June 2015, Vol. 242, No. 6


Shell Takeover of BG Group Could Reshape Global LNG Map

P&GJ Staff Report

Shell Oil Co.’s purchase of British rival BG Group for 47 billion pounds ($69.7 billion) in cash and stock, the largest energy deal in years, may signal a new wave of mega-mergers as the energy industry adapts to the world of lower prices.

Royal Dutch Shell announced on April 8 that it will pay the equivalent of 13.67 pounds in cash and stock for each share of BG Group, 50% more than April 7’s closing price. The deal will boost Shell’s oil and gas reserves by 25%, including offshore projects in Australia and Brazil, and give it a bigger presence in the global liquefied natural gas market, Shell said. It would be the largest deal in Shell’s long history.

Other energy giants could follow suit as they try to boost growth through acquisitions after increased production in the U.S. helped trigger a plunge in oil prices. Despite a modest rebound, the collapse in global oil prices has led to much speculation about mergers with struggling BG Group was often been cited as a potential target. The deal will combine the largest and third-largest natural gas producers in the United Kingdom.

“Will this be the opening shot in a new wave of mega-mergers like the 1990s?” asked Christian Stadler, associate professor of strategic management at Warwick Business School in Britain. “Quite a few oil companies are under cost pressure with no sense of the oil price recovering. Companies had gotten used to $100 a barrel, and many need $40-60 to break even, so we could see more of these deals.”

The international price of crude oil has plunged from over $115 a barrel last summer to a low around $45 before recovering slightly in recent weeks to trade at $58 a barrel April 8.

Brazilian Deepwater Attractive

Wood Mackenzie said BG’s large position in the deep waters off of Brazil was likely the most attractive target for Shell. “It’s all about the deepwater oil,” analysts wrote. The merger combines the two largest investor-owned sellers of LNG in the world. As new projects come online the combined company will be the world’s biggest seller of LNG by 2018, Wood Mackenzie said.

The takeover of BG Group makes sense for Shell because it enables Shell to replace reserves at a time when exploration budgets are being slashed and after its attempts to join the U.S. shale boom fizzled, Stadler said. Shell also had $21.6 billion in cash and short-term investments on hand at the end of the year so the purchase is not out of its range.

The boards of both companies recommended shareholder approval of the deal which they claim will create a more competitive, stronger company amid the volatility in oil prices. Shares in Shell were down about 7% while those in BG Group soared 32% on news of the deal. BG shareholders will own about 19% of Shell after its completion. Combining the two companies will produce savings of about 2.5 billion pounds a year, Shell said.

A successful deal provides Shell with access to BG’s multibillion-dollar projects not only in Brazil but also East Africa, Australia, Kazakhstan and Egypt, including some of the world’s most ambitious LNG projects. In terms of oil and gas mega-mergers, it would be the world’s fourth largest since 1996, when BG’s net debt of about $12 billion is included, according to Thomson Reuters data.

The talks come as BG has been plagued by delayed payments in Egypt, written $6 billion off the value of it oil and gas business and seen an 8% decline in annual net earnings. It has also cut capital expenditures by as much as 36% this year. BG had a record US$5 billion loss in the fourth quarter largely caused by a write-off on the value of its Australian assets with the decline in commodity prices.

‘Incredibly Exciting Moment’

“This is an incredibly exciting moment for Shell,” Chief Executive Ben van Beurden told reporters. “It is bold and strategic moves that shape our industry.”

Van Beurden became CEO of Shell in 2014 and has been selling assets and cutting costs after a series of poor performances. The company is also preparing a costly venture to drill off Alaska. van Beurden has clearly identified LNG, which makes a strong contribution to Shell’s earnings, as a business he wants to bolster.

BG’s Norwegian CEO Helge Lund, who took the job just two months after being released from his contract with Statoil, was absent from the press conference. Organizers said he remained at BG headquarters in Reading – a two-hour drive from London – in order to handle internal communication with the company’s workforce. He will leave BG once the deal is completed.

However, he said in a statement that BG would benefit from the takeover.

