The huge hidden risk facing Woodside, Santos

WOODSIDE Petroleum and Santos are among the highest-risk Aussie players as requirements to continually replace reserves under current oil prices threaten to strangle returns for investors over the next five years, analysts say.
The huge hidden risk facing Woodside, Santos The huge hidden risk facing Woodside, Santos The huge hidden risk facing Woodside, Santos The huge hidden risk facing Woodside, Santos The huge hidden risk facing Woodside, Santos

Barely 12 months ago both Woodside and Santos were beacons in the Australian oil and gas patch, with growing earnings giving confidence they'll be around for decades to come.

But with both companies ramping up production and recently announcing at least 20% cuts in capex for 2015 doubts are growing over how the companies' reactions to the current oil slump will affect their future.

"As low oil prices drag on there is a growing risk that, without the ample revenues to fund new capital intensive exploration projects, growing production will mean pools of energy reserves start to be depleted," Motley Fool analyst Regan Pearson said yesterday.

Santos announced in December it would shed 26% ($500 million) from its 2015 expenditure budget targeting growth, while Woodside plans on trimming back around 20% from its total 2015 capital expenditure plan.

Pearson noted that at current rates of production, Woodside has about 14 years of reserves, while Santos has a longer reserve life of around 23 years.

In this area, Santos' fellow Australian-listed Cooper Basin player, mid-tier producer Senex Energy, has them both beat, having around 27 years' worth of reserves.

Total 2P (proved plus probable) reserves for both Woodside and Santos have been declining over the last three years, Pearson said, while Woodside is hitting record production and Santos expected to start increasing its rate of production helped by the start-up of the Queensland-based Gladstone LNG joint venture.

"Without continued investment in exploration, reserve lives will continue to stall," Pearson said.

"The alternative is to funnel an increasing percentage of free-cash into trying to replace reserves in the short term which could mean lower distributions to shareholders."

One temporary solution, he suggested, is for producers with shorter reserve lives to buy production from other companies to meet long-term supply contracts, or acquire smaller producers to grow reserves.

"This is an approach Woodside has taken with the purchase of additional oil and LNG assets from Apache Corporation which could add between 3 to 4 million barrels of oil equivalent of production in 2015," Pearson said.

Although long term the LNG industry faces the prospect of supply short-falls and increasing prices, the requirement to continually replace reserves under the current low oil prices could strangle returns for investors over the next five years.

Upgrading his recommendation on Woodside from "sell" to "hold" in December, analyst Gaurav Sodhi said the $4.6 billion worth of purchases from Apache go a long way towards remedying his prime concern with the company that was it was not adequately investing in its business, allowing reserves to dwindle without replacement.

"The oil price collapse has shocked the industry and caused a rush of asset sales and development freezes," Sodhi said.

"Woodside, with a cash rich balance sheet, now has plenty of options to buy distressed assets at bargain prices to correct its reserves decline.

"Management is doing just that, having announced $4.6 billion worth of purchases from Apache, including a stake in the Wheatsone LNG project in [Western] Australia and some Canadian oil and gas assets.

"These are excellent purchases at attractive prices - the Wheatstone purchase was bought at a discount to sunk costs - and remedy our prime concern with the company.

"With lower prices and new projects in place, there is no longer a case for selling Woodside and we will investigate the buy case if prices weaken further."

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