Santos ‘hopenomics’ on oil price

Santos was one of many fossil fuel companies to announce write downs as part of the current reporting season, wiping US$1.5 billion off the value of their Gladstone LNG asset. This put Santos in second place overall among Market Forces’ list of fossil fuel write downs, but of greater interest was their future earnings.

As an oil and gas company, Santos’ revenue is critically tied to the oil price. But when we took a look at Santos’ estimates of the future oil price, they are making some very bold assumptions that tested the bullishness of brokers and analysts.

In the table below we have listed the oil price estimates from Santos and then compared these to estimates from brokers, analysts and several other Australian-based oil and gas companies.

According to Santos, for every $5 per barrel of oil that the price falls below their estimates they face an “impairment” (read: loss) of US$600 million. So in comparing the different forecast values of oil against the estimates made by Santos, we can also ascertain how much of a write down Santos would have to make if their forecasts are wrong.

Before we go on, let’s be clear on something. We don’t know what the oil price is going to be in the next five years and so we’re not saying someone is right and someone is wrong. What matters is that Santos is applying some of the most courageous estimates available and assuming its future revenues on this. If they’re right, well, lucky them. But looking at the spread of forecasts, it looks like Santos is forecasting next year’s revenues on a wing and a prayer.

If the likes of Deutsche Bank and Wood Mackenzie (who, by the way, provided their oil price forecast of $55/bbl in an analysis of Santos themselves) are right, it means a US$600 million write down is already on the cards for 2017.

If Santos had used the same projections released yesterday by Beach Energy, the company would face an impairment of US$1.2 billion in 2017 based on its own forward estimates.

Against those of Woodside for the same period, the impairment would amount to US$1.49 billion.

And Santos’ forecasts spread even further from the rest of the pack as the outlook extends into the future.

In other parts of the world, a stronger regulatory system means companies don’t get away with this kind of numerical sleight of hand. In the US for example, the Securities and Exchange Commission (SEC) – their version of ASIC – sets an oil price projection that all companies must use.

But here in Australia, oil and gas companies are able to set their own estimates of the future oil price, a factor that significantly influences asset values.

Across the resource market in general, it’s hard to avoid the conclusion that the regulators are asleep at the wheel.

Perhaps Santos are trying to keep their presumed book value afloat by picking the most optimistic forecast available for the price of oil. It might relieve some pressure on the company today but if they get this wrong…. next year is going to hurt.

Julien Vincent is a senior analyst with Market Forces