How Shell's $70 billion takeover shook global LNG markets

Published April 30th, 2015 - 02:09 GMT

Royal Dutch Shell’s $70 billion takeover bid for BG Group, the former British Gas, has shocked the world financial markets. This is the first super major oil and gas deal in a decade. The 50 percent fall in oil price is invariably a catalyst for a Big Oil merger move. The collapse of oil prices in 1999 after the Asian currency crisis and the Russian rouble default led to Exxon’s bid for Mobil, Conoco’s merger with Phillips Petroleum, Chevron’s Texaco tender offer and British Petroleum’s acquisition of Amoco. A major fall in oil prices forces oil and gas CEO’s to slash capex (Shell slashed capex by $15 billion in 2014), focus on economies of scale (Shell has a major commitment to the global LNG market and BG is a major upstream LNG producer) and generate cost savings. This strategic rationale led to Shell to pay a 50 per cent premium to BG Group’s share price on the London Stock Exchange to gain majority control. If Shell succeeds in its takeover bid, the combined company would have a value of $300 billion on the stock exchange.

BG Group, the upstream exploration and production arm of British Gas (Centrica is the retail distribution arm) is the third largest energy firm in the UK, after Shell and BP. BG Group had faced export allocation quotas from its gas fields in Egypt, had faced political fallout in Brazil from the Petrobas scandal and cost overrun on its LNG projects in Australia. Its focus on LNG production and emerging markets oil and gas exploration were both compelling strategic prizes for Shell that motivated its generous cash and share offer and 50 per cent takeover premium bid. BG Group increases Shell’s proven reserves by 25 per cent and production capacity in LNG by 20 per cent, mainly in Egypt, Brazil, Trinidad and Tobago, Kazakhstan, Tanzania, Australia and the North Sea. The acquisition of BG Group will also boost Shell’s replacement ratio, a key metric for any Big Oil supermajor

At $56, Brent crude is half its peak price last June. The oil price crash has forced the world’s oil and gas producers to slash exploration budgets, reduce high cost projects, slash costs/payrolls and write down the value of assets. BG Group was a victim of the oil price crash. Apart from its problems with the Egyptian and Brazilian governments, BG was forced to write down the value of its assets by $14 billion and saw the resignation of CEO Chris Finlayson after only six months in office. In fact, BG Group shares were in such a freefall in late 2014 that Wall Street speculated that ExxonMobil, the world’s largest oil and gas super major would make a takeover bid for BG. The idea of a Shell-BG merger deal was also not new in the trading halls of the City of London, mainly because BG Group is a major natural gas supplier to China, a strategic market for Shell. It is entirely possible that, as in 1999, the first Big Oil merger deal stimulates a global round of sector consolidation.

Now that BG Group is gone, Tullow Oil and Premier Oil, whose share prices fell 60-70 per cent from peak levels, are both potential targets on the London Stock Exchange. The 30 per cent fall in BG Group’s share price in 2014 created value for Shell and its free cash flow will help Shell maintain its generous dividend, a key corporate objective for Shell since its shares are held by almost all British pension funds. “Never sell Shell” is folklore among the City’s pension fund managers precisely because Shell’s dividend is so predictable. It is also politically impossible for Shell to close its North Sea oil exploration unit. Chancellor Osborne even cut corporate tax on North Sea oil drilling in the last UK Budget. BG Group’s North Sea oilfields and 1,500 staff in Aberdeen, Scotland could also provide Shell valuable cost synergies and avoid closure of its North Sea facilities.

The BG Group’s deepwater assets in Brazil and LNG production portfolio also accelerates Shell’s strategic mission to become the world’s prominent integrated gas producer. The combined Shell-BG company will control 16 per ent of output in the global LNG market.

By Sarie Khaled

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