Woodside and Santos are considering joining forces to create an Australian behemoth in a deal that could amount to a lifeline for the country’s big polluters. By Marc Moncrief.

A merger for desperate fossil fuel giants

Woodside’s North Rankin Complex, at the North West Shelf Project in Western Australia.
Woodside’s North Rankin Complex, at the North West Shelf Project in Western Australia.
Credit: Woodside

Two of Australia’s biggest corporations on the wrong side of the transition to renewable energy are considering joining forces to confront what’s been described as the death throes of the fossil fuel industry.

The deal being considered – and it is still only being considered – between Western Australia’s Woodside Energy and South Australia’s Santos would create one of the world’s largest exporters of liquefied natural gas (LNG). Oil and gas companies around the world are buying one another in a trend that is more than just corporate chair-shuffling.

“I think it’s generally accepted now that the end of fossil fuel is near,” says Jun Bei Liu, a financial analyst and lead portfolio manager for the Tribeca Alpha Plus Fund.

Rumours of a Woodside–Santos merger began circling more than a week ago, and the companies soon confirmed they were in talks. They have since begun the process of sharing information to investigate how such a deal might work.

The company that could be created is expected to be worth about $80 billion, generating about 16 million tonnes of LNG a year. On one level, though, the numbers are an abstraction. A big corporate merger is larger than the dollars: it is the process by which the economy responds to a rebalancing.

In this case, the shift is existential.

On Wednesday in Dubai, almost 200 nations at the COP28 climate summit agreed to “transition away” from fossil fuels in a bid to avoid catastrophic global warming.

The meetings were a dramatisation of the threat to big oil and gas companies, as demonstrated by a leaked letter from the head of OPEC to the major producing countries as negotiations progressed, urging they resist any language of a phase-out, as the “undue and disproportionate pressure against fossil fuels may reach a tipping point with irreversible consequences”.

And with a wave of legislation forcing the end of combustion-engine vehicles in some of the world’s biggest markets, and the weight of innovation being ploughed into development of electric models, there is little incentive to invest in maintaining oil fields or developing new ones.

Liu said fossil fuel companies were motivated to consolidate to make it cheaper and more efficient to exploit the resources they had, while they still could. “They have a bigger economy of scale when they merge, so they can have a little bit more profit margin for the last few years that they run it.”

Similarly, the transition to renewable energy requires natural gas providers build a plan for a new world.

Gas is cleaner than the coal that is still the dominant source of electricity worldwide. As coal is phased out, gas has a role as a reliable fuel until cleaner technologies are brought to scale. The invasion of Ukraine and subsequent closure of gas supply from Russia to Europe caused a massive spike in the gas price, emphasising the importance of the fuel.

But even that role may not last, and gas producers know it.

So globally, the big players are getting bigger, fast. This year, US giants Exxon and Chevron each announced deals worth tens of billions of dollars. Producers in China, Saudi Arabia and the Scandinavian countries have joined the rush to consolidate in the past few years.

These deals have made substantially smaller players of the two Australian fossil fuel giants, whose merger would be a shackling of two underperformers on the global stage. Over the past three years, Woodside and Santos have failed to keep up with the sharemarket gains recorded by their peers as a result of the war in Ukraine. That’s despite both having made acquisitions of their own, such as Woodside’s purchase in May last year of the petroleum business of the world’s largest mining company, BHP.

Woodside chief executive Meg O’Neill told shareholders the deal would help the company “build the scale, resilience and diversity to thrive through the energy transition”.

From 2019-21, Santos swallowed Quadrant Energy, Oil Search and assets to Australia’s north previously held by ConocoPhillips.

At the time, gas was being hailed as the preferred fuel for investment by the federal government, with former prime minister Scott Morrison saying in September 2020 there was “no credible energy transition plan for an economy like Australia that does not involve the greater use of gas”.

The Albanese government has pursued a different route. Last month, it announced it would expand its Capacity Investment Scheme, a program to attract renewable energy to Australia, to support 32 gigawatts of generation.

The policy aims to make renewable energy more attractive for investors, meaning those interested in Australian power markets may favour green projects over more carbon-intensive ones. The CIS plan was timely given the imminent failure of a landmark acquisition in the renewables sector – the proposed buyout of Australia’s fourth-largest emitter of greenhouse gases, Origin Energy. Days after the government’s announcement, the nation’s largest superannuation fund, AustralianSuper, used its shares in the power generator and retailer to reject a $19 billion takeover offer by Canadian fund Brookfield and US private equity firm EIG – a deal touted in media coverage as “the poster child for energy transition investing”. AustralianSuper said it supported the transition to clean energy but the offer didn’t reflect what it considered to be the long-term value of the company.

All of this is to say that Woodside and Santos are considering their future in spaces that are in flux.

Dale Koenders, head of energy and utilities at investment bank Barrenjoey, says Woodside has so far lacked a clear narrative for how it will deal with the energy transition, and buying Santos could be its pitch for longevity.

He says Woodside has chosen to emphasise hydrogen as a future fuel, but this is a longer-term story. Santos, on the other hand, is focused on carbon capture and storage, and has some “quite credible” projects, he says. With a merger, Woodside would be “inheriting a rational path and a right to play in the energy transition, which, if you think about the longer-term strategy, for a company like Woodside, is critical”.

Of course, investing in carbon capture comes with its own risks. Just last month, Chevron disclosed that only about a third of the emissions captured at the world’s largest carbon capture project off the coast of Western Australia were actually making it into underground storage.

Nevertheless, Santos has gained a lot of attention as a target worth buying. Its shares have languished as some of its older resources have become less productive and new resources struggle to get started.

Part of its $5.6 billion Barossa gas project off the coast of the Tiwi Islands was halted by a judge last year amid protests by Traditional Owners, who say a pipeline will disturb ancestral beings who are part of their dreaming stories.

At one point, the company said the delay was costing a million dollars a day, though it remains committed to the project and has continued to build in areas not affected by the ruling.

Investors frustrated by the poor performance of their shares wrote to Santos earlier this year suggesting the company split its LNG operations into a separate company.

Santos did not respond to the letter, but The Australian newspaper reported Citigroup was engaged soon afterwards to review the company’s options.

The newspaper has reported that Santos chief executive Kevin Gallagher has been keen on a deal with Woodside since at least May, but there are significant hurdles. The creation of the largest LNG producer in the country, controlling potentially more than a quarter of the east coast’s gas market, could raise concerns for the Australian Competition and Consumer Commission. The South Australian government has already raised objections. Santos, which stands for South Australia Northern Territory Oil Search, is the crown jewel of Adelaide’s corporate scene, and South Australian Energy Minister Tom Koutsantonis has said the government could block the transfer of licences in the state if it wasn’t happy with the merger.

“The South Australian government will not be a bystander here,” Koutsantonis says. “If Woodside have ambitions to take over Santos, to merge with Santos and relocate any resources out of South Australia, they’ll be having serious discussions with the South Australian government.”

And then, there’s the price: some vocal Santos shareholders don’t think Woodside will offer enough. It is possible that “other parties” could take an interest in buying Santos now the idea of a sale is in the market, according to analysts at stockbroker Ord Minnett.

“We need to see something pretty compelling from Woodside to make it worthwhile,” Wilson Asset Management portfolio manager Matt Haupt told The Australian Financial Review. “I’m not sure we’re going to get a knockout deal here.”

This article was first published in the print edition of The Saturday Paper on December 16, 2023 as "A merger for desperate fossil fuel giants".

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