December 28, 2006 - 12:35pm EST by
2006 2007
Price: 9.88 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 5,911 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Investment Thesis


Santos (STO.AU) is a cheap/stressed value Australian equity.  STO has traded down from A$13 to A$9.87 on issues relating to an Indonesian JV – Banjar Panji.  The long investment thesis is premised on a macro view on commodity prices – forward energy prices are accurately reflected in the futures markets.  If one expects oil to trade at under $40 long term this is not the right investment.  The catalyst is the equity market overreaction to the Banjar Panji JV dissipating with time.  The stock currently trades at under 4 times EV/EBITDA with a dividend yield of 4%. 


Company Background


  • Santos is an Australian-based oil and gas E&P company with interests and operations in Australia, United States, Indonesia, Papua New Guinea, Vietnam, Kyrgyzstan and Egypt.
  • Santos is one of Australia's largest oil and gas producers, supplying sales gas to all mainland Australian states and territories and oil and liquids to domestic and international customers.
  • The Cooper Basin, which Santos and its joint venture partners have developed in central Australia, is Australia's largest onshore resource project.






Fiscal YE                                             2005                2006E              2007E             


Valuation Ratios


P/E adjusted (x)                                    8.7                   7.2                   7.6                  


EV/EBITDA                                        4.4                   3.8                   3.8                  


Dividend yield                           3.9                   4.1                   4.2                  


EBITDA                                              1,637               1,902               1,830              


Operating cash flow                              1,458               1,598               1,470              


Assumption of oil at US $60.  Production at 66 MMboe.


STO.AU is cheaper than most international mid-cap E&P companies.  STO.AU has a stable cash flow generating domestic onshore natural gas franchise.  The international E&P operations are more exploratory and risk in nature but have greater upside and optionality to the pacific basin LNG sector. 


STO is trading at P/E of 8 versus 12, 4 EV.EBITDA of 4 versus 6 and a dividend yield of 4% vesus1.6% for comparable E&P companies in Australia (Tap Oil. Woodside, Roc Oil, Origin Energy, Oil Search, Beach, AWE). 


The trading in line with comps – STO should trade around A$12.  There is additional upside as projects in Vietnam and additional LNG trains at Darwin come on line. Downside is protected by underlying asset value of approx A$10 per share with no value given for Jeruk, Banjar Panji or additional Darwin LNG train. 


The market has reacted negatively to the Banjar Panji accident and to lower than expected output/reserves at the Jeruk project in Indonesia.   Even writing off the Jeruk project and Banjar Panji project – STO.AU has a good pipeline of projects in its international and offshore portfolio and a stable cash flows from its domestic operations to fund its capital investment program, debt liabilities and its equity dividend.


Banjar Panji Event


Banjar Panji JV has been the main overhang on STO.  The main issues with Banjar Panji are liabilities arising from the drilling accident and the impact of the accident on the relationship STO has with the government in Indonesia. 


The uncertainty relating to the Banjar Panji accident has become a significant overhang on STO stock.  The sell side analysts covering the situation have STO’s liability number ranging from $180 mil. to over $1 bil.  This uncertainty in liability along with Indonesian (emerging market) location has negatively impacted STO stock. 


Banjar Panji Accident


Banjar Panji-1, which is located onshore East Java in the Indonesian Brantas PSC, was drilling in late May 2006, two days after an earthquake when the well intercepted a mud volcano at depth. It is estimated that the mud is flowing at between 100,000 to 150,000cm/day, which equates to a very significant 600,000 to 900,000bbls of mud/day. So far the mud flow covers an area of around 435 hectares and has resulted in around 3,500 families being relocated. investor relations web site has a presentation on the Banjar Panji accident. 


JV Partners


The JV participants in Banjar Panji-1 are Lapindo Brantas 50% (Operator), PT Medco 32% and Santos 18%. Lapindo Brantas (Lapindo) is a wholly owned subsidiary of Energi Persada (ENRG). The Bakrie Group holds 50+% of ENRG, which has assets of US$850M. The well contractor was Alton International Indonesia, which is apart of the Bakrie stable of companies. The Bakrie Group used to be run by Aburizal Bakrie Indonesia's Minister for Welfare.


Banjar Panji Timeline


  • March 2006: PT Bumi Resources (Bumi) which is controlled by the Bakrie Group, signed an agreement to sell three coal mining companies to an unrelated party for a total of $US3.2bn. Under the deal, Bumi would sell its 95% interest in PT Kaltim Prima Coal and its 100% interests in PT Arutmin and IndoCoal Resources. The deal fell over due to rising opex costs and failure to agree on any revised valuation.


  • June 2006: Bumi announces plans to merge with ENRG. Both of theses companies are controlled by the Indonesian Bakrie Group. June 2006: Despite the collapse in Bumi’s deal to sell its mining assets, it still declared its intention to merge with ENRG, making the combined entity the largest natural resources company in Indonesia.


  • September 2006: As the mud flow continued and remedial work continued ENRG announced plans to sell its shares in the entities that controlled 100% of Lapindo to the Bakrie Group. Lapindo is the operator and owner of the 50% interest in the Brantas PSC.  This action was believed to underlie the Bakrie Group’s commitment to resolving the well control incident. The motivation for ENRG as documented by them was an attempt to protect ENRG’s minority shareholders and directors (ex Bakrie Group) and allow ENRG to focus on growing its remaining business. The intention was to move the liability in its entirety to the Bakrie Group.


