Oil has come under pressure this year due to the prospect of increased OPEC+ production, easing conflict in the Middle East, and concerns around the outlook for economic growth amidst escalating trade tensions. 

On the supply side, OPEC+ announced in early March that it will proceed with unwinding its 2.2Mb/d in production cuts in April. This was in line with the group’s plan, albeit market expectations were skewed towards another extension of the production cuts. The addition of new supply at a time when the global market is already in a small surplus has been a clear negative for the oil price. 

Easing conflict in the Middle East, with an Israel-Hamas ceasefire now in effect, has also driven a decline in the ‘geopolitical risk premium’ associated with the risk of oil supply shocks in the region. 

On the demand side of the equation, the threat of US tariffs on imports from its major trading partners has fuelled concerns that an escalating trade war could meaningfully weigh on global economic activity, and hence energy demand over the medium-term. 

Ongoing weakness in China’s economy has also presented headwinds to global oil demand, which has not yet been met with a significant fiscal stimulus response. 

Unsurprisingly, in the context of the falling oil price, the energy sector has underperformed this year-to-date. While the major ASX oil and gas producers (Santos and Woodside) primarily produce LNG, the majority (~80%) of their earnings are indexed directly to the oil price. As such, this report is focussed on our near and long-term outlook for the oil price, and our preferred exposure, Santos. 

Leaving aside the near-term crosscurrents, our long-term view towards oil remains positive. 

Despite the multi-decade challenges posed by the energy transition, we expect oil demand to grow until 2050 (in line with OPEC forecasts), as declining demand in OECD countries will be more than offset by growth in demand from non-OECD countries, driven by the economic development of Asia. 

On the supply side of the equation, after driving a substantial ~10Mb/d lift in production in the last ~15 years (representing a ~10% increase to global supply), US shale production is expected to plateau over the next few years. This dynamic should support a relatively ‘balanced’ market, with OPEC+ likely to lift its production market share over the medium-term. 

We expect this dynamic to give OPEC+ greater influence over the oil price across the medium-term, which is supportive of a long-term oil price of US$70-90/bbl. 

The Focus Portfolio remains modestly overweight the oil and gas sector, with our 5% sector weighting (solely in Santos) representing an 2% active weight compared to the ASX 300.

Santos (STO) remains the standout oil and gas exposure among the ASX large caps (compared to Woodside), given its attractive (and de-risked) production growth outlook, superior free cash flow profile, and disciplined approach to capital allocation (driving improving shareholder returns).

Santos’ growth projects are nearing completion 

Santos’ two major growth projects - Barossa (North Australia, LNG) and Pikka (Alaska, Oil) - are now largely de-risked and progressing according to plan. Barossa is ~91% complete and on track for first gas in Q3 2025, while Pikka is ~76% complete and remains on track for first oil by mid-2026. These projects underpin Santos’ consensus production CAGR of ~7% over 2024-2027. 

Free cash flow build to underpin attractive shareholder returns

With the bulk of Santos’ capex for Barossa and Pikka now complete and both projects set to come online soon, the company is on the brink of a significant step change in its free cash flows from late 2025. 

In addition, Santos has also unveiled its plans to drive $100-150m in annual structural cost savings over the next 12-24 months, which should provide a further ballast to free cash flows. 

In line with its improving free cash flow outlook, late last year management unveiled its new capital management framework, which will strengthen shareholder returns over the coming years. 

Under its new framework, Santos will return at least 60% of all-in free cash flows to shareholders from 2026 (vs 40% previously), The business has also committed to returning 100% of free cash flows once its gearing is below its target range of 15-25% (likely in ~2029 according to consensus). 

Trump 2.0 means Pikka selldown is back on the table 

The Trump administration has been highly supportive of the Alaskan resources sector. The president has already signed an executive order that aims to unwind many of Biden’s restrictions and ultimately boost Alaskan resources (and particularly oil and gas) development. 

The regulatory/environmental tailwinds provided by the Trump Administration (alongside the natural de-risking of the project) have improved the likelihood that Santos can garner investor interest in its Pikka asset after first oil in mid-2026. 

Santos has signalled it is likely to explore a partial selldown of its 51% stake in Pikka (our base case is up to 50% of its stake) to unlock capital for shareholder returns (special dividends or buybacks).

However, a complete sale of Santos’ stake in Pikka is unlikely given this is a high quality, well located, long-life asset with significant strategic value as it diversifies its portfolio and will deliver strong cash flows for the group over the long-term. 

As one of Alaska’s largest oil projects, Pikka phase 1 will have a production capacity of 80,000 Bp/d and will generate an IRR of ‘20% or higher’ at an assumed oil price US$75/bbl. Last year, the project was independently valued at ~US$4.5bn (Santos’ 51% share: ~US$2.3bn). 

Therefore, assuming Santos sells down half of its 51% stake in the project after first oil, this will liberate ~US$1.15bn of cash, which we expect will be used to fund capital returns to shareholders (via buybacks and/or special dividends), possibly as soon as FY26/7. 

In figure 11 and figure 12 we have conducted a hypothetical analysis of the potential capital returns a Pikka selldown could generate.