Over the last six months (until recently), the oil price trended down from ~US$90/bbl to a low of ~US$70/bbl amidst softening amidst subdued Chinese demand and OPEC’s plans to add 180,000 additional barrels per day to the global oil market in December.
Broadly speaking, the global oil market has been relatively balanced from a supply/demand perspective.
However, the oil price has pushed sharply higher to >US$80/bbl over the last week amidst an escalation of conflict in the Middle East. While there have been no material disruptions to oil supply so far during the Israel-Hamas war, the risk of a major supply shock has increased after Iran fired 200 ballistic missiles at Israel last week.
The potential for Israel to target Iranian oil infrastructure in retaliation has driven a surge in oil price volatility. Meanwhile, with Israel’s ground and air offensives in Lebanon and Gaza also intensifying, the threat of the situation evolving into a broader regional conflict is growing. Risks to supply are compounded by the threat of further attacks from Houthi rebels on oil tankers in the Red Sea.
Meanwhile, on the demand side of the equation, China’s recent stimulus package (with further fiscal measures on the way), robust US economic data and the interest-rate cutting cycles in the US and Europe are incrementally positive for oil demand over the medium-term.
Remaining Positive Towards Oil
Everything considered, we expect oil prices to remain buoyant over the medium-term, with risks skewed to the upside over the near-term amidst the evolving situation in the Middle East. The oil price is likely to retain a ‘geopolitical risk premium’ for the foreseeable future until tensions ease.
Over the longer-term, we also have a constructive outlook for oil. Declining demand in OECD countries is likely be offset by strong growth in energy demand from non-OECD countries, driven by the economic development in Asia.
On the supply side, given OPEC’s influence over oil supply and the prospect of plateauing US shale production, we expect the global oil market to remain relatively balanced over the next decade. As non-OPEC production wanes, OPEC is likely to increase its production market share and have greater influence over the oil price, which is supportive of a long-term oil price of US$70-90/bbl.
Risks Skewed to the Upside for LNG
The global Liquefied Natural Gas (LNG) market remains tight amidst supply constraints, robust demand, and elevated geopolitical risks, which together continue to support above-average LNG prices.
Risks are skewed to the upside for the LNG price over the near-term, with the key swing factors for the supply/demand dynamic being the Northern Hemisphere winter, ongoing geopolitical risks in Europe and the Middle East, and the risk of further LNG project delays.
1. Northern Hemisphere winter
The Northern Hemisphere winter is a seasonally strong period for LNG demand. A harsh northern hemisphere (namely European) winter would drive a surge in LNG demand (and therefore prices) over the near-term, noting LNG’s share of Europe’s energy mix has doubled in four years to 40%. While European gas storage levels are currently high (at 93% utilisation), a deep winter would quickly draw down on this storage, which would require the EU to replenish its gas storage levels before the 2025/6 winter.
2. Geopolitical risks
Ukraine’s transit agreement for exporting Russian gas to Europe (which accounts for ~6% of EU gas supply) is set to expire at the end of this year, and Ukraine has indicated that this will not be renewed. Further European sanctions on Russian gas or a confirmation of the end of Ukraine transit would adversely impact global supply. Separately, escalating tensions in the Middle East present risks to LNG supply, which has already been evidenced by shipping constraints in the Panama Canal and the Red Sea in 2024.
3. LNG project delays
Delays to LNG projects will extend the tight market into the second half of 2025. There have already been delays at Golden Pass Phase 1 (10 mtpa) in Texas, Plaquemines LNG Phase 1 in Louisiana (13 mtpa) and Altamira FLNG (2.8mtpa) in Mexico, representing ~6% of current supply. Further delays in the construction and commissioning of projects in the pipeline will prolong LNG market tightness.
Medium-term LNG fundamentals remain sound
In the short-term, we see little downside risk to LNG prices amidst the fragile supply environment, with risks skewed to the upside from higher seasonal demand, geopolitical risks, and LNG project delays.
Over the medium to long-term, LNG will play a key role on the path to net zero as a transitionary fuel that fill the gap created by the world’s the pivot away from coal, while also providing the necessary firming capacity to support renewables. Global demand for LNG is expected to rise by more than 50% by 2040 led by non-OECD countries, as coal-to-gas switching gathers pace in China and Asian countries use more LNG to support their economic growth.
