Gallagher is the boldest rider in Australian gas

The Quadrant deal delivered Santos with step-change growth in Western Australian gas production and infrastructure and 80 per cent of Australia’s next important oil horizon, the Bedout Basin-opening Dorado discovery in the north-west.

The ConocoPhillips deal, for all its complications, is constructed from a similar combination of long-dated exploration and balance sheet strategies and nimbleness in the face of opportunity.

Amazingly, as it turns out, Santos was presented with a chance to take the American lion’s share of DLNG, and the Bayu-Undan gas fields that currently support it, within just weeks of the Quadrant deal being confirmed and well ahead of that transaction’s ultimate completion.

“I can tell you, we have been working on this one for almost one year to the week,” the Santos chief executive told The Australian Financial Review from ConocoPhillips' home town, Houston.

“We hadn’t even bedded it [Quadrant] down when the opportunity arose. But we were comfortable because we knew it would take a while. Mind you, I didn’t think it would take quite a year. But these deals are just complex, with a lot of things to work through, structure, valuation and then you get the lawyers in the room.”

Given the complexities ahead, it is a fair bet that Gallagher and his M&A crew will be spending a fair bit more time yet with those lawyers.

Part of the supporting narrative of the DLNG deal is that it liberates two joint ventures to better align the ownership of the legacy infrastructure business and that of the next big gas development that will feed it. The corollary of that objective is that there are a few more trades to happen yet.

At completion of the ConocoPhillips deal, Santos will temporarily own 68.4 per cent of the legacy projects and 62.5 per cent of the Barossa-Caldita gas resource that is the subject of plans for a $US4.7 billion development whose final investment decision is expected next year.

Having leapt from second or third-tier owner in each project, Santos will become operator of old and new. The plan is to retain that shaping position but to trim the ownership of DLNG and Barossa-Caldita to something nearer 40 per cent.

Santos arrived at this deal with the DLNG-side of that pruning already organised with a letter of intent signed with SK of Korea that will see it take 25 per cent of the LNG facility and Bayu-Undan.

Until Monday SK was the second-biggest owner of the Barossa-Caldita project with 37.5 per cent. Given Gallagher’s pitch on alignment, it would seem to be a fair bet that SK too will move to trim its place in the now Santos-operated expansion project.

According to Gallagher, Santos continues in productive conversation about ownership alignment with the other investors in DLNG. There are four other owners, three Japanese companies and one Italian. They are Inpex (11.4 per cent), ENI (11 per cent), JERA (6.1 per cent) and the half-owner of the world’s biggest LNG buyer, Tokyo Gas (3.1 per cent).

Santos expects that the SK deal, along with the ownership tinkering that will follow, should allow it to very promptly reduce gearing from the 35 per cent it will reach on deal close to something nearing its through-the-cycle target of 25-30 per cent.

Just on debt, Gallagher expressed three reasons why shareholders should be confident and comfortable with another debt-funded deal that takes the total transaction toll over the past 14 months to $US3.5 billion.

First, Santos continues to generate strong cash flow through a period of relatively soft oil and gas prices. Second, the Quadrant deal stands a proof-point of the capacity of the company’s balance sheet and management ability to digest a major transaction. And finally, the level of debt required to complete the ConocoPhillips deal will be nothing like the headline numbers in the transaction.

That is because of the SK transaction and because the cash flows generated since January will be allocated on the new ownership structure.

So, in the end, the funding requirement is expected to range between $US775 million and $US825 million. As a result Santos, which has $US1.2 billion in cash on hand, has secured itself a $US750, two-year acquisition facility.

As you might imagine, Gallagher insisted that the prudence learnt through the collision of the ramp-up of the company’s Gladstone LNG project with the 2015 oil price crisis still guides investment hands at Santos. His business will not excessively stretch its balance sheet, he promised.

The really fascinating product of Gallagher’s push on DLNG is how it leaves Santos as the gatekeeper of so much latent and future opportunity in Australian gas.

As things stand, DLNG is a one-train project with capacity of 3.7 million tonnes and a bank of contracted customers, a lot of whom will likely want to extend their connections by signing up to take Barossa-Caldita gas.

But, as Gallagher noted several times on Monday, the project carries approvals for three trains and he believes there is gas enough to the north, west and south of Darwin to create a 10mtpa export hub.

To the north and west, Santos lists the relatively proximate Petrel-Tern-Frigate fields that total 2.6 trillion cubic feet of gas (about half the size of the Barossa-Caldita accumulation. Santos also owns a lead share of 2.8TCF of gas in the Browse Basin, a package of four fields that includes the Crown and Lasseter finds. And there is the more distant 2.1TCF Poseidon resource.

Even more intriguing is the potential offered by the deep onshore shales of the Northern Territory’s MacArthur Basin. Santos is set to start drilling in the MacArthur and just last week Origin Energy re-opened its shale exploration campaign in the adjacent Beetaloo Basin.

Santos’ share of the NT shales is expected to generate dry gas while there is informed hope that Origin’s play will produce liquids as well. But, either way, the most likely exit-point for shale discoveries of any scale has always been Darwin.

Another of the points that Gallagher made over and again through the opening phase of his deal marketing was that the ownership of any future Darwin LNG trains could be quite different to that of the foundation project.

To my mind this observation demonstrates the level of optionality that Santos has acquired in assuming ConocoPhillips' standing as the operator of DLNG.

There is reason to imagine, for example, that if the potential of the MacArthur-Beetaloo plays out as hoped, then Santos and Origin, along with some big gas customers, might share ownership of an expansion train at DLNG.

Just while we are enjoying a bit of harmless speculation, another NT exploration project that will be worth keeping a weather eye on over the longer term is the Santos-operated Dukas wildcat in the Southern Amadeus Basin.

Dukas was drilled through July and August of this year and generated encouragement and frustration in almost equal measure. Drilling produced indications of hydrocarbons but ultimately the work had to be suspended because the formation pressures were assessed to be too high for the rig deployed to do the drilling.

It seems likely that Santos will not return to Dukas until 2021. But if the play works to its currently assessed potential, then it could well justify being connected to the east coast network through Moomba. And that, folks, makes it a possible game changer for the east coast markets.