Oil shock! Is now the time to buy Santos Ltd?

Shares at seven-year lows, but is the new 'oil shock' a buying opportunity for Santos Ltd (ASX: STO)?

| More on:

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The price of oil has officially gone into 'shock'.

Last week's OPEC decision to maintain production levels has sent the price of Brent crude plunging to US$68 per barrel (A$80.57) and markets reeling.

The reaction to energy producers was swift and merciless. Shares in Santos Ltd (ASX: STO) have now been slammed 24% in the last five trading days alone. Volatile share price movements are not new for Santos, so is the company worth buying (or even doubling down on) today?

Strong production growth

The most attractive feature of owning Santos today is the company's aggressive production growth profile over the next few years. Production is estimated to grow by as much as 25% in FY15 over FY13 as the company begins production from the 90% completed GLNG joint venture, as well as the commencement of production from the PNG LNG joint venture.

This growth has already started to flow, with Santos achieving its highest quarterly production in seven years in Q3. Paired with a reduction in capital expenditure and a target of 9% reduction to unit production costs in FY15 the company should be in fine form.

A strategic error

One major reason Santos' market value is being hit so hard is because of the increasing proportion of revenue that is derived from oil-linked pricing. Santos expects around 70% of revenues to be derived from oil-linked pricing in FY15, compared to around 35% in 2012.

This was likely a strategic decision in the hope of further energy price increases which looks to have back-fired.

The falling price of oil will likely have a bigger impact on Santos than on fellow producer Woodside Petroleum Limited (ASX: WPL) which has contracted pricing increases for its flag-ship Pluto LNG project, helping to insulate the company against the falling oil price.

Therefore the significant increase in Santos' cash flows which was expected to come from the growth in production looks to be dwindling fast.

In a recent presentation Santos noted that at an oil price of US$100 per barrel the company's operating cash flow will increases by 100% in 2016, but at $90, (a 10% fall), the 'consensus' was that operating cashflow would grow by just 65%. The price of oil is now 32% below $100 per barrel, which offers a bleak outlook for 2016 if prices remain at current levels.

The long-term view

The challenge for investors is anticipating what the price of oil will do next. While the volatility could well correct itself and bounce back, there have historically been long periods (decades) of stagnant prices and the current situation of oversupply could remain for some time.

Santos certainly looks cheap relative to prospective future earnings at recent historical oil prices, but with so much uncertainty around oil prices over the short and even medium term, the value of this growth is now in question. Now could well be a bargain time to buy Santos, but the company also suddenly appears to be a high risk speculation.

A safer bet than Santos

Motley Fool contributor Regan Pearson does not own shares in any of the companies mentioned in this article.

More on Resources Shares

A man with a wide, eager smile on his face holds up three fingers.
Resources Shares

3 reasons to buy this surging ASX All Ords mining stock today

A leading broker expects this Aussie mining share could surge 26% and begin paying dividends.

Read more »

A smiling woman holds up an apple with a laptop open on her desk.
Resources Shares

Rare earths shares charge as Apple weighs in

Tech giant commits to $500 million deal with MP Materials.

Read more »

Three miners wearing hard hats and high vis vests take a break on site at a mine as the Fortescue share price drops in FY22
Resources Shares

Why Infratil, Iluka Resources, Lynas Rare Earths shares are jumping higher today

These three ASX 200 shares are gaining ground today.

Read more »

Ecstatic woman looking at her phone outside with her fist pumped.
Resources Shares

Guess which ASX mining share is jumping 10% on big news

This miner is having a good session on Wednesday. What's going on?

Read more »

A young woman sits with her hand to her chin staring off to the side thinking about her investments.
Resources Shares

Should I switch my ASX 200 banking stocks for ASX 200 miners before earnings season?

The ASX 200 Index is dominated by Australia's bank and materials/mining sectors, which together account for around half of the…

Read more »

Miner looking at a tablet.
Resources Shares

Does Wilson Asset Management prefer Rio Tinto or BHP shares?

Which miner is in favour?

Read more »

Two smiling men in high visibility vests and yellow hardhats stand side by side with a large mound of earth and mining equipment behind them smiling as the Carnaby Resources share price rises today
Resources Shares

Macquarie tips this ASX 200 resources stock to soar nearly 40%

Big returns could be on offer here according to the broker.

Read more »

A man clenches his fists in excitement as gold coins fall from the sky.
Resources Shares

Bell Potter says this ASX 200 mining stock can rise ~30%

Let's see why this miner could be destined to deliver big returns over the next 12 months.

Read more »