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A potential A$80bn ($52bn) merger of two of Australia’s largest oil and gas companies to create a national champion in liquefied natural gas reflects a harsh reality in the sector: without global scale, it is hard to remain relevant.
Woodside Energy and Santos said on Thursday they had opened talks over a potential deal. If completed, it would consolidate nearly all of Australia’s LNG sector into a single entity.
Talks are at a very early stage, according to multiple people with direct knowledge of the situation. They said the discussions were triggered by the need for both companies to increase their size as the market looks to consolidate and the risk of developing new projects increases due to cost, regulation and opposition to the industry.
James Byrne, an analyst with Citi, said a deal could be justified as “Woodside fixing its stagnating portfolio and Santos fixing its balance sheet”. He said a combination would create a globally relevant company listed in the US and Australia that could spread the higher risk and declining value of some projects.
However, the combined entity will still pale in size compared with major global LNG players. Woodside sold about 11.2mn tonnes of the super-chilled fuel in 2022 and Santos 5.8mn tonnes. By contrast, Shell and Total Energies, the two largest private LNG suppliers, sold 66mn tonnes and 48.1mn tonnes, respectively. A combined entity would be comparable to BP, which sold 19mn tonnes last year.
“LNG is increasingly about scale and having a large portfolio,” said Frank Harris, head of global LNG consulting at Wood Mackenzie. “People who have aspirations to be top players need scale and Woodside will be aware of that. As the industry gets bigger, to keep up, one could contend that they need more scale.”
Santos has been under pressure from investors, notably fund manager L1 Capital, to review its strategy due to the company’s poor returns compared with the global average. The company has been urged to consider a break-up of the business or a sale. Woodside has long been seen as a potential partner in the Australian industry.
Santos shares rose 6 per cent to A$7.24 on Friday, while Woodside’s fell slightly, by 0.7 per cent, to A$29.78.
A deal could come with substantial risks, including how to value flagship projects that have hit problems. Woodside’s giant Scarborough project off the coast of the Pilbara region in Western Australia has been delayed by opposition from indigenous communities, as has Santos’s Barossa gas project near the remote Tiwi Islands in the Timor Sea.
Regulators could also demand disposals of domestic Australian assets given the potentially dominant position of the combined entity in its home market. Both companies count LNG as their main product but also produce crude oil and pipeline gas from their operations.
Santos, which has also invested in carbon capture and storage assets including the Moomba gas plant in South Australia, derived more than half of its production from LNG in 2022. Woodside, which has invested in the US oil sector and has become a growing presence there, previously said it anticipated 45 per cent of its production this year would be from LNG.
There could also be an objection from the South Australia government, which could fight against any attempt to consolidate the business away from Adelaide. Santos — which stands for South Australia Northern Territory Oil Search — has been headquartered there since the 1950s, but Woodside is based in Perth.
A combination would bring together assets on both of Australia’s coasts but also grow the international presence, with the new group having assets in Alaska, Senegal and Papua New Guinea.
Russia’s invasion of Ukraine has made LNG trading extremely complex, with the slashing of pipelines leaving Europe to look elsewhere for gas supplies to meet its needs. Europe and Asia now increasingly compete for the same supply, with traders and suppliers constantly having to figure out where to send their cargo to make the best returns.
A large portfolio allows LNG companies to “find efficiencies and swap vessels around internally for [cost] savings without even having to find a partner to trade with”, said Alex Froley, LNG analyst at consultancy ICIS.
The potential deal “is a significant consolidation play in the Australian oil and gas industry”, said Felix Booth, head of LNG at energy analytics firm Vortexa. Santos’s LNG project in Papua New Guinea “will be a notable addition” to Woodside’s LNG portfolio and the mooted merger would bring improved scale and efficiency to their operations, he said.
In recent years, Woodside has also tried to expand its global footprint by signing LNG deals in North America. It has agreements with US LNG producers for long-term supplies and this week announced a 20-year LNG deal with a project in Mexico.
Woodside is “focused” on the growth of its LNG portfolio, Mark Abbotsford, executive vice-president of marketing and trading, said in a LinkedIn post after Woodside announced the Mexico deal.
“We see scale, geographical diversity and cost-competitive LNG as being critical to our future and also essential to meet continued growth in gas/LNG demand through the energy transition,” he said.