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Abdul Davids: Analysing Sasol’s delay on its gas-to-liquids plant investment


The latest numbers we have on South African crude oil imports show them to be running at over 500 000 barrels a day. So with the collapse in the price, instead of paying $50m daily, the bill has dropped to under $25m. Direct savings dwarf the disadvantage to the Fiscus of lower profits from local oil-from-coal producer Sasol, which paid R14bn in the year to end June. That forms the context to this insightful interview on what next for Sasol with Kagiso’s Research Chief Abdul Davids. – AH

ALEC HOGG:  Going ahead with the chemicals cracker, this latest adjustment is in response to the low oil price, well surprise-surprise.  Joining us in our Cape Town studio for an analysis of Sasol, a share that is very widely held by investors on the JSE is Abdul Davids.   He is Head of Research at Kagiso Asset Management.  Abdul, let’s just get a couple of things really straight, to start off with.  Yes, we’re sorry that Sasol is not making as much money as it made in the past but for South Africa as a whole, to cut the cost of its oil imports, which were running at about R500m a day, to R250m a day has got to be, all things considered, than the poor Sasol shareholders are getting  hurt.

ABDUL DAVIDS:  I think that’s right Alec.  I think obviously, especially taking into account that your shareholder base of Sasol, the entire market-cap of Sasol today is around R260bn, so that just puts it in perspective.  That your shareholders in total compared to the benefit to the economy for a much lower oil price, is far outweighed, by the benefits of the lower oil prices, yes.

ALEC HOGG:  But the point we need to focus on now, having put that to one side, so we know the context, is that there are a lot of people who own Sasol shares and, I guess they must be wondering ‘what to do next’.  Have you got some privy advice?

ABDUL DAVIDS:  Yes, unfortunately, I didn’t bring a crystal advice and I think if I have to be honest, many people were caught off-guard by the extent and the steepness of the decline in the oil price that we have seen.  I think we have been watching the US shale oil production numbers, for the last couple of years and the US has really come to the fore, in terms of producing oil.  Historically the US has always been a big net import of oil and Opec supply to the US in particular.  What has been happening increasingly is that the US has first of all reduced their imports and in the foreseeable future could potentially be an export of oil as well.

Now all of that has played into the classic supply on demand fundamentals, with a slow in China and slow in growth, globally, we’ve seen demand slowing and its supplies, obviously continue at a pace in terms of the growth that we’ve seen there.  Ultimately, it had to impact on pricing, but ultimately, we believe that as with most commodities and with most cycles, there are extremes on the upside and similarly there could be extremes on the downside.  At current levels, below $50.00 especially, the oil price is probably too weak and you probably should see some sort of rebound in the oil price.  However, I do not think that we’ll see an oil price going back to $100.00 or $110.00 plus, at least for the next couple of years.

ALEC HOGG:  I need to challenge you on that, on the rebound in the oil bound.  We met, in Davos, with our media leaders group, with the Head of the Interim Governed at Libya.  Libya is a country that hopefully, is going to settle down soon.  They’re pumping 200.000 barrels a day, at the moment.  They were pumping one-point-six million barrels a day.  We also saw the Foreign Minister of Iran getting even cosier to the West, to try and get out of sanctions.  Iran comes to the party; you’ve got another Saudi Arabia pumping oil.  You’ve got Iraq and hopefully things settle down there, another Saudi Arabia, so three Saudi Arabia’s, plus a Libya coming to the party.  That’s a big amount of pent-up supply.  What makes you think, given that that’s a possibility that the oil price has room to rebound?

ABDUL DAVIDS:  I think everything has a price and a lot of the…so outside of Saudi Arabia a lot of, even the OPEC members, their costs of production, especially on an all in cost basis.  Taking into account the capital cost of processing plants, etcetera, is quite prohibitively expensive.  As a result, they require a much higher oil price or clearing price, to make it viable for them to produce.

I agree, there’s a lot of capacity to produce but at current prices, there’s not a lot of profitable capacity and ultimately, economy should dictate.  Already we’ve seen a lot of the larger oil companies shelving massive capital projects.  If we look at outside of Opec, the non-conventional (sort of) oil suppliers, they are all struggling to even break even at current prices.  Ultimately, that will have an impact in their ability to supply the market, in the future as well.

GUGULETHU MFUPHI:  So you’re pretty pleased with the call by management, which many have hailed as a good decision, but I understand you are also quite bullish on the ethane crack and the plans to go ahead with that one.

