As you may remember from previous columns, there are three principal sources for searching behind the numbers of any share company:

1.    Visit the company’s website and read annual reports and other items of interest.

2.    Learn what you do not know through online searches.

3.    Read company-specific news items and industry-related items through online searches.

However, it is more efficient to approach the search with a rifle rather than a shotgun.  With a rifle, you have an idea of a target.  In our case, we know we want to focus the search on the oil exploration story for STO.  What is the future of their new oil discovery?  Is their oil exploration portfolio as large as they claim?

We also know we want to see what we can learn about where oil prices may be heading.  A drop in price would be a problem for any oil exploration company.  Analyst George Sakellariou based his bullish outlook on oil shares in last week’s Sector Scan on two things:

•    Rising crude oil prices, and

•    Increasing demand for oil from China and India.

Before searching the Internet for information on these two issues, let us first look to the Santos website to see what we can learn about their oil exploration portfolio.

We go immediately to the Investor Centre where we quickly confirm the company’s solid foundation in the natural gas market.  A very recent (June 2011) Investor presentation made to US investors lays out the whole story, but has no information about oil exploration projects.  A similar presentation made to Australian investors paints the same picture – extensive planned growth in the LNG (Liquefied Natural Gas) market.

Finally, we find a section on Current Well Information where the story begins to unfold. They list twelve oil wells in stgelopment along the coast of Viet Nam.  They have an additional seven wells underway in the Carnarvon Basin in Western Australia, and the Eromanga/Cooper Basin in Central Australia.

We check the News Announcements section to see what we can learn about the most recent discovery at Finucane South in the Carnarvon Basin, offshore of Western Australia.  The company states they are considering different stgelopment options, one of which would allow actual oil production to begin as early as the end of 2013.

At this point, it would seem their claim about the size of their oil exploration portfolio is valid.  However, we would need to check industry websites and other sources to learn more about how far along each site is.  

Before moving on to the price of crude oil, we check Australian news site, wotnews.com, and search for Santos oil discovery.  There we encounter a tiny Australian company – Drillsearch Energy – that has made another discovery in an area controlled as a Joint Venture, with STO holding a majority interest.  Now for the price of crude.

Another Internet search takes us to the website of the Australian Institute of Petroleum.  There we learn there are actually several different types of crude oil, and we find the following list of factors that influence the price:

•    overall supply/demand for crude

•    supply/demand for petroleum products

•    freight rates

•    competition in the crude markets

•    competition in the regional and domestic markets for petroleum products.

There we also find this concluding statement:

– They all have a role in determining the final price charged to consumers and the role that each of these elements plays can change over time. It is this very complexity in markets which makes it very difficult to determine a theoretical price as part of regulation in markets because there may be a perception that because the theoretical price is different from the market price that the market price is ‘not fair’ for some reason.

Why would the AIP (Australian Institute of Petroleum) comment on perceptions of “fair” pricing?  What is strange is why they do not offer some opinion on the reason.

If you have followed the markets at all since the beginning of 2011, you may know the reason – speculation in oils futures markets.

Like many commodities, oil trades in futures contracts “derived” from the value of physical crude oil.  Within these markets (the major markets are the NYMEX in New York and the ICE in London) there are both physical hedgers and non-physical hedgers.

Physical hedgers are corporations that actually use crude oil.  Non-physical hedgers are investment speculators who buy and sell contracts to purchase crude oil at different prices, but never take delivery of the oil.  They are in it for the profit and they have a valuable purpose – they provide liquidity to the market.

There are a growing number of voices who claim the price of crude oil is being artificially inflated by these speculators.  Enter oil price speculation into the wotnews search engine and you will see the following headlines:

•    Saudis have warned U.S.: Speculators drive oil prices up, cables show

•    A group of financial speculators made $50 million by manipulating the price of oil in 2008, the Commodity Futures Trading Commission charged Tuesday.

•    Speculation explains more about oil price hikes than anything else  

•    ExxonMobil CEO Says Oil Price Should Be $60 To $70 A Barrel  

•    Time for Financial Regulators to Limit Speculation in Oil Market

Here is an excerpt from the first article, published on 25 May 2011 by the United States McClatchey-Tribune News Service:

– Another confidential document from the embassy in Riyadh, dated Feb. 14, 2007, indicates that Saudi officials had concluded years ago that speculation played at least as big a role in setting oil prices as traditional issues of supply and demand did.

– Recounting the presentation by Yasser Mufti, a planner for Aramco, at a conference of U.S. and Saudi officials, the cable said: “The Saudi analysis indicated a link between higher oil prices and the influx of investor funds into the oil markets.”

– The cable noted, “As the oil futures markets play an increasingly large role in setting world oil prices, [Mufti] remarked his team was now obtaining better insights into prospective oil prices from banks than from those working in the real oil sector, such as refiners.

If the CEO of Exxon-Mobil – the world’s largest oil producer – says the market price of oil based on true supply and demand fundamentals should be between $60 and $70 a barrel; and the Saudi government says speculation is playing at least a big a role as supply and demand, who are we to disagree?

What does all this mean for a potential investment of a few thousand dollars or so in STO?  The last headline above says it all, financial regulators in the US have the authority to take action to limit speculation.

If they do, it is probable the price of oil will fall, in the short term.  If you continue looking behind the numbers regarding future demand for oil, you will find it is real.  China and India are giving birth to a giant middle class, and that will not change in the long term.

If you are comfortable holding STO for the longer term, everything we see says the reward will be worth the risk.  If, however, you are interested in STO for a short-term profit, you may want to keep checking on regulatory efforts to curb speculation. 

>>Back to the newsletter to view other articles – June 19th 2011

 

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