(Posting this full article, as dont know if the link will open it): Where in the world is David Knox? AFR - 10.1.15 - By Tony Boyd (Chanticleer ) When a company loses about $7 billion in value in the space of three months, it is understandable the management team would want to bunker down and become invisible. That appears to have been the reaction at oil and gas company Santos, where chief executive David Knox has gone from being a high-profile figure to the opposite. Chanticleer does not want to be arrogant, but the fact Knox could not find time to participate in this paper’s annual CEO Outlook Poll says a lot about the mentality pervading the Adelaide head office of Santos. There is nothing Knox can do about the plunge in the oil price. His guesses about how low the oil price will go and how long it will remain at low levels are probably as good as anyone else’s. But he can make sure the company is on the front foot. It should be taking a proactive approach to the flood of speculation and wild claims that hit markets whenever there is a sudden and unexpected dislocation in prices. It is the CEO’s job to be out front and working hard for the interests of shareholders during times of crisis. Santos appears to have fallen into the same trap as the majority of people in financial markets who opined on where oil was heading. It did not give enough weight to the possibility of an absolute worst-case scenario in oil prices. Failure of imagination: A widely published opinion piece by Howard Marks, chairman of Oaktree Capital, honed in on the failure of market pundits to make the right calls in relation to key asset classes. Oaktree is best known in Australia for buying and selling Nine Entertainment Co and making a motza on the way through. Marks’ primary example of pundit failure is the virtual 100 per cent consensus in the United States in 2014 that US Treasury bond yields would rise. In other words, investors in bonds would lose capital. As it turns out, US Treasury bonds were one of the best-performing asset classes in 2014, with a return of 11 per cent. When Marks talks about the failure of pundits to accurately predict the collapse in the oil price, he refers to a concept he calls “ the failure of imagination”. This concept, which was first published in the book The Most Important Thing, is defined as “either being unable to conceive of the full range of possible outcomes or not understanding the consequences of the more extreme occurrences”. “Forecasters usually stick too closely to the current level, and on those rare occasions when they call for change, they often underestimate the potential magnitude,” Marks says. “Very few people predicted oil would decline significantly, and fewer still mentioned the possibility that we would see $US60 [a barrel] within six months.” Since Marks wrote that in December, the price of oil has fallen to $US50 a barrel. This so-called failure of imagination is surprising in oil, considering the oil price collapsed by 69 per cent in 1986, 58 per cent in 1990, 56 per cent in 2001 and 78 per cent in 2009. Three-quarters of those collapses resulted in recessions in several global economies. Hindsight: The latest decline in oil prices is the most aggressive selloff since 1987 with the exception of the global financial crisis, according to John Garrett at Moelis & Co. The single issue that has contributed most to Santos being sold off heavily is its balance sheet leverage. It was trying to fund LNG expansion in Gladstone while continuing to run its own capital-intensive core business. It is clear in hindsight that the company was not well prepared for a collapse in the single commodity that determines its cash flow and ability to fund its debt. That is clear from two out-of-the-ordinary announcements. The company was forced to abandon its Euro debt issue within days of talking it up and then it made an emergency reduction in capex by 25 per cent to $2 billion for 2015. As a further emergency measure, Santos said it had secured an additional three-year, $1 billion bilateral bank loan facility. Also, it has highlighted its strong funding position – it has about $2 billion in cash and undrawn debt facilities. Perhaps Santos management modelled the worst-case scenario and figured out it could get through the price collapse without anything more than cutting capex and raising more debt. Now Knox is focusing on strengthening the balance sheet, and that is likely to include asset sales if the oil price remains low or the company’s BBB credit rating is cut. The obvious major asset to sell is the pipeline linking the LNG project in Gladstone. It would be worth about $2.5 billion and would mean about $700 million for Santos, which owns a third of the project. It is hard to argue the company did not have some inkling of the collapse. In particular, it was warned the world’s largest producer of oil, Saudi Arabia, would not be cutting production. The Iran threat: Chanticleer understands respected oil forecaster Fereidun Fesharaki, chairman of Facts Global Energy, has Santos as a client. Fesharaki is one of the few, if not the only, global adviser on oil who accurately predicted a price collapse. He first started talking about an oil price decline in 2013. In October last year, when the Santos share price was at $12.60, Fesharaki warned Saudi Arabia would gain strength from lower prices. He told Chanticleer on Friday that the oil market was vulnerable to further significant falls because of the slow pace of reduction in supply by shale oil producers in the US. Fesharaki says shale oil producers in the US have break-even oil prices in a range between $US30 a barrel and $US80 a barrel. But no one knows at what price the Americans will cut production and restore equilibrium between supply and demand. It is possible, he says, that we would see oil as low as $US40 if there was agreement between Iran and the six powers negotiating over nuclear disarmament. If that occurred, Iran would immediately add about 1 million barrels of oil a day to world supply. “Iran has realised that it needs to regain its power in oil markets,” Fesharaki says. “It has slipped from being No. 2 producer to No. 5 or 6 and it will accept any price available to regain its position behind Saudi Arabia.” Hedging bets: One factor which works against a rapid recovery in the oil price is the widespread use of hedging in the US. Oil and gas companies are usually well-hedged to protect themselves against price declines. A good example is Pioneer Natural Resources, a Texas-based company, which this week said it had converted about 85 per cent of its 2015 oil derivative contracts from three-way collars to fixed-price swaps. It also has derivatives in place covering about 85 per cent of forecasted gas production in 2015 through a combination of three-way collar contracts. Pioneer’s chief Mark Sheffield is on the Santos board. But fund managers in Australia have always preferred to swallow the impact of volatile commodity prices rather than have companies enter into hedging contracts that remove the upside. As one well-respected fund manager with a formidable track record of getting it right told Chanticleer: “They would have been crucified if they hedged at $US100 oil and it went to $US120.” Arthur Berman, a petroleum geologist and consultant to the oil industry, says about 40 to 50 per cent of all independent exploration and production companies in the US have hedged their 2015 oil output. Of course, the flip-side of the sudden and destructive collapse in the Santos share price is that the company carries tremendous leverage on the upside. It could well provide the sharpest recovery of any energy company in Australia when the oil price turns. As David Herro from Harris Associates says in the latest Value Investor Insight publication, oil reserves will keep getting harder to find and more difficult to extract. That means the cost of production is going up, meaning the market-clearing oil price is likely to go up. Global oil demand should continue to increase, with growing middle classes around the world becoming more intensive in their energy usage. Tony Boyd The Australian Financial Review afr/p/business/chanticleer/where_in_the_world_is_david_knox_SS5nM056wB5l03oQQ2hs3J
Posted on: Fri, 09 Jan 2015 23:20:17 +0000
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