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Morningstar | Dorado-2 Seals the Deal for Santos’ 100mmboe Group Production Target. No Change to AUD 8.15 FVE.

Any lingering doubts on the merit of Santos’ USD 2.15 billion acquisition of Quadrant Energy last year are now surely expunged. Following the success of Corvus gas field drilling last quarter which intersected a gross interval of 638 metres--one of the largest columns ever discovered across the North West Shelf--Santos can now confirm one of the largest ever oil pools on that same shelf at its 80% owned Dorado discovery off Port Hedland. The Dorado-2 well successfully confirms pre-drill expectations of a major oil and gas resource, and then some.

No-moat-rated Santos still targets group production growth to greater than 100 million barrels of oil equivalent, or mmboe, by 2025 versus 58.9 mmboe in 2018. We now target more--108 mmboe in 2025--increasingly confident with greater certainty wrapped around Dorado. Our last note ascribed USD 300 million or AUD 0.20 per share for the Dorado oil field given its still early status. However, we added this could perhaps double if appraisal drilling proved successful. As it happens, we now more than double the ascribed value to just over USD 800 million, given the stellar result. But our Santos fair value estimate overall is unchanged at AUD 8.15, given a number of minor offsets, not least a decline in the near-term oil price outlook in line with the futures curve. This is still well above the subdued AUD 6.75 share price. Our midcycle USD 60 per barrel Brent price forecast in 2021 dollars is unchanged.

The Dorado-2 well encountered 83 metres, or m, of net pay, including a minimum 40m of net oil pay, and an additional 43 m of condensate rich gas and/or oil. This follows up on Dorado-1’s 132 m of net hydrocarbon pay, including 80 m of oil, 2 kilometres to the south-west. There is high-quality reservoir in each target with initial indications that fluid compositions are similar to the light oils and gases sampled in Dorado-1, where enviably high condensate yields range from 70 to 245 barrels per million standard cubic feet.

The pressure data also indicates continuous columns between Dorado-1 and Dorado-2, and some reservoirs did not intersect a water contact meaning potential for further field extension. Santos says the result should drive a significant increase in gas resources relative to pre-drill estimates, and derisks a future development, particularly in the context of the shallow-water setting. It also opens up a new basin, the Bedout Sub-basin, where a rich exploration inventory remains, with potential to add substantially again to the resource base through a number of look-alikes. The drill rig will now move to Roc South-1 to the immediate north-east in the same permit, before returning for Dorado-3.
Santos has not separately released a resource estimate for Dorado, but its 20% joint venture partner Carnarvon Petroleum had earlier reported a gross 2C resource of 283 mmboe, and 362mmboe including Roc. The figures will likely grow, on a 3C basis the prior estimate was over 700mmboe.

A Dorado development is likely to produce oil first to generate strong up-front cash flows, followed by a full field development adding gas and condensate production. Cost should be competitive given shallow water, near gas infrastructure and support services. Carnarvon Petroleum points to a final investment decision in 2020 and Santos’ preliminary development concept is for jack-up drilled deviated wells tied back to an FPSO with 50,000 barrels of oil per day capacity. For context that would equate to 18 millions of barrels, or mmbl, in annual production, of which Santos’ majority 80% or 14.5mmbl share would represent a meaningful 20% increment on its current annualised group production rate of 75mmboe. Dorado should also be particularly value-accretive given likely low capital intensity for high-margin oil production. Field life would be well in excess of 10 years, allowing plenty of time to test surrounding targets for tie-back.

Our Santos fair value estimate equates to a 2028 EV/EBITDA of 6.7, crediting 10-year non-third-party group revenue CAGR of 6.5 % to USD 4.8 billion. This supports 10-year EPS CAGR of 7.0% to AUD 0.94 by 2028 for a nominal P/E of 7.2 at the current AUD 6.75 share price, or 18 inflating at WACC. Our comfort to credit these earnings levels is supported by growth projects and favourable activity on Santos’ part.