How long can Santos Ltd remain profitable?

There’s an uncomfortable question facing Santos Ltd (ASX:STO) as the oil price takes another tumble. How low can the oil price fall before Santos becomes cash flow negative? Shareholders won’t like the answer.

| More on:
a woman

Santos Ltd (ASX: STO) is to oil & gas as Fortescue Metals Group Limited (FMG) is to iron ore.

Much like Fortescue, the energy major has a higher cost of production, a weaker balance sheet and a larger capital expenditure program ahead of it when compared with its peers.

This begs the question: can Santos survive in a low commodity price environment with the West Texas Intermediate (WTI) price tumbling 5% to $US48.87 a barrel?

The prognosis isn’t great and Santos’s share price is at risk of falling further even though it has halved in value over the past six months.

Credit Suisse estimates that Santos will need an average oil price of $US83 a barrel for 2014-15 to 2019-20 to be at breakeven on a free cash flow (FCF) basis, assuming that the company requires $US27 a barrel in finding & development (F&D) cost – or the cost of maintaining its reserves.

In contrast, Woodside Petroleum Limited (ASX: WPL) and Oil Search Limited (ASX: OSH) can still be FCF neutral at below $US35 a barrel.

In the spirit of austerity that’s gripping all resource companies, even if Santos could slash F&D cost by 20%, it would still need oil to fetch $US75 a barrel on average to be FCF breakeven over the next six financial years, according to the broker.

This explains why Santos tracks the oil price falls far more closely than Woodside or Oil Search.

STO

But Santos is caught in a catch-22. There is only so much cost cutting it can do and cutting all “growth capex” (costs required to grow and not just maintain its reserves) is not a way to be running an oil & gas major given the long lead times to bring projects online.

Having your fortunes so closely tied to the oil price also means that the upside is far greater for Santos if crude recovers.

Credit Suisse estimates that the amount of free cash Santos would generate if the oil price jumps back above $US108 a barrel far exceeds that of Woodside or Oil Search.

Unfortunately, experts do not think we will see oil above $US100 a barrel for a very long time and this is why I sold my shares in Santos several months ago and put the cash into the other two oil majors instead.

Wondering where you should invest $1,000 right now?

When investing expert Scott Phillips has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for over ten years has provided thousands of paying members with stock picks that have doubled, tripled or even more.*

Scott just revealed what he believes could be the five best ASX stocks for investors to buy right now. These stocks are trading at near dirt-cheap prices and Scott thinks they could be great buys right now.

*Returns as of January 12th 2022

Motley Fool contributor Brendon Lau owns shares in Woodside and Oil Search . Follow me on Twitter - https://twitter.com/brenlau We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policyThis article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

More on ⏸️ Investing