Are Santos Ltd shares set to run out of gas?

Santos Ltd (ASX: STO) issued its fourth-quarter production report to the market today.

Here are some key stats from the update.

Source: Santos ASX Announcement, 22 January 2016

Source: Santos ASX Announcement, 22 January 2015

As can be seen in the top section of the table, production levels were mostly flat (negative 1%) during the December quarter, yet the price received for its products had fallen by 33% to $61 a barrel. Over the full year, production rose 7%, but average prices fell 37% to $71.44 a barrel.

Is the worse yet to come for Santos?

Large institutions like Santos use futures contracts on commodities as ‘hedges’ to lock-in prices. For example, producers will sign contracts for weeks, months or years in advance if they believe oil prices could fall. As a consequence, there is a lag between falling market prices and the reduced prices being reflected in company accounts. So Santos’ prices could get worse before they get better.

Indeed, the market prices of oil and gas (including LNG) have fallen away in recent years, as oversupply engulfed major markets. In the table above, you’ll notice that the average price Santos received in 2014 was $114 a barrel.

However, it’s worth remembering that since oil prices are quoted in US dollars the recent falls in the Australian dollar (which Santos uses in the table) do not appear as dramatic as they perhaps could be if they were cited in US dollars. World oil prices fell to $US26 a barrel earlier this week which means the Australian dollar equivalent is $37 a barrel.

Santos is not doing anything wrong by quoting in Australian dollars. After all, its major projects are located in Australia, and, therefore, it incurs costs in Australian dollars. However, if the Australian dollar does not continue to fall, there may be more reductions in the average prices Santos receives over coming quarters.

Management commentary

Commenting on today’s update, Santos’ Executive Chairman, Peter Coates, said his company is well placed to withstand an extended period of low oil prices, with $4.8 billion in cash and committed undrawn debt facilities, and no material debt maturities until 2019.”

“We are continuing to focus on reducing our capital expenditure and will build upon the significant improvements that we have made to our operating efficiency,” Mr Coates added.

Write downs ‘expected’

As we saw with BHP Billiton Limited’s (ASX: BHP) $10.31 billion write-down last week, energy companies are often forced to take big hits to the value of their assets when commodity prices sink. Santos said that in light of the recent falls, “the company expects to book reductions to both asset carrying values and reserves as part of finalising its 2015 full-year financial accounts, which are scheduled to be announced to the market on 19 February 2016.”

Further: “The company is also considering its 2016 operational and development plans and forecasts, with a focus on preserving cash and will provide an update at the release of its 2015 financial accounts.”

Source: Santos ASX Announcement, 22 January 2016

Source: Santos ASX Announcement, 22 January 2016

The company said its guidance (seen above) is subject to finalisation from accountants and auditors, including the impairment review on assets and reserve levels.

Are Santos shares about to run out of gas?

Santos’ share price has fallen more than 60% over the past year as concerns over the implications of plunging oil prices rose. Rivals Oil Search Limited (ASX: OSH) and Woodside Petroleum Limited (ASX: WPL) have also felt the pressure of lower market prices.

However, Santos is often perceived as a higher-risk investment because of its $6.55 billion net debt position.

In my honest opinion, Santos shares could rebound if oil prices stage an unexpected recovery in the near future, but a meaningful, sustainable recovery in prices isn’t likely to occur for some time. Therefore, I think there are better places to invest your money.

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Motley Fool writer/analyst Owen Raszkiewicz does not have a financial interest in any company mentioned. Owen welcomes -- and encourages -- your feedback on Google+,  LinkedIn or you can follow him on Twitter @ASXinvest.

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks 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 policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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