Santos Limited (STOSY)
Q2 2007 Earnings Call
August 22, 2007, 7:00 PM ET
John Ellice-Flint - Managing Director & CEO
Peter Wasow - CFO
|TRANSCRIPT SPONSOR |
John Ellice-Flint - Managing Director and Chief Executive Officer
Good morning, and thanks for joining us for our 2007 Interim Results. In this presentation, we will highlight the ways in which we are delivering operationally, transforming our business towards higher margins and monetizing contingent resources.
In today's webcast, I will initially provide a brief overview of the results and we will then hand over to Peter Wasow, our Chief Financial Officer to run through the financials in more detail. Following that, I will discuss our strategic value drivers and outlook in the context of our unique portfolio of five growth businesses.
I am pleased to report that our record of production growth continued in 2007. First half production of 30.1 million barrels of oil equivalent was a record for the Company. And we remain on track to achieve our guidance of between 59 million and 61 million barrels for the full year. First half sales revenue has grown at a compound rate of over 20% for the last three years and stands at over $1.2 billion. This is slightly lower than last year, reflecting in part, the negative impact of the stronger Australian dollar.
Production cost per barrel increased by 8% year-on-year, a credible result in this hyperinflationary environment. As a result, earnings before interest, tax, depreciation, amortization and exploration decreased by 4% to $964 million. Compound growth in EBITDAX has been more than 27% for the last three years.
Reported net profit after tax of $262 million was 29% lower; although, this figure was negatively impacted by a number of one-off expenses. Underlying net profit after tax after adjusting for non-recurring items, decreased by 25% to $305 million. Peter will elaborate on the profit results shortly. A final dividend of $0.20 per share has been declared which is unchanged from 2006.
Safety is one of our highest priorities, and pleasingly our total recordable case frequency rate has resumed its downward trend over the last nine years. This reflects a high degree of focus on safety performance across all of our operations.
In the first half of 2007, we advanced the ball in a number of areas. On this slide, we have grouped our progress under the areas that drive our day-to-day activities at Santos; delivering operationally, transitioning to a higher margin business and converting contingent resources into production and cash flow.
Looking at operational delivery first, we see record production and at a level which is consistent with our guidance. And we have done so while controlling our costs.
Our objective of growing in higher margin businesses is evident across our asset base. The Cooper Oil Project is an attractive exploitation program, which is unique to Santos. In Western Australia, where gas prices have more than doubled, we continue to commercialize reserves, most recently, with the announcement to develop the Reindeer Field. In Eastern Australia, we are the largest producer of both conventional and coal seam gas. With large un-contracted reserves and resources, we are well placed to meet growing demand and to benefit from higher prices.
Our objective of converting continued resources has taken some large steps forward in the past half year with our payment of past costs on the PNG LNG project and the announcement on Gladstone LNG.
In addition to managing our new business opportunities, we continue to optimize our existing portfolio and capital structure. During the half, we sold our U.S. business, completed a successful off market share buyback and asked the South Australian government to review the 15% shareholder cap. We welcome the government's decision to initiate such a review. And in its submission, Santos makes, what we believe is a compelling case for its removal. In particular, cap removal will enable Santos to reach its full growth potential. The government has indicated that it will announce the outcome of its review by the end of September.
With that introduction, I will hand over to Peter to run through our financial and operational performance in more detail.
Peter Wasow - Chief Financial Officer
Good morning. As you have gleaned John’s introduction and summary comments, the 2007 interim results represents a solid performance for the company, which is in line with our commitments. Production is 5% higher than for the first half of 2006. Nonetheless the underlying profit is down by 25.5% on the half and the headline profit is down by 29%.
Our margins, like the margins for all resource companies have suffered from the rising, but recently fallen Australian dollar. This chart shows how last year’s first half profit of $370 million compares with the $262 million profit for 2007. After removing the significant items from both results, we can see that the underlying profit has decreased from $407 million to $305 million this year. I will discuss in more detail, the factors driving the $102 million decrease in underlying profit shortly. Just let me say for now that market prices are a large part of the story.
