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Bigger not better: reservoir engineer

THE Beach Energy-Drillsearch Energy merger approved by Drillsearch shareholders this week, which could spark further Cooper Basin consolidation, is the worst thing the basin needs right now, for the same reason a speculated Origin Energy-Santos marriage is bad news, veteran reservoir engineer Don McMillan says.

Bigger not better: reservoir engineer

Queensland-based McMillan, who runs his own consultancy for valuations, reservoir and petroleum engineering and teaches CSG courses, told Energy News that the Cooper Basin's current "harvest phase" means a more prudent strategy from operators is needed than the merger and acquisition frenzy that low oil prices often prompt.

"It's a historical problem," said McMillan, who fields a plethora of calls from financial people in New York, Hong Kong and London for engineering and geology data on assets in Australia.

"When Santos was small the geology was quite large so it could grow into it quite well. Now having been there over four decades the fields are becoming depleted, the discoveries are becoming meagre, and the shale gas is just not going to happen as the next big play they were going into."

He said Santos' current size - even though its share price has shrunk from a $7.92 high last May to $2.90 yesterday - renders it too big to operate its marginal oil and gas fields.

"Bigger is not better," he said.

"Financial instruments will not solve the underlying issue that their individual oil and gas resources and company size is mismatched.

"More value to the shareholder would be generated by breaking [Santos] apart.

"Merging Origin and Santos together you'd think you're saving money but you're actually making things worse, because a lot of the Cooper Basin fields are in ‘harvest mode'.

"Once you're in that mode, when you merge them thinking bigger is better you actually speed up the decline of the fields.

"You need to break it up. It's just a natural evolution - these fields need to be moved onto a much smaller player who can concentrate their efforts and really boost the industry up."

That may be easier said than done, with low commodity prices exacerbating the dry capital markets that are crushing juniors across the resource space at the moment, and have done for the best part of the past three years.

Oil prices have just caught up with the general commodity malaise over the past 18 months.

McMillan said that as Origin, BG Group and Santos have "gobbled up" many of the small plays in the Cooper and elsewhere in north-east Australia, and most of the producers are now mostly billion-dollar companies when there should be a "splattering of companies" across the market cap spectrum.

"This has thrown the market completely out of equilibrium, which is why when these companies try selling assets they don't want to sell, they're going to have a problem finding a market," he said.

Morgan Stanley recently flagged concerns over Origin's inability to sell non-core assets at prices in line with valuations, while JP Morgan said new Santos CEO Kevin Gallagher could re-start the asset sale process to revive its bottom line when he starts his rescue mission of the Adelaide-based oiler next Monday.

Yet the problem, as McMillan sees it, is that commercial guns are now routinely hired to head up Australian mid-caps - and Beach poaching Oil Search general manager Matthew Kay as its new CEO, hailing his M&A experience to further one of its key strategic pillars going forward, is a classic example.

This trend has only been exacerbated by low oil prices which often trigger more consolidation.

Two separate analysts have flagged to Energy News that another Cooper player, Senex Energy, could be the combined Beach-Drillsearch entity's first takeover play.

"In the last two decades the commercial department has dominated the direction of companies, and there has been a big change to focus on deals," McMillan said.

"A good example is Beach's latest CEO announcement, which I personally think is the worst choice.

"They talked about how he's good at making deals … the problem with Beach is not deals. Getting bigger is not going to make it better.

"The Drillsearch-Beach merger, which I thought was absolutely ridiculous, takes two mediocre companies to supposedly make something special, but it won't.

"It would have been better for Beach to offload some of its assets into Drillsearch to give it some strength to move forward.

"These days, commercial guys think deals can fix a problem, but you need to get the engineers and geoscientists back in charge of these companies so they can get out there and get their fingers dirty by digging holes."

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