Australian hydrocarbon producer Santos (ASX: STO) reported a 2% increase in first-quarter 2025 production to 21.9 million barrels of oil equivalent (mmboe). Key development projects are nearing commissioning with Barossa 95% complete and Pikka 82% complete.

Santos’ development project progress is pleasingly within cost and schedule guidance. Group production is expected to increase by more than 30% by 2027 or to around 125 mmboe when Barossa and Pikka reach full production.

We increase our 2025 earnings per share forecast marginally to USD 0.40. Despite being down, first-quarter price realisation was higher than we’d credited on better liquefied natural gas, down only 8% to USD 11.57 per mmBtu, and liquefied petroleum gas price up 24% to USD 700 per metric ton.

First quarter exploration expense was also lower than anticipated, down 40% to USD 13 million. Guidance for 2025 remains unchanged, including production of 90-97mmboe, assuming Barossa LNG comes on-line in the third quarter. At 96mmboe, our forecast remains at the high end of this guidance.

Attractive assets but no moat

Santos’ Gladstone and Papua New Guinea LNG projects are large, long-life, have low cash operating costs, and offer expansion potential. They are also proximal to key Asian markets, with shipping around a fifth of the Australia-delivered Asia cash cost.

Depending on shipping rates at the time, Australia-Asia shipping costs are a third those for US-Asia via Panama, or a fifth for US-Asia via South Africa. Low operating costs ensure cash profits throughout the commodity cycle—Santos has enjoyed EBITDA margins averaging 75% over the past five years. Unit operating costs are around USD 15 per barrel of oil equivalent.

Despite this, we think Santos lacks a moat. The primary source of competitive advantage for resource stocks stems from maintaining lower costs than peers and we don’t think Santos qualifies on this front.

Santos has favorably low cash operating costs, but these are largely countered by high capital costs, meaning it is not a low-cost operator on an all-in basis. Liquefied natural gas is an upfront capital-intensive business, and Australia’s remoteness and underdeveloped industrial base makes for particularly high capital costs in contrast to markets with deeper services industries like the US.

What about hydrocarbon demand?

Natural gas is the predominant value driver for Australian E&Ps like Santos. Natural gas is less carbon-intensive than coal or oil, and stands to benefit from efforts to minimize emissions, at least in the medium term. This is because renewables like wind and solar, while growing rapidly, can’t hope to entirely meet global energy requirements for decades, if ever.

Hydrocarbons’ share of primary energy consumption fell to 84% from 87% over the decade to 2023 according to the Energy Institute’s latest Statistical Review of World Energy, though in absolute terms consumption increased by 15%. The share of fossil fuels was displaced by renewables, which increased to 5% of total consumption from 2%. But it is worth noting that in absolute terms, growth from hydrocarbons was more than triple that for renewables.

Gas played the lead role here, with consumption increasing by 34%. We expect the trend for gas in particular to continue, at least in the medium term, as it is the most effective way to quickly reduce emissions meaningfully. Gas’ share of primary energy consumption increased to 24% from 22% over the last 10 years.

Market seems overly bearish

Our $10 fair value estimate for no-moat Santos stands and at recent levels of $5.60, we think the market is overly bearish. Progress at the growth projects is as expected and supportive of fair value.

Our fair value still assumes a five-year EBITDA compound annual growth rate of 11% to USD 5.9 billion by 2029. This includes near 70% production increase toward 150mmboe, capturing first production from new projects Darwin LNG, Pikka phase 1, and later production from Dorado oil, and PNG LNG.

Barossa and Pikka represent strong long-term production. But Santos has a number of additional high-quality development options including Dorado oil, Narrabri gas, PNG LNG, and Alaska North Slope. These could support group production ultimately near doubling on 2024 levels.

First-quarter free cash flow increased 9% to USD 465 million and leaves Santos well-positioned to maintain existing businesses, fund growth, and fund shareholder returns. Gearing is healthy at 22% and net debt/EBITDA of 1.3 is sound and likely to remain so. There are no drawn debt maturities until September 2027.

Santos

  • Moat Rating: None
  • Fair Value estimate: $10 per share
  • Star Rating: ★★★★★
  • Uncertainty Rating: High

Remember: Before you get to choosing investments, we recommend you form a deliberate investing strategy. You can read more about how to form your strategy here.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company’s future cash flows, resulting from our analysts’ independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.

Uncertainty Rating: Morningstar’s Uncertainty Rating is designed to capture the range of potential outcomes for a company. An investor can think of this as the underlying risk of the business. For higher risk businesses with wider ranges of potential outcomes an investor should consider a larger margin of safety or difference between the estimate of what a share is worth and how much an investor pays. This rating is used to assign the margin of safety required before investing, which in turn explicitly drives our stock star rating system. The Uncertainty Rating is aimed at identifying the confidence we should have in assigning a fair value estimate for a stock. Read more about business risk and margin of safety here.