While supply is also expected to increase materially over the next five years, led by major projects in Qatar and the US, we expect the LNG market to remain relatively balanced over the medium-term, given the demonstrable strength of demand alongside the possibility of further LNG project delays. Even with growth in LNG capacity, we do not expect the LNG market to be ‘flooded’ with new supply beyond what is required to meet demand.
In any case, we note the majority (~80%) of Australian LNG exports are indexed to the oil price, rather than sold at the spot LNG price (i.e. the JKM). Therefore, while LNG market fundamentals are relevant for the ASX energy sector, the oil price is by far the pre-eminent earnings driver for LNG exporters, Santos and Woodside.
Change in Preferred Oil and Gas Exposure – Santos > Woodside
Santos (STO) is now our preferred oil and gas exposure, as the company has a significantly stronger production/earnings growth outlook and a superior free cash flow profile compared to Woodside Energy (WDS).
Given the share price performance of established producers is typically highly correlated with their earnings trajectory, we expect Santos to outperform Woodside over the medium-term, noting its 3-year EPS CAGR is +15% compared to Woodside at +4% (see figure 12).
Accordingly, Woodside has been removed from the Focus Portfolio (-6%), and Santos has been added to the portfolio at a weight of 5%, which represents an active weight of 4% compared to the ASX 300. The portfolio retains an overweight exposure to the oil and gas sector, with a 5% sector weighting compared to the ASX 300 index weight of 3%.
The rest of the proceeds have been added to James Hardie (JHX) (+1% to 4%), reflecting our level of conviction in the business amidst a buoyant US economy and the Fed’s ongoing rate cutting cycle.
Removing Woodside due to Thesis Break
Woodside Energy (WDS) has been removed from the Focus Portfolio (-6%) due to a thesis break.
Previously, WDS was our preferred oil and gas exposure over Santos (STO) due to:
- disciplined approach to capital allocation (focused on capital returns)
- less onerous capex requirements
- less project specific risks compared to Santos
- more attractive free cash flow yield
However, these rationales no longer hold.
Disappointing capital allocation decisions
Woodside has departed from its disciplined approach to capital management. Previously, shareholder capital returns were a priority, with management demonstrating a greater focus on dividends and buybacks.
However, in the last three months the business has committed to a number of questionable capital investments, including the US$900m acquisition of Tellurian (owner of the Driftwood LNG project) and its US$2.35bn acquisition of the OCI Clean Ammonia Project.
The internal rates of return (IRR) that these acquisitions will deliver are uncertain at best - particularly Woodside’s recent push into green energy initiatives. These projects are likely to yield a lower return on capital than Woodside's core oil and gas assets, noting its IRR hurdle for green energy investments (>10%) is lower than its hurdle for oil and gas investments (>15% and >12% respectively).
Moreover, recent M&A has diverted capital away from capital returns (i.e. buybacks), which would be a far better use of capital (generating a greater IRR for shareholders) in our view.
Weaker free cash flow outlook
Previously, we were attracted to Woodside’s easing capex requirements, which had underpinned our expectations of a pickup in free cash flows over the medium-term.
However, Woodside’s free cash flow (FCF) outlook has deteriorated in recent months due to a greater capex burden, driven primarily by the Driftwood LNG project. Phase 1 (11 mpta) and phase 2 (5.5 mtpa) of the project will likely require US$15bn of capex in total, based on management's guidance of US$ 900-960 of capex per tonne.
Therefore, until first production (expected in 2029), Driftwood LNG will weigh on group free cash flows, which could necessitate dividend cuts given the pressure this will place on gearing (particularly if oil prices weaken).
While a partial selldown of Driftwood LNG could ease the capex burden, the timing of when this will occur, if at all, is uncertain. Moreover, even with a 50% selldown of the asset, Woodside’s FCF yield would remain unappealing relative to STO (see figure 12).
Adding Santos – Growth Projects De-risked
Santos (STO) has been added to the Focus Portfolio at 5%.
With key growth projects de-risked, free cash flows are set to build…
The investment case for STO has improved materially in the last six months.
Previously, we were cautious around the risk of regulatory delays and cost blowouts to key projects, most notably Barossa, which is a low-cost LNG project located offshore in the NT. We had also been unenthused by the company’s relatively significant capex requirements and unattractive free cash flow profile relative to Woodside.
