Junior partner hits out at Santos decision to pull plug on Dorado

Santos Ltd (ASX:STO) has recently faced criticism from its junior partner, Carnarvon Energy Ltd (ASX:CVN), following its decision to withdraw from the Dorado oil project, located offshore Western Australia. Santos, which holds a 70% interest in the project, announced that it would not proceed with the next phase of development due to concerns over the project's economic viability. This decision comes after a series of disappointing drilling results and rising costs associated with the project, which have led Santos to reassess its investment strategy in the region. Carnarvon, which holds the remaining 30% stake, has expressed its disappointment, stating that the decision undermines the potential of the Dorado project and could negatively impact future exploration activities in the area.

The Dorado project has been a focal point for both companies, with significant investments made in exploration and development over the past few years. Santos' withdrawal raises questions about the project's future, particularly given the recent downturn in oil prices and the increasing costs of offshore drilling. Carnarvon's management has indicated that they believe the project still holds substantial value and potential, and they are exploring options to either bring in a new partner or take on a larger share of the project themselves. This situation highlights the ongoing challenges faced by junior partners in large-scale oil and gas projects, particularly when major operators decide to scale back their commitments.

From a financial perspective, Santos' decision to exit the Dorado project could have implications for both companies' valuations. Santos, with a market capitalisation of approximately AUD 16 billion, is in a position to absorb the costs associated with this decision. However, for Carnarvon, which has a market capitalisation of around AUD 300 million, the impact is more pronounced. The junior partner's reliance on the Dorado project for future growth makes this decision particularly concerning. Carnarvon's current cash balance is reported to be AUD 30 million, with a quarterly burn rate of approximately AUD 5 million, suggesting a funding runway of around six months. This situation raises questions about the company's ability to finance its ongoing operations and any potential new initiatives without additional capital.

In terms of valuation, Carnarvon's current enterprise value is significantly influenced by its stake in the Dorado project. The market has reacted negatively to the news, with shares of Carnarvon falling by over 10% in the wake of Santos' announcement. Comparatively, peers such as Beach Energy Ltd (ASX:BPT), which has a market capitalisation of approximately AUD 4 billion, and Oil Search Ltd (ASX:OSH), with a market cap of around AUD 3 billion, are also facing similar pressures in the current oil market. However, these companies have more diversified portfolios and stronger cash positions, allowing them to weather the downturn more effectively. For instance, Beach Energy's recent production figures indicate a robust operational performance, with an EV/EBITDA ratio significantly lower than Carnarvon's, suggesting that the latter may be overvalued given its current circumstances.

Carnarvon's execution track record has been mixed, with several delays in drilling schedules and project developments over the past year. The company has previously indicated ambitious timelines for the Dorado project, but the recent decision by Santos to withdraw raises concerns about management's ability to deliver on its commitments. The risk of further delays or potential write-downs on the project could lead to additional volatility in Carnarvon's share price. Furthermore, the reliance on a single project for growth exposes the company to significant risks, particularly in the context of fluctuating oil prices and the competitive landscape of offshore drilling.

Looking ahead, the next measurable catalyst for Carnarvon will be its ability to secure a new partner for the Dorado project or to outline a clear strategy for moving forward independently. The company has indicated that it will be engaging with potential partners in the coming months, but the timeline for any new developments remains uncertain. The outcome of these discussions will be critical in determining the future direction of the company and its ability to maintain investor confidence.

In conclusion, Santos' decision to withdraw from the Dorado project represents a significant setback for Carnarvon Energy, raising concerns about the project's viability and the junior partner's financial health. The announcement is classified as significant due to its potential impact on valuation, funding risk, and execution outlook. Carnarvon's reliance on the Dorado project for future growth, coupled with its limited cash reserves and mixed execution track record, underscores the challenges it faces in the current market environment. As the company seeks to navigate these challenges, the ability to secure a new partner or develop a clear strategy will be crucial in mitigating risks and restoring investor confidence.

Key insights

• ●Santos withdraws from Dorado, impacting Carnarvon's growth prospects.
• ●Carnarvon's cash balance is AUD 30 million with a burn rate of AUD 5 million.
• ●Next catalyst is securing a new partner for Dorado.

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