The significant items for this half year comprised a write-down of $75 million on the sale of our U.S. business and the $32 million after-tax gain recognized on our increased interest in the Bayu-Undan field as a result of the re-determination concluded during the first half of the year.
Production for the first half of 2007 rose by 5% to a new record level and put us on track to deliver our production guidance of between 59 million and 61 million barrels of oil equivalent for 2007. Gas production increased by 11%. Additional volumes from Casino, Fairview, Maleo and Darwin LNG more than offset decline in other areas. The Maleo field continues to operate under a production constraint, due to pipeline capacity restrictions, which when resolved would immediately add about 1 million barrels of oil equivalent per annum to production. Oil production was flat at 6.3 million barrels for the half.
The Mutineer Exeter field continued to perform strongly, but progress on the Cooper Oil exploitation program was hampered by flooding in Central Australia during the period. Condensate and LPG production, both fell, mainly due to the Bayu-Undan field moving out of the cost recovery phase, which resulted in lower net entitlement under the PSC terms. LNG production increased as this half represented the first full half year of production from Darwin and was marginally higher due to our higher interest.
A detailed analysis of the production story can be found in our second quarter production report, which was published a couple of weeks ago and is also available on this website.
Sales volumes in the first half of 2007 were flat compared to the first half of 2006 despite higher production. This is due to third party gas volumes being replaced by our own production in 2007. Santos’ continued diversification away from traditional gas production sources is evident in the period as increased sales from Darwin LNG, Maleo, Casino and Fairview replaced Cooper Basin gas.
We can see from this chart how lower Australian dollar liquids prices were the principal factors in the lower sales revenue. The main cause was an Australian dollar, which was almost 10% higher against its U.S. counterpart. Had exchange rates been constant, sales revenue would have been approximately $80 million higher. Average gas sales prices were 2.2% higher overall. This modest increase masks an even higher 7% increase in Australian domestic gas prices as the increased exchange rates also impacted the reporting of our international gas sales revenue in Australian dollars.
In terms of our overall sales mix, liquids volumes were down slightly by 0.7 million barrels, which was mostly offset by 0.5 million barrels of higher LNG sales volumes. The lower LNG sales value per barrel of oil equivalent resulted in a small negative variance due to a lower value sales mix.
As a net receiver of U.S. dollars, the recent realignment of the Australian and U.S. currencies has provided welcome uplift in value.
At the end of 2006, I reported that Santos' production costs on a unit basis had declined year-on-year, which was contrary to the industry trends that had seen other companies report rising costs as a result of materials and services cost inflation. Santos continues its focus on cost control, but in this half we have seen production costs increase 8% on a dollars per barrel basis, as a result of three main factors, none of which is a general increase in costs.
Firstly, a structural change due to the start-up of the Maleo field in October 2006. Maleo is a higher cost of production field as we include the cost of least operating facilities in lifting costs. Maleo costs account for most of the increases attributed to new fields and volumes in the chart on your screen. I also note that the production constraints at the Maleo field, which I referred to earlier have the effect of exaggerating this impact on a unit basis.
Secondly, the ramp-up of our Cooper Oil exploitation program continues and this has added approximately half of the cost increases shown in the chart. Finally, the cost increases, as a result of the ramp-up in Cooper oil have outpaced the increase in Cooper oil production. Flooding in Central Australia during the first half of this year significantly slowed progress during the period, and therefore contributed to the dollar per barrel cost increase.
We are, like everyone else, feeling the pinch of increasing services and materials costs. However, we have continued to maintain our cost disciplines, the benefit of which is apparent from this analysis, which shows that most of the increases in production costs have been driven by factors other than general cost pressures.
Apart from the effects of higher exchange rates, our margins have largely been maintained. On a dollars-per-barrel basis, our net back or cash margin per barrel sold is 6% lower. And accounting for the decrease, we see that the lower Australian dollar reduced margins by 7%. Other factors, including higher gas prices and lower PRIT expense largely cancel each other out, leaving margins per barrel slightly up on equivalent price basis. And so, while we have not been immune to the impact of higher exchange rates, we have been successful inhibiting the impact on our margins in the areas we can control.
