As the COVID-19 pandemic sees a dramatic dive in oil prices, energy companies with strong balance sheets are best-positioned to weather this period of uncertainty.

For example, according to S&P Global Ratings, the balance sheet that oil giant Santos has built up over 2017-2020 has formed a solid buffer to help it withstand the oil price plunge. 

The company’s recently announced measures to preserve cash should support the key ratio of funds from operations (FFO) to debt at between 20 per cent and 25 per cent in 2020. 

This forecast incorporates S&P’s revised assumptions of Brent crude oil at US$30 per barrel (/bbl) for the remainder of 2020, US$50/bbl for 2021, and US$55/bbl for 2022.

S&P Global Ratings said it believed Santos emerged from the oil price slump in 2015-2016 with a more resilient business model, and its production portfolio would outperform peers in a lower oil price environment, given that about 30 per cent of its production is domestic gas linked to the consumer price index. 

In addition, about 15 per cent of the company’s oil-linked liquefied natural gas (LNG) portfolio (6.2 million metric barrels of oil equivalent in 2020) will benefit from hedging at oil prices of below US$54/bbl over the next nine months. 

Santos aims to reduce its free cash flow break-even to about US$25/bbl in 2020 with the recent cash conservation measures.

For Australian LNG producers, LNG contractual pricing structures will help dampen the immediate effect of lower oil prices on actual cash flows. Oil price declines are unlikely to flow through to cash flows until about June 2020, given that LNG contractual pricing is generally on a three-month lagged basis. 

In addition, some LNG price structures provide relief against a significant oil price drop, given the existence of LNG ‘S’ price curves, whereby oil price-linkage flattens at currently depressed prices. We note Santos’ LNG portfolio for 2020 is highly contracted (more than 95 per cent) with predominant exposures to Korean and Malaysian customers.

S&P Global Ratings’ predicts that Santos still has the financial capacity to undertake the proposed acquisition of ConocoPhilip’s Northern Australia assets. The assets include a 56.9 per cent interest in Darwin LNG, Bayu-Undan, Barossa, and Poseidon. 

Santos’ net funding requirement will be about US$800 million, which we consider to be manageable given its US$1.2 billion of cash on hand (at the end of February 2020) and the committed US$750 million two-year bridge acquisition facility. 

S&P Global Ratings regards Santos’ recently announced agreed sell-down of a 25 per cent equity interest in Darwin LNG and Bayu-Undan to SK E&S for US$390 million to be supportive of the company’s credit quality. 

However, the sale remains conditional upon a final investment decision on the Barossa project and does not currently form part of base-case assumptions.

Given Santos’ major upcoming capital investments, key rating risks will stem from a prolonged weak oil price environment of below US$40/bbl. Downward rating pressure could arise if we believe that Santos’ FFO-to-debt ratio will approach 20 per cent with limited signs of recovery.

Growth projects sanctioned in the current environment would indicate a heightened risk appetite, and would likely be negative for the company’s credit profile. 

For example, a willingness to progress projects with a high ownership stake and on a lowly contracted basis, amid a depressed oil and LNG spot price environment, would translate to incremental project and commodity price risk, in S&P’s view.

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