There is no sugar coating it; shares in oil and gas major Santos Ltd (ASX: STO) are getting crushed.
Shares have lost almost 14% in the last five trading days, compared to shares in Woodside Petroleum Limited (ASX: WPL) which are down just 6%.
The company has been quick to shut down rumours that it was planning an equity raising, defending its ability to pay for its short-term obligations (a company's liquidity) and noting earlier this week that it had over $2 billion in cash and debt available.
But the price of oil has certainly not been helping. After trending upwards until May the price has plunged, currently sitting at US$48 per barrel and there are few, if any, optimists around. Headlines from news agencies have been ruthless, like Bloomberg's screamer "Oil's Worst-Ever Summer".
Santos will release its half-year results for the six months ended 30 June 2015 on Friday, (21 August 2015), so should investors brace for more pain?
The billion dollar question
The billion dollar question every investor wants to know – is Santos producing free cash flow? Free cash flow is the cash that's left after paying operating and capital expenses and is crucial for paying back debt and funding any dividends.
In May this year Santos noted in a company presentation that it expected the company to be free cash flow positive by the fourth quarter of the year at an oil price of US$60 per barrel. Oil is a long way from that point, and even though the Aussie dollar has fallen about 8% since then, it is nowhere near enough to buffer the almost 27% fall in crude oil.
Santos' huge GLNG project was anticipated to be free cash flow positive at US$40 per barrel, but has not yet made its first LNG delivery which is forecast for the third quarter of this year.
Costs down, but is it enough?
Since that time, in its second quarter activities report issued in July, Santos noted that "production costs for the first half are tracking below guidance at A$14.0 per boe (barrel of oil)".
This is good news, but is it enough? All investors' eyes will be on Santos' cash flow when it reports on Friday. Without free cash flow companies cannot sustain themselves over the long term and will require additional capital in the form of debt, or shareholder equity. Under these conditions, or if oil keeps falling shareholders could be set for more pain to come.
