Santos, Oil Search to merge into Australia's largest oil and gas producer

Australian oil and gas producers Santos and Oil Search are pursuing a merger that will create the resource-rich country's largest listed oil and gas company by reserves held and production volume and one of the country's largest by market capitalization.

The deal comes during a rough time for global and Australian exploration and production companies who have had to write down billions of dollars in assets and face growing stranded asset risk as energy transition accelerates.

Santos and Oil Search's proposed merger also comes at a time of flux for upstream developments as international oil majors have shifted focus to keeping the most valuable tier 1 acreage with the lowest production costs, and large resources companies are actively divesting their petroleum assets.

The merged entity is expected to have a combined production of 116 million boe in 2021, compared to Australia's largest listed oil and gas producer, Woodside Energy, which is expected to produce 93 million boe in the same period, Santos and Oil Search said in a joint statement.

The merged company will have proved and probable reserves of 1,378 million boe, surpassing Woodside's 1,041 million boe, the statement said, adding that the merged entity and Woodside would both command a market capitalization of $16 billion.

Dominating LNG supply

Both Santos and Oil Search are important LNG producers with supply contracts to the largest Asian gas importing economies.

Santos will gain, from the proposed merger, more supply in the Pacific basin from Oil Search's share of production and reserves in Papua New Guinea, Jeff Moore, manager of Asian LNG Analytics at S&P Global Platts, said.

Nearly 47% of the merged entity's combined sales volume of 135 million boe will be from LNG, the two companies estimated. And out of the 4,983 million boe of its combined 2P and 2C reserves and resources, 79% will be in the form of natural gas and the remaining will be oil, underscoring the role of gas in their future production portfolio.

The companies said the deal "creates one of the largest Asian LNG suppliers and potential to unlock portfolio optionality" and that their multiple pricing benchmarks will provide price diversification.

The bulk of Santos and Oil Search's current LNG portfolios has secured term offtake. IHS Markit estimated the Darwin LNG, Gladstone LNG and PNG LNG projects have sales and purchase agreements signed for over 90% of their volumes spanning through to the 2030s, Nick Sharma, managing director for upstream, said.

Santos has also been increasingly active on the LNG spot market in Asia, boosting its trading capabilities to take advantage of lucrative spot prices, according to market participants.

Low cost projects

The merger puts the spotlight on two major upstream projects rated among the most cost competitive to supply LNG to gas-hungry Asia.

They are Santos' Barossa gas field development that will extend the life of the Darwin LNG export terminal in northern Australia, and the 5.4 million mt/year Papua LNG project in Papua New Guinea.

Both Santos and Oil Search may benefit from improved gearing ratios through the merger that support project financing for Darwin LNG, Papua LNG and its other projects, IHS Markit said.

The Barossa gas backfill project to feed Darwin LNG targets a cash cost of production of $2/MMBtu, S&P Global Ratings noted in a March report, which is one of the lowest gas production costs in Australia where east coast LNG projects have been infamous for having one of the highest project break-evens.

In Papua New Guinea, the merged entity is expected to benefit from combined equity interests and social license to operate fossil fuel projects that could help TotalEnergies reach FID for Papua LNG in 2023.

The combined entity will have a 17.7% share in the existing ExxonMobil-operated 8 million mt/year PNG LNG project and become the largest stakeholder in Papua LNG with a 42.5% share. Papua LNG stands to tap existing infrastructure from PNG LNG, which Oil Search has said will lower costs further.

The deal

Oil Search will back a sweetened merger proposal by Santos, the two companies announced separately Aug. 2, after an earlier proposal was knocked back.

The new proposal offers Oil Search shareholders 0.6275 new Santos shares for each Oil Search share they own, an improvement from the previous offer of 0.589 new Santos shares. Oil Search shareholders would own 38.5% of the merged entity.

Santos said the revised merger proposal implies a transaction price of A$4.29 ($3.15) per Oil Search share based on the closing price of the two companies on July 19. This represents a 16.8% premium to Oil Search's closing price on the same date, Santos said.