements in the AUD/USD exchange rate. OOO has earned investors 51% over the past 12 months, but has lost 14.6% a year over the past three years, and is down 8.9% a year over the past five years.
Another is the BetaShares Global Energy Companies ETF – Currency Hedged – (ASX code: FUEL), which is a cheap and simple way to gain exposure to a diversified portfolio of the world’s largest energy companies, in a single ASX-listed stock. FUEL gives investors a stake in a diversified portfolio of some of the world’s largest vertically integrated energy companies. The return is hedged into AUD.
At present, the top ten holdings in FUEL are:
- Exxon Mobil Corp – 8.7%
- Chevron Corp – 7.9%
- TotalEnergies SE – 7.2%
- ConocoPhillips – 6.4%
- BP Plc – 4.1%
- Enbridge Inc – 3.9%
- Schlumberger – 3.2%
- EOG Resources Inc – 3.0%
- Pioneer Natural Resources Co – 3.0%
- TC Energy Corp – 2.9%
FUEL is managed for an annual management fee of 0.57% and has earned investors 36.5% over the past 12 months. However, it is virtually even (up 0.2% a year) over the past three years and over the past five years (up 1.4% a year).
Of course, there is also a plethora of oil and gas explorers listed on the ASX, drilling all over the world.
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