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Three reasons Santos will smash the market

The energy industry is more predictable than some because of the large lead times involved in developing projects, long-term contracts for supply, which can span 10 years or more, and stable demand estimates. This benefits investors looking into companies like Santos Limited (ASX: STO), Origin Energy (ASX: ORG), and Woodside Petroleum (ASX: WPL).

Santos is one energy company in line to perform particularly strongly over the next decade. Here are three key reasons why.

Growing domestic demand

The current situation playing out across NSW and Queensland on Australia’s east coast is almost a textbook case. Limited supply of natural gas and huge increases in demand for domestic energy needs (particularly in NSW) are expected to push prices up significantly.

The supply is being restricted on two fronts. The first is from high international demand, which competes with domestic demand and offers producers long-term contracts at premium prices. The second is the impact of regulation by the NSW government in response to environmental concerns, which has restricted the development of new coal seam gas (CSG) projects over the last 18 months.

Both are a problem for NSW, which imports 95% of its gas needs from outside the state. The issue is becoming increasingly worrisome for domestic users as many contracts start to expire in 2016. NSW-based Brickworks Limited (ASX: BKW) has already announced it will be taking four of the company’s plants off gas over the next six months, but for suppliers the increase in demand shifts the power into their hands.

Capacity to supply

Santos is one of Australia’s largest producers of gas to the domestic market. The company also holds the largest exploration and production position in Australia of any company, and has several key projects as well as enviable infrastructure to support the growing east coast gas demand.  These include current production from Coopers Basin; the 47% complete, 30% holding in the Gladstone LNG (GLNG) joint venture in Queensland; and exploration of CSG in NSW’s Pilliga State forest.

The projects (excluding GLNG) will provide Santos natural gas to offer towards domestic demand, lower transportation costs than international supply, and increasing product prices.

Growing international demand

Santo’s stake in the Gladstone LNG is set aside to supply the growing international demand for LNG, particularly from growing Asian economies, when it comes online in 2015. The company is also tapping into gas veins in the Asia-Pacific with the 75% complete PNGLNG joint venture.

The benefits to Santos are already starting to flow. The company’s underlying net profit spiked 34% to $605 million in 2012 and the combined result of above factors will see the company’s fortunes improve further.

Foolish takeaway

Future outlook is important when assessing a company, but just as important is the price paid to own it. Santos’ current price at 22 times annual earnings is higher than the industry average, which is in the mid-teens. However the company’s outlook and positioning is also arguably stronger than industry average. Any reduction in price would make the Santos proposition very compelling indeed.

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More reading

The Motley Fool’s purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.  This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool contributor Regan Pearson does not own shares in any of the companies mentioned in this article.

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