Decision On Santos’ Narrabri CSG Project Nears

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As a critical decision on Santos' Narrabri project nears, brokers note the company has several other irons in the fire which can generate cash flow and growth

-Critical Narrabri decision due on Wednesday
-Will Santos defer Dorado and Barossa FID?
-Moomba CCS a differentiating prospect
 

By Eva Brocklehurst

A decision on the controversial Narrabri gas project may be nigh, yet Santos ((STO)) has several options from which it can continue to generate free cash flow despite depressed oil prices.

Upstream oil & gas is facing structural headwinds associated with the transition in global energy, UBS points out, and the sector needs to align its business model with this transition or risk losing relevance to a growing investor base for whom environmental considerations are an important part of the investment decision.

In this way, Santos is considered to have the best solution via its Moomba CCS (carbon capture & storage) project. The ideais to capture CO2 emissions from the Moomba gas plant and re-inject this underground into depleted oil & gas reservoirs.

The NSW Independent Planning Commission is expected to hand down a decision on whether Narrabri CSG can go ahead on September 30. If the project is approved, and Citi assesses it could go either way, an expedited federal approval process is likely.

Elsewhere, Macquarie suspects, amid a softening growth profile, that Santos will defer Dorado oil and Barossa LNG final investment decisions (FID) to 2022 and allow more time to repair the balance sheet as well as pursue asset sell-downs.

In contrast, UBS believes Santos is ready for a major growth phase and has better access to existing infrastructure compared with peers. Within 12 months three diversified growth projects could make it to a final investment decision, including Barossa, Dorado and Moomba.

Moreover, the broker believes two of the northern Australian assets are mispriced by the market because of the attention being given to the shorter-term growth projects.

These longer-dated projects include the MacArthur Basin, which provides exposure to a highly prospective shale resource in the Northern Territory, and the Petrel/Tern/Frigate assets, in the Bonaparte Basin offshore northern Western Australia.

While the heavy lifting on cost reductions has been done, Morgan Stanley envisages upside for the stock is now dependent on progress at Dorado, lower costs at Barossa or a go-ahead at Narrabri.

The stock has performed well compared with peers recently but the broker believes higher oil prices will be required to repeat the performance. Santos remains a top pick for Citi because of a greater level of confidence in farming down growth assets compared with peers, as well as execution on growth.

Narrabri

What could Narrabri be worth for Santos? Citi models a 150TJ/d project with around 400 wells, less than half of the original 850 proposed, that develops 75% of the 2C resource. At an ex-field gas price of $8/gigajoule the broker values the development at $0.31 a share on an un-risked basis. Half of this is included in the target price calculation.

The projected return is 24% with a break-even gas price of $6/gigajoule. Importantly, Citi considers this more competitive than LNG imports on a delivered basis. Outside of cases for which coal seam deliverability is poor, the broker assesses Santos has significant room for capital expenditure over-runs before economics are compromised.

The broker remains comfortable that Narrabri can deliver value and expects Santos will opt for more complex, albeit expensive, higher-production wells to reduce the environmental footprint and the first phase should reach production in the first half of 2024, ramping up to 50TJ by the second half of 2025.

If economics hold up a second phase of development, reaching a plateau rate of 150TJ/d, is expected by 2028. Assuming the project is approved, UBS expects front end engineering design (FEED) in 2021 with a final investment decision in 2022 and first sales gas in 2024.

Moomba

Moomba CCS differentiates Santos, UBS asserts. The gas plant currently processes raw gas from the Cooper/Eromanga basins into sales gas and the gas in these fields is quite high in CO2.

The project is expected to be ready in 2020 for FID and should reduce net emissions by around -60%. UBS expects the federal government will legislate a process for CCS to be eligible for Australian carbon credit units, offsetting more than 50% of the life-cycle cost.

UBS values the project at around $0.60 a share, fully risked, with future upside if the plant is expanded for open-access CCS and if the Australian carbon credit units can be traded in overseas markets.

The broker has modelled a multi-stage development for Moomba by applying average productivity of enhanced oil recovery (EOR) achieved in North American basins with similar geological properties to the Cooper Basin.

Significant Risk

Narrabri offers significant risk as there has been overwhelming community opposition and, even if it gets the green light, Citi is aware it may come with conditions that hamper field economics such as onerous water and solid disposal requirements.

Another condition placed by the NSW government is that no production wells are drilled until a pipeline is in place. Given APA Group ((APA)) has not yet submitted an environmental impact statement for the proposed western slopes pipeline, UBS assesses production beyond the current pilot wells is more than three years away.

At Moomba CCS there are a number of technical factors required for it to work, none more so, UBS points out, than the miscibility of the basin oil.

FNArena's database has six Buy ratings and one Hold (Macquarie) for Santos, which compares with five Hold and two Buy a year ago. The consensus target is $6.53, suggesting 27.6% upside to the last share price.

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