However, these concerns are now largely behind Santos, with the Barossa and Pikka (Alaskan oil) projects now largely de-risked. After receiving key regulatory approvals and following better than expected drill results, Barossa and Pikka are on track for first gas/oil in Q3 2025/1H 2026 respectively. As these projects come online, Santos will see a material step change in its free cash flow profile.
Overall, Santos now strikes the best balance between production growth and capex levels, and hence its free cash flow profile. This contrasts with Woodside, which has both an inferior medium-term growth outlook and a weaker free cash flow profile (driven by the combination of growing capex and declining production to 2029).
Santos – Investment Thesis in Charts
| FY24 | FY25 | FY26 | FY27 | FY28 | ||
| Production volume per day - oil equivalent (Mboe) | 3 yr CAGR (FY25-28) | |||||
| Santos | 237.2 | 247.1 | 303.8 | 315.2 | 313.3 | 8% |
| Woodside | 518.3 | 520.1 | 496.9 | 506.2 | 463.6 | -4% |
| Earnings per share (USD) | 3 yr CAGR (FY25-28) | |||||
| Santos | 0.44 | 0.42 | 0.5 | 0.59 | 0.63 | 15% |
| Woodside | 1.39 | 1.32 | 1.16 | 1.33 | 1.49 | 4% |
| Dividend yield | 3 yr change (FY25-28) | |||||
| Santos | 5% | 4% | 6% | 6% | 7% | 2% |
| Woodside | 7% | 5% | 4% | 5% | 5% | 0% |
| Free cash flow yield | 3 yr change (FY25-28) | |||||
| Santos | 7% | 8% | 13% | 13% | 14% | 6% |
| Woodside (consensus) | 1% | 6% | 7% | 8% | 9% | 3% |
| Woodside (Driftwood LNG 100% ownership)* | 1% | 5% | 1% | 0% | -1% | -6% |
*Consensus forecasts do not reflect the total capex burden of Driftwood LNG for Woodside (suggesting most analysts are forecasting a partial selldown of the asset). Source: Visible Alpha, Wilsons Advisory.
Written by
Greg Burke, Equity Strategist
Greg is an Equity Strategist in the Investment Strategy team at Wilsons Advisory. He is the lead portfolio manager of the Wilsons Advisory Australian Equity Focus Portfolio and is responsible for the ongoing management of the Global Equity Opportunities List.
About Wilsons Advisory: Wilsons Advisory is a financial advisory firm focused on delivering strategic and investment advice for people with ambition – whether they be a private investor, corporate, fund manager or global institution. Its client-first, whole of firm approach allows Wilsons Advisory to partner with clients for the long-term and provide the wide range of financial and advisory services they may require throughout their financial future. Wilsons Advisory is staff-owned and has offices across Australia.
Disclaimer: This communication has been prepared by Wilsons Advisory and Stockbroking Limited (ACN 010 529 665; AFSL 238375) and/or Wilsons Corporate Finance Limited (ACN 057 547 323; AFSL 238383) (collectively “Wilsons Advisory”). It is being supplied to you solely for your information and no action should be taken on the basis of or in reliance on this communication. To the extent that any information prepared by Wilsons Advisory contains a financial product advice, it is general advice only and has been prepared by Wilsons Advisory without reference to your objectives, financial situation or needs. You should consider the appropriateness of the advice in light of your own objectives, financial situation and needs before following or relying on the advice. You should also obtain a copy of, and consider, any relevant disclosure document before making any decision to acquire or dispose of a financial product. Wilsons Advisory's Financial Services Guide is available at wilsonsadvisory.com.au/disclosures.
All investments carry risk. Different investment strategies can carry different levels of risk, depending on the assets that make up that strategy. The value of investments and the level of returns will vary. Future returns may differ from past returns and past performance is not a reliable guide to future performance. On that basis, any advice should not be relied on to make any investment decisions without first consulting with your financial adviser. If you do not currently have an adviser, please contact us and we would be happy to connect you with a Wilsons Advisory representative.
To the extent that any specific documents or products are referred to, please also ensure that you obtain the relevant disclosure documents such as Product Disclosure Statement(s), Prospectus(es) and Investment Program(s) before considering any related investments.
Wilsons Advisory and their associates may have received and may continue to receive fees from any company or companies referred to in this communication (the “Companies”) in relation to corporate advisory, underwriting or other professional investment services. Please see relevant Wilsons Advisory disclosures at www.wilsonsadvisory.com.au/disclosures.