Irrationality and Lord Keynes' end game

THE latest revelations about Santos underline the urgency of last week's suggestion from <i>Slugcatcher</i> that a merger with Origin Energy makes admirable sense, but before a Santos refresher there is an even more interesting topic to explore; the Kingdom versus The Lord.

Irrationality and Lord Keynes' end game

The topic, while soundly decidedly biblical, could not be further from religious matters because the Kingdom in question is that of Saudi Arabia and The Lord is a man who specialised in money matters, John Maynard Keynes, also known as Baron Keynes of Tilton.

According to the latest report on the price of oil, fresh from the snowfields of Davos in Switzerland where the World Economic Forum is underway, Saudi Arabia's top oilman reckons the price at $US30 a barrel is "irrational".

Khalid al-Falih, chairman of Saudi Aramco, also told media representatives that the oil price has "overshot on the low side and it is inevitable that it will start turning up".

Fingers crossed that the man from Riyadh is right and that the price continues the recovery seen late last week because the slide into the high $20/bbl was rather worrying.

Unfortunately for Falih his choice of words were somewhat inappropriate because while he might be correct in calling $30/bbl oil an irrational price, the question of markets being rational was brilliantly addressed by Lord Keynes in the 1930s.

"Markets can remain irrational longer than you can remain solvent," was the memorable comment Keynes made when stock market prices were in a prolonged slump and some of the world's best companies were being priced as if they were penny dreadfuls.

Saudi Arabia is one of the better placed oil producers to ride out the oil price storm because it has a large cash buffer to prop up its weakening economy.

Other countries are not so fortunate and it's The Slug's prediction that we're drifting close to a sovereign debt and solvency crisis in a number of countries and companies with both of those entities quite capable of financial collapse.

In the case of companies a financial failure is simply a matter of bankruptcy in its many forms with the most extreme being the break-up and sale of a company's assets and the most benign being a work-out process such as Chapter 11 in the US, a procedure by which a company can achieve an orderly restructuring.

Countries do not have a version of Chapter 11. They simply stop servicing their debts, allow their economies to crash, and hope that civil war is avoided.

Venezuela is the country being watched most closely by international markets because it is sliding perilously close to a crisis which started with profligate government spending on social welfare and is being finished off by oil at $30/bbl, or thereabouts.

If looked at through Falih's rose-coloured spectacles, the current period of irrational oil pricing will eventually come to an end - and he is certainly correct with that view, though how long it will take is the important question.

Enter Lord Keynes (again) because he had another wonderful saying which covers the hopes of people who believe that everything changes "in the long run".

"The long run is a misleading guide to current affairs. In the long run we are all dead," said the gloomy Lord.

What's any of this got to do with Santos? Lots, actually.

Last week, when a possible merger between Santos and Origin was the hot topic, there were plenty of critics who said it would never happen because both companies were fiercely independent and it would be too hard to integrate their LNG interests because of third-party involvement.

Since then Santos and its suffering shareholders got a fresh glimpse of the future if the oil price does stay in the irrational world of $30/bbl.

First came news on Wednesday that Santos' share price had dropped to a fresh 12-month low of $2.46, a price which valued the company at $4.34 billion, an embarrassingly low point for a business once valued at $15 billion.

The second hit came when management warned of fresh asset-value write-downs less than two months after it raised $2.5 billion in fresh equity at $4.60 a share, and three months since management rejected a merger proposal from Scepter Partners when it was trading at around $5.50 a share.

The value gaps between last week's share price low, the equity raising and the merger proposal narrowed a little on Friday when Santos staged a pleasing recovery to end the week at $2.84.

However, if the oil market decides to side with Lord Keynes and remain irrational for longer, then the second part of his famous saying, solvency, comes into question which is why Standard & Poor's shifted Santos's credit rating last week to one notch above junk.

Irrationality and solvency continue to lurk in the background for everyone in the oil game, though hopefully not for how Keynes saw what happens to everyone - in the long run.


A growing series of reports, each focused on a key discussion point for the energy sector, brought to you by the Energy News Bulletin Intelligence team.

A growing series of reports, each focused on a key discussion point for the energy sector, brought to you by the Energy News Bulletin Intelligence team.


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