Looking at our cash margins in absolute terms, we see EBITDAX decreasing by $43 million. Partially offsetting the impacts of lower prices, was the $44 million gain recognized as a result of Santos’ interest in the Bayu-Undan field, increasing from 10.6% to 11.4%. This represents a 7.5% increase in our working interest. And I think the incremental value from this outcome was lost on some market commentators. Bayu-Undan ranks as one of our top two assets by value. So the re-determination impact is clearly positive as the accounting demonstrates.
DD&A is up against the corresponding period, but importantly is down $1 per barrel versus the full year rate for 2006. Santos formally reviews its reserves annually including future development costs, and when there are out changes, inter period comparisons are difficult. You may recall that at the end of 2006, the rate increases we reported were largely attributed to higher future development and restoration costs and higher provisions, as a result of lower discount rates. The average DD&A rate per barrel for 2006 was $11.35, which was much higher than the rate in the first half. Comparing depletion and depreciation expense, for the first half of 2007 to the first half of 2006, therefore shows an increase as indicated in the chart. The only structural changes in depletion and depreciation were positive.
During the period Maleo commenced production, but this was more than offset by the cessation of depletion and depreciation for our US activities. As a result, the average DD&A rate for the half year has fallen to $10.42 per barrel of oil equivalent. Reserves, future development costs, restoration obligations and the useful lives of assets will be formerly reassessed again at the year end 2007.
Operating cash flow for the first half of 2007 was $538 million, or $105 million lower than for the first half of 2006. The 2006 first half operating cash flow of $643 million included $95 million of insurance proceeds relating to the 2004 Moomba incident. The first half of 2007 includes higher tax payments of $91 million, as a result of higher profits last year. Favorable working capital movements totaled $107 million. The ongoing capital investment program exceeded operating cash flow by $86 million, and together with the share buyback, completed on the 30th of June resulted in a small increase in gearing over 2006 year end levels.
Santos has continued its substantial investment program across all areas of its business with $628 million expended in the first half of 2007. This slide shows our first half capital expenditure and full year outlook by strategic theme with comparisons to last year. The three key features of the chart are the significant ramp up of our Cooper oil program, which is evident with $192 million spent in the first half of the year where 69 delineation and development wells were drilled.
Second, a substantial reduction in our expenditure in Asia, as the Maleo project has been brought on to production and the Oyong project spend reduces, as we approach production start-up in the next month.
Last, the increased spend in Eastern Australian gas includes additional spending on development of the Fairview field where 32 wells were drilled in the half.
Included in the LNG spend is $37 million relating Bayu-Undan catch-up payments for prior year's capital expenditure, as a result of Santos’ increased interest in the field. Also included in our Asian spend is the $30 million payment for Santos’ participation in the PNG LNG project.
Exploration expenditure in the first half of 2007 was only $45 million as the 2007 program is significantly back-end loaded. Some additional analysis of exploration and evaluation expense is included in the reference slides for those who might be interested.
The second quarter production report also includes more details on the capital expenditure program.
Our outlook for 2007 is for capital expenditure of approximately $1.3 billion, which includes a further $129 million on exploration. On the capital structure front, the first half saw the company complete a $300 million off market share buyback with a repurchase of 4.1% of issued capital at the maximum discount to market of 14%. This was an efficient way of distributing approximately $100 million of franking credits.
Thanks for listening. I’ll now hand back to John.
John Ellice-Flint - Managing Director and Chief Executive Officer
Thanks Peter. The Santos portfolio comprises five strong business positions. Each of these is built on a new competitive advantage and we see the power of the portfolio in the way each exploits the core competencies the company is built on. These are, understanding and applying the principle of basin excellence, which in turn enhances our ability to discover oil and gas. The ability to commercialize discovered oil and gas resources. World class project development skills to bring these projects to fruition. And operating expertise to deliver the maximum value. These competencies are what make Santos worth more than simply a collection of oil and gas assets. Let me elaborate on each of the business themes in more detail.
