I wouldn't blame you if energy producer Santos Ltd (ASX: STO) is a company you 'wouldn't touch at any price'. But we should take a moment to reconsider that view, because Santos could be the type of company to make you rich.
A lesson from the best
To understand why let's channel legendary U.S investor Howard Marks, co-founder of Oaktree Capital Management. As far as investing idols go I'm a big fan of Marks and his straight-shooting investment advice.
Marks has a contrarian style of investing and stresses that to beat the market and be better than the average investor you must think the way other investors don't and see things other investors miss.
"The truth is," says Marks, "the best buys are usually found in the things most people don't understand or believe in".
Right now energy is one of the investment ideas investors believe in the least and that is reflected in the share price of Santos, which has been crushed under the weight of falling energy prices. Even if investors understand the outlook for energy prices going forward, they certainly don't believe they'll show much recovery.
Underestimated?
Santos was caught on the back-foot when prices started falling as it had gambled on oil-linked LNG pricing rather than set contracted pricing. It is completely understandable that investors have lost faith in the company. But are they underestimating the long-term value that Santos could achieve?
"Large amounts of money (and by that I mean unusual returns) aren't made by buying what everybody likes. They're made by buying what everybody underestimates" – Howard Marks
The big picture for Santos is really anchored to long-term LNG demand which the company has spent the last decade positioning towards.
Will LNG rise again?
The focus then should be on the price for LNG and if it will rise, like a great Phoenix, to give Santos greater returns in the future.
Well, aside from a likely increase in price for gas on Australia's east coast, consensus opinion for global LNG suggests that the flood of LNG supply entering the market over the next 5 years (driven by new U.S. based projects) could still outstrip the increase in demand. This is expected to create a buyers' market which means prices will likely fall or be suppressed.
It's hard to argue a strong contrarian position against numbers that show supply exceeding demand, even for Santos which has been steadily reducing operating costs.
Looking beyond this to 2022, there are forecasters, including Santos, who see demand again outstripping supply, driving prices up. However, as we have seen, a lot can change in six years and longer range projections come with greater risk.
Weak contrarian case
Santos' share price could be set to rise in the short term if the price of oil rebounds from current lows, but calling it a meaningful, long-term contrarian investment case would seem to me to be a big stretch.
