Santos bid puts Harbour Energy over a political barrel

Harbour Energy's $13.5 billion takeover offer for Santos is a gift for Prime Minister Malcolm Turnbull as he moves into the second year of a campaign to secure greater certainty in the supply of affordable gas on the east coast of Australia.

Turnbull now has considerable leverage over the country's second largest oil and gas company, which produces about 163,000 barrels of oil and gas equivalent per day, has 2P reserves of 848 million barrels of oil equivalent and current LNG production of about 3.1 million tonnes per annum.

He can use this leverage to secure a positive outcome for businesses struggling to cope with record high gas prices. Although his preferred outcome will probably involve Treasurer Scott Morrison pulling out the national interest card.

The Foreign Investment Review Board has spent years trying to clarify its role as an independent arbiter of foreign takeovers. But, as we discovered with the sudden change in policy toward foreign buyers of energy generation and distribution and assets, Australia's foreign investment policies are fluid.

That fluidity is probably enhanced during an election year. The trade off for greater certainty about east coast gas supply is likely to be the 100 per cent foreign ownership of the GLNG project in Gladstone.

Harbour Energy's chief executive Linda Cook is conscious of the need to ensure that Santos under her control works harder to ensure the gas crisis affecting the Australian industry is alleviated. That conciliatory position is in sharp contrast to the aggressive rhetoric of Santos CEO Kevin Gallagher.

Gallagher made the valid point last year that the surge in east coast prices was directly attributable to the lack of cheap gas in Australia and not because of the construction of three separate LNG terminals in Gladstone.

Gallagher pushed the blame for the lack of supply of cheap gas back on to state and territory governments, which he said had blocked the exploration and development of coal seam gas. While that was accurate it did nothing to help Turnbull.

Diplomatic messages

With 29 years at Shell it would not be surprising to know that Cook is a master of diplomacy. She confronts the east coast gas problem head on by saying that a Santos backed by the financial muscle of Harbour Energy will have the capacity to spend more on domestic exploration in both conventional and unconventional gas.

One of Cook's first diplomatic stops on Tuesday was the new South Australian Premier Steven Marshall to give assurance about head office not moving and more jobs being created in the state from increased drilling in the Cooper Basin.

Part of Cook's pitch to the politicians and FIRB will be her contention that Harbour Energy is not your typical private equity investor. It is a long-term investor with "permanent" capital.

The competitive advantage that Harbour Energy brings to the table is the significantly lower cost of capital available to an American organisation accessing global debt markets.

It is ironic that Harbour Energy's financial firepower comes from the debt markets. Santos has basically spent about seven years trying to restore stability to its balance sheet after it borrowed too much in fulfilling its commitments to the GLNG consortium's Gladstone LNG plant.

Gallagher deserves credit for putting Santos back on a growth path and delivering a respectable cash flow. But the moment he gets the net debt down to $2.7 billion Harbour Energy walks in ready to load it up with $US7.75 billion in fresh debt.

Market scepticism

JP Morgan and Morgan Stanley will underwrite the debt issue. Cook used debt in her $US3 billion purchase of North Sea oil and gas assets from Royal Dutch Shell in October last year. That debt raising was twice over subscribed.

There is obviously scepticism in the market about Harbour Energy's bid given that Santos shares closed on Monday at a 10 per cent discount to the $6.50 a share takeover price. Trading desks reckon the stock should have settled at about $6.10.

The discount can be interpreted in a number of ways. One view from the arbitrage funds that make money out of takeover offers is that the Harbour Energy due diligence will be fine but the politics and FIRB risks mean it is too early to make a firm judgment on the outcome.

Another reason for the discount is that the market may be taking the view that the due diligence will throw up problems that can be used to pitch a lower takeover price. But that is unlikely given that Harbour Energy has now bid against itself twice to get control of Santos. Its latest offer is $4 billion higher than the one launched just eight months ago.

Another factor causing the discount is possibly a slightly bearish view on the outlook for the oil price.

A successful takeover of Santos will mean Harbour Energy has annual production of about 290,000 barrels of oil and gas equivalent per day and 2P reserves of 1.2 billion barrels of oil equivalent. It would rank among the top five independent oil and gas companies outside of North America.

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