The Cooper oil project is really about the application for the first time of proven oil and gas technologies to a commanding acreage position in a world class hydrocarbon province. We started in 2004 with a pilot program that proved the constant. From there we have consolidated our position and imported three state-of-the-art drilling rigs. We ramped up activity levels in early 2006 and focused in the under-drilled Endeavour, Mulberry, Tarbat and Tirrawarra areas in Queensland. Success in this area then led us to contract a fourth rig which was commissioned in the second quarter of this year. To date, the project metrics are positive with a total of a 190 wells drilled and a success rate of 78%. Based on this success, we have continued to increase our net acreage position through acquisition and farming. And we are now diversifying the project from a geological and geographical perspective, as we move into different parts of the basin and target different reservoir horizons.
The primary focus of the Cooper oil project is to increase oil recovery through a variety of techniques which have been well proven elsewhere but which are new to onshore Australia. To date, Cooper Basin oil exploitation has relied on primary recovery techniques.
Enhancing oil production through secondary recovery will play a key part in the project. Unlike development drilling, where the results are instantaneous, the benefits of water flooding can take longer to materialize. An example of this is the Mulberry 5 well in the Tirrawarra block. As you can see from the chart, this well exhibited a steep decline of approximately 50% in its first year under primary recovery alone. This was due to the pressure in the reservoir depleting as we produced the oil. In June 2006, we started injecting water into the Mulberry reservoir to restore pressure, and within six months, the rate had increased back to previous highs. This is an ideal response as the water injection increased the reservoir pressure and pushed oil towards the producing wells. Whilst I stress that it is early days, results such as this bode well for the future and give us the confidence to continue to invest in the necessary infrastructure.
Further enhancing production through tertiary recovery techniques is the next logical step. The use of carbon dioxide flood is now doing actively examined for a potential startup in 2010. All going well, this would not only further increase oil reserves and production rates, but would also effectively sequester carbon dioxide and reduce greenhouse gas emissions.
And so let’s have a look at what we have achieved in the first half of 2007. The initial focus of the project has been the Tirrawarra area in Queensland with over a 110 wells drilled to date. Infrastructure has been put in place to minimize the total cost of production. This includes gas fired power generation, transmission lines, a pipeline from Tarbat to Jackson and water flood facilities.
Through farmings and acquisitions we have increased our net oil acreage position by 25% since 2005 to approximately 28,700 square kilometers today. During the second half of 2007 we’re diversifying our program into other areas of the Cooper Basin in both South Australia and Queensland with rigs currently drilling in the Naccowlah, McKinley and Jenna fields.
In an another initiative to reduce costs, we are drilling… currently drilling four deviated wells from the same surface location in the Mulberry field. This results in a rig move time of less than 12 hours. As we have previously flagged, unseasonably high rainfall levels in Central Australia over the first half of the year impeded our ability to bring new well capacity online and resulted in the deferral of some production. In total, over 40 drilling rig days, 80 work-over rig days and a 160 flow-line construction days were lost due to the flooding, although operations are now back to normal. The discovery of deeper high pore point oil in a number of high flow-rate wells has resulted in the shutting of some production. Contingency planning is well advanced to return these wells to service.
The Moonie to Brisbane oil export pipeline has currently shut-in which has necessitated tracking oil from Jackson to Moomba. We are considering a new pipeline to transport all of the oil from Southwest Queensland to Moomba in the future. All up, the crude properties and tracking issues are causing the deferral of approximately 3,600 barrels per day of production. We now expect to drill a 150 wells this year and whilst production capacity will increase to almost 17,000 barrels per day by the end of the year; actual production is expected to reach to approximately 14,000 barrels per day.
In 2008, we’ll also be acquiring further seismic data to grow our inventory of drillable propspects. Overall the original value proposition is intact and our tactics remain sound.
Now to Eastern Australian Gas. What was once a relatively staid, low volatility business is now in transformation. Over the last few years, we’ve seen a number of game changes including new pipeline interconnections which have improved market flexibility and the emergence of coal seam gas as a credible and reliable source of supply. Along with these supply changes, domestic gas demand is rapidly increasing. After taking account of carbon impacts on global warming, gas is now seen as the fuel of choice for the next generation of power stations in Eastern Australia.
Santos is in a very strong competitive position to be a primary beneficiary of these changes. We have a high quality portfolio of strategically important assets and infrastructure in our hub and spoke strategy. We are low cost producers. In coal seam gas our Fairview field rates is one of the best assets globally and we are continuing to build in our leading position in the sector.