  • October 2006: Indonesia’s President and Minister for Welfare Aburizal Bakrie visit the site of the mud flow.


  • November 8 2006: Bumi confirmed growing market speculation that it would cancel plans to merge with ENRG after its failure to sell its mining assets and gain approval from the financial regulators to spin off ENRG’s wholly owned subsidiary Lapindo.


  • November 14 2006: ENRG announces instead plans to sell Lapindo to Freehold Group (incorporated in the Virgin Islands) a friendly but unrelated third party to the Bakerie Group. This latter transaction in particular increased the JV participants risk to the Banjar Panji well incident. Although the Bakrie Group continued to express commitment to providing finance to Lapindo, the market became increasingly concerned that the third party could allow Lapindo to become insolvent.


  • November 2006: Medco a 32% participant in Banjar Panji-1 is files a law suit against Lapindo through the International Arbitration Association in New York. If the arbitration is successful it will absolve Medco of all financial responsibility for the mudflow. Santos has yet to seek arbitration. According to the operator the Brantas PSC is a joint operating agreement between all JV participants. The agreement involves performing exploration, exploitation and oil and gas production in the Brantas PSC.


  • November 27 2006: ENRG announced that it had cancelled plans to sell Lapindo to Freehold, following failure to gain acceptance for the transaction from theIndonesian regulators. The Indonesian regulators are forcing accountability of the disaster on ENRG/Lapindo Brantas.


  • December 12, 2006:  Bloomberg Story - PT Energi Mega Persada's unit Lapindo Brantas Inc. must pay 3.8 trillion rupiah ($421 million) to cover repairs and losses after gas exploration drilling in East Java triggered a mud flow disaster, Indonesia's President Susilo Bambang Yudhoyono said.      ``It has not been possible to stop the mud flow, this is a fact that I have to convey openly,'' Yudhoyono told reporters in Jakarta today. ``The cost must be covered by Lapindo.''      The mud started flowing from a well after a blowout on May 29 and has inundated homes, rice fields, factories and roads and displaced more than 12,000 villagers.   Lapindo is the operator and owns 50 percent of the so-called production sharing contract, or drilling license, in the area.  Yudhoyono didn't state whether Lapindo's two partners in the field, PT Medco Energi Internasional, which owns 32 percent of the venture, and Australia's Santos Ltd., which owns 18 percent, must share the costs.  The cost of managing and stopping the mud flow ill reach 1.3 trillion rupiah, while compensation and aid for villagers and workers who lost their homes, rice fields and jobs will be 2.5 trillion rupiah, Yudhoyono said. Lapindo must pay 20 percent of the 2.5 trillion rupiah as a down-payment for the villagers in March.   In October, Energi Mega said that the cost of covering the damages from the mud flow incident will reach $180 million. UBS AG estimated last month that the costs may quadruple to $750 million.


Risk Factors


Lack of Corporate Control Actions:  STO ownership is restricted to 15% by the government of South Australia.  It is very unlikely than any corporate change – merger or a  spin off - can be imposed by shareholders on STO


Commodity Risk:  A long term decline in oil and natural gas commodity prices. 


Indonesian Sovereign and Legal Risk:  STO operates its E&P operations in developing countries.  There is some emerging market and sovereign risk.  But STO revenues are mainly $ denominated as its underlying commodities are global traded and its costs in developing countries is not dollar denominated.


Value Catalysts


Resolution or better understanding of Banjar Panji accident by the market:  The resolution of the Banjar Panji accident and the realization that STO is a minority member of a JV with limited liability.  The other JV member is Medco Enrgi – the largest E&P company in Indonesia with good political connections.  It is unlikely than Indonesia which needs foreign direct investment in its E&P sector will impose liabilities only on STO and not its Indonesian JV partners.  On Jeruk the government of Indonesia is urging STO to develop the Jeruk field.  Given Indonesia need for energy it is unlikely the government will undertake actions to hindering foreign investment in the sector.  Indonesia was a need importer of oil for May, June and July of 2006 – not a desirable position for a member of OPEC to have to import oil as existing fields mature and domestic consumption increases. 


STO has stated that they are adequately covered by their insurance. 


Blackbird Vietnam


  • Santos recently announced that they have delineated a 70+ metres of net oil pay from the offshore Vietnam well Blackbird-1 (net 37.5%).
  • The Blackbird find comes hot on the heels of the Dua oil discovery made almost 2-months ago. The two fields are located within the same block and are within tie-back distance to each other.
  • The pre-drill estimate was for 50Mbbls-100MMbbls of oil.  

LNG Optionality


STO has made significant investments in LNG – Darwin LNG (supplied by Caldita/Barossa fields).  As global LNG market and the Pacific Basin LNG market develop, STO by adding another LNG train at the Darwin LNG facilities could have significant upside.  Another LNG train at Darwin could make STO the most exposed independent E&P firm to LNG. 


Resolution of Banjar Panji JV drilling accident
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