Is the bad boy of the oil & gas sector set to become the biggest comeback kid in the industry? I am talking about Santos Ltd (ASX: STO), which is surging to its highest level this month on the back of a resurgent oil price.
The debt-laden energy stock jumped 4.7% to $5.13 in early trade as the Brent and West Texas Intermediate oil price benchmarks gained nearly 5% each.
Falling US oil inventories and easing worries about the health of the Chinese economy are behind oil's rally and this couldn't come soon enough for Santos with its share price plunging by over two-thirds in value over the past year.
The stock is a favorite among short-sellers, who have been blamed for the big drop in the share price. But I think it's too early to turn bullish on the stock as I suspect short sellers aren't quite ready to close their positions on Santos.
If anything, the recent bounce in Santos' share price could actually encourage short sellers to increase their bearish bets on the company.
Short sellers are traders who borrow stock to sell on-market in the hope of buying it back at a lower price later to profit from the difference.
The reason I say that is because one of the big reasons why short-sellers are targeting Santos is on the belief that it will have to raise capital, a process that typically puts downward pressure on a stock.
Santos is desperately trying to avoid doing an equity raising as its low share price makes this a very painful way of getting a cash injection.
If Santos had to sell new shares, it will have to do so at a big discount to its already depressed share price, and that will give short-sellers a close out their positions to lock in big profits.
Instead, Santos preferred capital raising strategy is to sell some of its assets and it may be close to getting over $1 billion from such transactions. But will that really be enough to save the stock from further falls?
I don't think it will because Santos needs more than $2 billion before investors start to feel more comfortable about the health of its balance sheet, which holds $9 billion in debt due to the massive and ill-timed investment in its GLNG project that starts up before the end of this calendar year.
Supporters will say that Santos could quite easily raise more than enough cash if it sold its stake in the liquefied natural gas (LNG) project in Papua New Guinea (PNG). This is the most valuable asset in Santos' portfolio.
But selling what is effectively its crown jewel is swapping short-term gain for long-term pain. Investors will have to ask themselves if Santos is still worth investing in without PNG LNG.
Credit Suisse has shed light on this question. It estimates that around 65% of Santos' projected free cash flow comes from PNG LNG. Without this asset, Santos will not have enough cash to invest in exploration and production to replace its current oil reserves.
This means the company's output will halve to 25 million barrels of oil equivalent by 2025 and there are no prizes for guessing which direction its profits will be heading either.
Further, this bearish projection is based on the oil price averaging $US65 a barrel. The Brent oil price is sitting under $US50 a barrel and experts warn oil could stay lower for longer due to the global supply glut.
What is also interesting is also interesting is that short-sellers have been increasing their positions against Santos. The latest data from the Australian Securities and Investments Commission (ASIC) shows an increase in shorts even as Santos' share price recovered from its low.
The percentage of Santos' stock that is being shorted rose to 9.3% on September 10 from 8.8% on September 7 (the latest ASIC data is always a week behind). Over the past month, shorts have risen by 5.9 percentage points.
While the percentage of shorts don't put Santos among the 10 most shorted stocks, it's still in the top 20 and is ahead of embattled higher cost iron ore producers like Mount Gibson Iron Limited (ASX: MGX) and Fortescue Metals Group Limited (ASX: FMG), which are also suffering from the commodity price crash.
Santos is facing some hard choices and until there is clarity around its capital raising, I would stay away.