In the Otway Basin, the Henry and Kipper development projects are progressing and we plan to drill five exploration wells in this region during 2008. We have large un-contracted gas reserves in a rising gas price environment. Our depleted reservoirs are well suited to carbon sequestration and our proposed Gladstone LNG project will forever change the dynamics of the Eastern Gas market by providing an export alternative for local gas production.
For some time, we have expressed the view that the low gas prices in Eastern Australia are not sustainable. This slide demonstrates the stark difference between the Asian LNG prices and Santos’ average realized gas price. And this is notwithstanding the fact that we have seen our realized gas prices ex-Moomba increase by approximately 40% over four years.
The shaded area in the middle of the graph is a theoretical net-back price for LNG which takes account of the extra liquefaction and shipping cost. This clearly demonstrates the significant incentive that exists for gas producers to sell into the high value LNG market. And Gladstone LNG will provide Santos with this opportunity.
The Mutineer Exeter oil development has continued its strong production performance during the first half. Since start-up in March 2005, the two fields have produced a combined 43 million barrels, which is 70% of the original to-pay [ph] reserves of 61 million barrels.
Late last year we acquired a high definition 3D survey over the fields, which has now been interpreted. This new data has given us increased confidence as we head into the 2007 phase for drilling program. In addition, the seismic data has highlighted a number of attractive 2008 appraisal targets including a possible South-West extension of Mutineer and a North-East extension of Exeter.
Gross production rates are presently around 30,000 barrels of oil per day with three wells requiring workover to repair electrical submersible pumps. This remediation work is expected to increase production rates by a further 10,000 barrels per day.
Gas margins in Western Australia are improving rapidly. Santos has been able to write new gas contracts with recent sales at prices of over $7 per GJ. This higher price environment also allows us to monetize previously contingent resources to supply this growing market.
Last year’s successful appraisal of the Reindeer gas company which has up to 640 PJ of recoverable resource has enabled us to move forward with FEED for this project. This represents a significant new source of gas supply for Western Australian market and we are aiming for first production in 2010.
And all the while, the John Brookes gas field continues to operate at maximum capacity with excellent field performance and reliability.
Today much of our gas production is in the relatively low volatility, but currently low priced domestic gas business. Consistent with our objective of targeting higher margin businesses, LNG will pay an increasingly important role as a high value market for our gas.
Demand for LNG remains strong, particularly in the Asian region. This is reflected in the positive trend in the LNG pricing from a low in 2003 to a position where LNG prices are now at parity with oil. Against this backdrop, Santos is now up to five potential LNG opportunities. In fact, by 2020 over half of our LNG production will be LNG, which is the ultimate expression of our ambition to move to a portfolio of higher margin businesses.
For a company of Santos’ size, this is a significant opportunity set and we continue to focus on progressing these various projects and monetizing the large contingent resources pointed at this market.
A great example of the progress we are making is the recent announcement of our proposal to construct 3 million to 4 million ton per annum LNG plant at Gladstone using coal seam gas as the FEED stock. This is the culmination of several years of feasibility work including resource definition, site selection, engineering studies and market assessments. Importantly, we now have secured a suitable site and have received significant project status from the Queensland government.
We have also been inundated with interest from potential customers and prospective partners. They all recognize the potential of our project to supply gas from a low risk onshore development in a stable political environment on the doorstep of Asia’s insatiable energy demand. This project is transformational for Santos. Not only does it give us the ability to commercialize large quantities of contingent coal seam gas resources, it also targets these resources towards a rapidly growing, high value and deep international market. We firmly believe that the project is technically and commercially feasible. However, more work remains, as we strive to reach final investment decision in 2009.
Last week, Santos’ board approved the expenditure of more than $300 million over the next 18 months to progress the expansion of our coal seam gas reserves and production base.
The Timor Bonaparte basin is clearly seen as an important LNG region for Australia, and Santos is one of the most active players. Recent industry positioning has seen several major companies enter the region including Exxon Mobil, Total and Reliance. The existing LNG plant in Darwin continues to perform at full capacity. The recent re-determination of working interest in this field was a positive for Santos, with our interest increasing from approximately 10.6% to 11.4%. Santos has now acquired over 6,000 square kilometers of 3D seismic representing the largest proprietary 3D survey ever undertaken off shore Australia.
