Warren Buffett’s US$3.4 billion bet on oil and gas producer Exxon Mobil (NYSE: XOM) last year left many investors scratching their heads. Sure, Exxon Mobil is one of the world’s five largest companies, but what was it that separated Exxon from the other big energy or consumer companies in the world?
There seemed to be two reasons that stood out about Buffett’s purchase: firstly, Exxon Mobil was cheap, trading at around 11.8 times forward earnings. Secondly, the purchase reflected the view held by Buffett and his partner Charlie Munger that energy prices, as finite resources, will rise over the long term.
Charlie Munger has publically voiced his view on oil before, saying: “Oil is absolutely certain to become incredibly short in supply and very high-priced. The oil in the ground that you’re not producing is a national treasure.”
But how would Santos Limited (ASX: STO) stack up to Buffett’s discerning eye? Santos, one of the largest oil and gas producers on the S&P / ASX 200 Index (Index: ^AXJO) (ASX: XJO) is certainly set to benefit from the same long-term trend of rising energy prices over the long term after all.
Santos also has a longer production reserve life-time than Exxon, at 27 years compared to Exxon’s 16 years. However Exxon has had better success at increasing reserves by more than it produces, known as the company’s reserves replacement ratio. Exxon has exceeded 100% of its reserve replacement ratio for the last 20 years, whereas Santos failed to replace the majority of reserves produced in the 2013 financial year, instead focusing investment on its two big LNG projects, PNG LNG and GLNG.
Price wise, the two are hard to compare. Santos currently trades at a forward price to earnings ratio of around 18, a reflection of the strong production growth anticipated in the coming years, and a premium to the 11.8 times paid by Buffett for Exxon.
By comparing these two limited factors Santos doesn’t immediately jump out as a bargain fit for the world’s greatest investor. However Santos is going through an enviable phase of growth that will see it increase production by as much as 50 percent in the coming six years.
This will bring down both reserve life and price to earnings ratio. If Santos can then begin to regularly exceed the critical 100% reserve replacement ratio, it would certainly have the potential to become a Buffett stock.