Falling oil prices have been a disaster for Santos Ltd (ASX: STO).
Not only does the company earn around 46% of sales revenue from oil, but throughout 2014 Santos was increasing its exposure to oil-linked pricing for the LNG it produced – right at the time the oil price started plummeting.
It was a double blow for Santos which didn't stretch to Woodside Petroleum Limited (ASX: WPL). At the same time Santos was increasing its exposure, Woodside was increasing the price of its LNG contracts for Pluto LNG customers.
Santos' experience is partly a lesson in betting on the price of commodities. But it is also a lesson in focusing on the long term, because looking ahead Santos is set to be a winner.
Despite the current glut in oil, forecasts for LNG from industry analyst firm Wood Mackenzie show demand for the fuel outstripping supply from as early as 2020, and rising progressively from there.
Above: Industry forecasts for LNG suggest the tables will turn for producers. Source: Santos Ltd presentation.
It seems unlikely that enough new supply will come online to meet the demand by 2020 given the lead time on developing major projects can be up to five years. The challenge is compounded by current low oil prices which are strangling free-cash flows for many energy companies. This makes it a hard sell when asking investors to approve spending billions of dollars and taking on heavy debt burdens to fund new projects.
That's where things are looking up for Santos. The company is on track to deliver its first LNG cargo from the GLNG Joint Venture in Queensland in the second half of this year. Santos has a 30% stake in the joint venture which at its peak will have the capacity to produce 7.8 million tonnes of LNG per year.
Although demand and supply are forecast to grow evenly over the next five years, GLNG has an anticipated production life of 25 years which will bridge the expected shortfall period from 2020.
So too will PNG LNG – the project Santos owns a 13.5% share of. PNG LNG commenced operation last year. It has an annual production capacity of 6.9 million tonnes and a slightly longer 30-year project life.
Theoretically the two projects give Santos rights to 3.237 million tonnes of LNG per annum (mtpa). If demand forecasts continue to follow the current trend, this suggests that from 2020 Santos' production will be able to command notably higher prices and accelerated free-cash flows.
This would be a new phase in the commodity cycle for Santos and investors willing to hold on for the long term could profit big.