Interpretation of the seismic and integration with well data is now underway and initial results are expected in the first quarter of 2008. Screening studies for the commercialization of the Caldita and Barossa fields have recently been completed by ConocoPhillips. Results from this initial evaluation work have been positive and further studies will now be undertaken.
Momentum is also building for the development of the Petrel and Tern fields which contain approximately 1.5 trillion cubic feet of low carbon dioxide gas. While these fields were discovered over 30 years ago, a number of commercialization options are now being actively pursued, including LNG and industrial supply alternatives. Reflecting this, we will require 3D seismic data over the Petrel field in the coming months.
Significant progress has been made on the Exxon Mobil operated PNG, LNG project since we kicked off the pre-FEED studies in April this year. To create competitive tension, parallel engineering, design and execution studies are being conducted, one by Bechtel and the other by KBR with JGC. A short list of preferred LNG site locations has been agreed. The PNG government has been engaged on key elements of the state agreement and a Kutubu, Gobi and Moran oil field parties have opted to join the evaluation. Positive progress is being made. The joint venture is aligned behind Exxon Mobil, and we are on track to move to a formal FEED process by late this year.
At project sanctions, Santos would book reserves of 230 million barrels of oil equivalent and this would lead to an additional 8 million barrels of annual production.
In the Browse basin, we have a strong acreage position adjacent to the Ichthys field. By early next year, we expect to be drilling the Ichthys North prospect. This is analogous to Shell’s recent Prelude One success. Our partners in this well are Inpex and Chevron and success would add to the momentum for a major new LNG hub in the region.
With the sale of our US business, our new ventures activities are now clearly focused on the Asian region. Our competitive advantages in this region stem from a deep knowledge of the hydrocarbon basins and systems, regional experience, and extensive industry and political networks.
Over the last two years we have made several new country entries and secured significant new acreage positions. In India, we have secured two deepwater exploration blocks in the Ganges-Brahmaputra delta. Several large gas discoveries have recently been made to the west of these blocks, demonstrating the prospectivity of this region. Our exploration activity will commence in October with the acquisition of 2D seismic data.
In Kyrgyzstan, we have a dominant acreage position and our intention is to start a drilling campaign in 2008.
In Vietnam, we are progressing the Blackbird and Dua discoveries towards a project sanction decision in the first half of 2008. With our joint venture partner, Premier Oil, we have contracted a drilling rig for a six to 12 month campaign from April next year. With a recoverable resource of approximately 80 million barrels, the development concept for Dua and Blackbird consists of wellhead platforms producing to an FPSO station between the fields. First oil is expected in 2010. In the same block we have a number of mature explorations prospects including Falcon and Peacock, which will be drilled during 2008.
During 2006, we also secured acreage in the Song Hong basin in Northern Vietnam. This is a very prospective acreage, well located, relative to other discoveries in the region and contains previous undeveloped gas discoveries. Earlier this month we completed a seismic survey and we are now in the process of generating prospects for drilling during 2008.
In Indonesia, the Oyong oil field development is expected to be on line next month with initial production rates of 8,000 to 10,000 barrels per day. The production barge is en route to site and pre-commissioning activities are well advanced. We have completed FEED studies for the gas phase of this project and our final investment decision is expected by the end of this year. This would also create an opportunity to develop the Wortel gas discovery using the Oyong infrastructure. Subject to further appraisal drilling next year, we expect this to be in production by 2010.
So let me sum up. I hope I have demonstrated that we have made significant progress in a number of areas we have delivered operationally, both on production and on costs. We have continued to move towards a higher margin business, with good progress in Cooper oil and LNG and we have made some real progress in monetizing contingent resources, and all targeted at high value markets. And we have done so while cleaning up our portfolio and capital structure.
In closing, can I reiterate that notwithstanding the recent volatility in global equity markets, I’m confident that the fundamentals of the energy markets and Santos’ positioning have never been stronger? Thank you.
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