I must admit, buying shares in oil and gas producer Santos Ltd (ASX: STO) is starting to look enticing.
The falling Aussie dollar has cushioned some of the recent fall in oil prices and, operationally, Santos is on a clear runway to production growth.
But before buying shares today there are three important things to check:
1. How much oil and gas does Santos have?
At the start of 2019 Santos had 2P (proved plus probable) reserves of 1,022 million barrels of oil equivalent (mmboe).
If Santos kept pumping oil and gas at the same rate as it did in 2018 (58.9 mmboe) it would have enough 2P reserves to last 17 years. By the same measure Woodside Petroleum Limited (ASX: WPL) would have enough for around 13 years.
Investing is about looking forward though and Santos is expecting to quickly ramp-up production to more than 100 mmboe per year by 2025. This will accelerate the decline in reserves so Santos will need to continue to unlock reserves through exploration or asset purchases.
2. How much debt does Santos have?
Great question! Commodity prices are volatile and unpredictable. Debt amplifies the impact of price changes and can radically increase risks and returns.
Santos learned this the hard way when the price of oil plummeted in 2015 and it was left trying to service billions of dollars of debt with falling sales revenue.
At 31 December 2018, Santos reported interest bearing liabilities of US$4.9 billion. To me it still feels high, but the outlook for growing production and cashflows helps to alleviate the risk. Last month Santos reported that strong free cash flows had helped to reduce its net debt position to US$3.1 billion.
3. What is Santos' 'break-even' cost?
An important number to know is the point at which Santos is 'free cash flow break-even', this is where cashflows from operations covers cashflows from investing activities. In 2018 this was US$31.30 per barrel, leaving plenty of clearance to the current oil price of around US$57.
Foolish takeaway
Together these points give me a sense that Santos has a lot of upside potential if the price of oil rises and more moderate risk on the downside if it falls, supported by the growth in production and the lower Aussie dollar.
They also set a useful starting point when thinking about investing in any commodity business before buying shares.
