Is it time to sell Santos Ltd?

Royal Dutch Shell's takeover offer of BG Group may make life for Santos Ltd (ASX:STO) more difficult when it comes to securing gas supplies.

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When big buyouts happen, the effects spread out far. The Royal Dutch Shell $97 billion takeover offer of UK-based BG Group announced yesterday could also make life more difficult for Santos Ltd (ASX: STO).

Royal Dutch Shell is a US$202.2 billion multi-national oil major that recently sold a 9% stake in Woodside Petroleum Limited (ASX: WPL), reducing its total holdings to around 13%. With the purchase of BG Group, which specialises in LNG production, Shell will have a major stake in the QCLNG project in Gladstone.

The need for gas supply

BG Group is the operator and majority owner of the LNG project. Last December, the project's first production of LNG was shipped, so this new income stream will be a great benefit to Shell. Two more LNG projects, the GLNG with Santos and the APLNG with Origin Energy Ltd (ASX: ORG) and ConocoPhillips, are scheduled to start exporting LNG in 2015.

Santos is said to need more gas to meet its long-term export contracts. Although it has agreements to take gas from producers in the Surat and Cooper Basins in Queensland and SA, one huge source owned by Arrow Energy may be pursued by Royal Dutch Shell more vigorously. If Santos doesn't secure this resource, it may have to take others that could be more difficult and expensive to develop.

Santos and world crude oil prices

This comes when world oil prices are near multi-year lows. Santos reported an annual net loss of $935 million due to write-downs related to falling oil prices. The Australian Financial Review reported analysts calculated Santos needed crude oil to be around US$83 a barrel over the next five years just to break even on a free cash flow basis. The analysts also said the energy producer would need to raise capital because debt levels are too high.

If Royal Dutch Shell through BG Group strikes up a deal with Arrow Energy, Santos could have higher production costs coupled with lower export revenues should oil stay low for an extended period.

Santos stock rose 4.37% to $7.41 on Wednesday when Shell's BG Group takeover was announced. However, it is still down more than 50% from its Sept 2014 highs. Analysts forecast annual earnings to be lower over the next several years, so the share price pressure may not let up.

Investors should wait until the GLNG project is in production and see how the oil market is then before taking any action. Having too many variables at a cyclical market low is risky.

Motley Fool contributor Darryl Daté-Shappard does not own shares in any company mentioned.  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.

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