ABDUL DAVIDS:  Yes, I think so.  Firstly, on the GTL plant.  Clearly, that’s taking gas and converting that into various fuel products, etcetera.  That conversion ratio is a key ratio that we look at and even at current gas prices; you need a substantially higher oil price, to make it a viable proposition.  Currently, clearly with the current oil price, GTL would still, effectively not be viable at all, so I think they’ve taken the right decision.

Clearly, given the fact that it’s a substantial capital amount that they need to invest, in excess of $14bn for that plant, we think to, at least shelve it, in the short term, is the right strategy.   On the ethane cracker, I think clearly you have significant shale gas production in the US and a lot of that dynamics hasn’t really changed.  Admittedly, we are seeing, at the margin, some of those big, gas producers, talking about reducing supply, etcetera, but the fundamental reality is that there’s a substantial amount of gas in the US and that needs to find a home.

So the ethane cracker really is going to enable Sasol to take some of that gas and produce various ethane products, etcetera that has a fantastic and exciting growth market opportunity as well.

ALEC HOGG:  Now, again when I had a chance to chat to David Constable about that, he was very excited about the ethane cracker, for all the reasons that you’ve articulated but how, when you take Sasol as a whole, how important is the chemical side in the complete picture?  In other words, would the ethane cracker, which is going to print money at these oil prices and gas prices, would that be enough to offset the drop for Sasol in the oil price?

ABDUL DAVIDS:  In the short term, no, clearly with the drop in the oil price…  If you look at the makeup of Sasol’s earnings, the bulk of the earnings still came from the Secunda complex, and Secunda has obviously, been going for a number of decades as well.  So in the short term clearly, a lot of the pain will be felt from just the mere fact that oil prices are down.  We are looking at Secunda’s earnings, basically halving.

Bearing in mind that the ethane cracker, we expect only to see first profits by late 2017/2018, so you have this period where, as you ramp up and as you build the ethane cracker, you’re relying on substantial cash flows from your existing operations, especially Secunda, in South Africa.  So, in the short term, definitely there is not going to be any contribution from ethane and yet a negative contribution from the much lower oil price.

GUGULETHU MFUPHI:  Abdul, for investors, should they be concerned about their dividend?

ABDUL DAVIDS:  I’m asking the same question as well.  I think, clearly in terms of their current policy, they’ve got a progressive dividend policy.  That basically implies that, at the very least, your last year’s dividend of 21 and 50, should be maintained and obviously, if there’s growth in earnings, the theory says that your dividend should grow in line with growth in earning.

However, we have seen other companies, even with the progressive dividend policies, basically cutting dividends, so the Sasol share price, where it is currently, suggests that there might be a cut in the dividend, given that the dividend yield, currently, is over five percent, which is much higher than the average dividend deals that we’ve seen in the market.

I think, in the interim split, you’re probably likely to see a maintenance of the dividend around eight Rand, as we saw last year for ourselves, but I think clearly, the extent of the various cash flow movements, in terms of inventory adjustments and ultimately what the oil price is going to be on the 30th June 2015.  This will dictate what will happen to the Sasol dividend.

ALEC HOGG:  Abdul, I know that value investors like to talk about reversion to the mean, and again a challenging question for you here.  If you look at the long-term oil price graph, it bumped around between $20.00 and $30.00, from 1986 until 2005.  Then it had this spike upwards, surely, reversion to the mean is closer to that long-term average, rather than what we’re now saying as well, $80.00 to $100.00?

ABDUL DAVIDS:  Yes, I have seen that chart and I’ve seen other scarier charts that look at the 100-year averages that suggest much lower oil prices.  I think the counter to that is mainly twofold.  Firstly, the rise of China, we haven’t really seen China as a big demand driver before, and that has changed the terms of trade (if I can call it that).  The other is a reality that even outside of Opec; Opec historically, was a much bigger contributor to overall supply, in excess of 50%.  As we’re saying today, Opec’s market share has obviously declined substantially, as other people have risen but those non-Opec supply is at a much higher cost.  That needs to be taken into account when looking at future costs and future cost growers as well.

ALEC HOGG:  That was Abdul Davids, Head of Research at Kagiso Asset Management.  It is interesting when you look at that graph, Gugu you’ve got to think that maybe from 2005 onwards there was a bubble.

GUGULETHU MFUPHI:  Exactly.

ALEC HOGG:  And it is only now coming back to normality.

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