“BG’s deepwater positions and strengths in exploration, liquefaction, and LNG shipping and marketing will combine well with Shell’s scale, development expertise and financial strength,” he said.

Shell, Europe’s largest oil producer, operates in over 70 countries with 94,000 employees. Its shares have fallen 5.5% in the past year as Brent crude prices have fallen 45%. BG has a market value of US$46 billion and was started in 1997, evolving from the UK’s state-owned utility. BG shares have fallen 20% in the past year.

Shell will boost its reserves of untapped oil and natural gas by 28% with the addition of BG’s assets, according to data compiled by Bloomberg. Shell is struggling to reverse years of slumping output from its wells. Its worldwide production dropped to the equivalent of 3.08 million b/d in 2014, the lowest in at least 17 years. Reserves have declined in two of the past three years. In contrast, BG boosted reserves in six of the past seven years. Its reserves were 78% gas as of Dec. 31, compared with 47% for Shell.

Largest Deal Since XTO

The deal would mark the largest in the energy industry since ExxonMobil bought XTO Energy for $31 billion in 2009. XTO was highly regarded for its prowess in shale drilling and has become ExxonMobil’s domestic production company in the U.S. Many companies have instead turned to the stock markets to raise cash and bolster their balance sheets. Producers have been reluctant to merge because of the effects of price volatility. Once oil prices stabilize, analysts expect merger activity to speed up.

Analysts at Wood Mackenzie say low prices are gradually prompting most major oil companies to weigh acquisitions, though only a few have the size and resources to pull off a mega-merger. “If you’re looking to the next big deal, ExxonMobil stands out as most likely to pull the trigger,” they wrote in a research note.

Bloomberg says ExxonMobil and BP could contemplate deals – perhaps even with each other. Speculation of an ExxonMobil-BP combination surfaced last year as oil prices declined sharply, increasing the appeal of big mergers that could yield massive cost savings. BP has largely put behind it the legal troubles surrounding the 2010 Gulf of Mexico spill. Still, the $124 billion company remains among the cheapest major producers relative to estimated profit, according to data compiled by Bloomberg.

There are other targets for ExxonMobil and BP that have gotten less expensive in recent months. Anadarko Petroleum Corp., Cabot Oil & Gas Corp., Pioneer Natural Resources Co., Occidental Petroleum Corp. and Tullow Oil are among those that have risen to the top of analysts’ lists. Their market values span from Tullow’s $4.2 billion to Occidental’s $59 billion. Exxon is valued at $353 billion.

Mergers of the 1990s Recalled

The last wave of huge oil mergers took place in the late 1990s after new production from the North Sea, Alaska and Mexico led to excess global capacity and sparked an oil slump. BP began things when it bought Amoco Corp. and soon acquired ARCO. Exxon and Mobil then joined forces followed by Chevron’s takeover of Texaco and the Conoco-Phillips merger. Should prices remain depressed, history could repeat itself because it is much cheaper to buy another company’s reserves than to drill for them.

“There’s the potential for a lower-for-longer scenario when it comes to oil prices, which suggests that the majors should at least be considering the playbook they used at the turn of the last century,” said Eric Gordon, a Baltimore-based energy analyst for Brown Advisory, which manages $52 billion. “You really have to spend time thinking about not just the next chess move, but two and three moves out.”

BP may be more likely to go on a shopping spree than sell itself because its portfolio is lacking, said Aneek Haq, a London-based analyst at Exane BNP Paribas. In addition to U.S. shale targets, Galp Energia SGPS SA may draw interest from buyers because, like BG, it offers access to oil assets in Brazil, he said. Lisbon-based Galp has a market value of about $10 billion.

For the other oil majors, Shell’s takeover of BG “increases the pressure on them to look at doing an acquisition,” Haq told Bloomberg. “It will probably just mean that they are going to be quicker and looking at stuff a lot more closely than they were previously.”

Pricing Raises Questions

Potential targets will probably ask for bids based on a higher price of oil, which could make it harder to get deals done at valuations that are still attractive to buyers, Gordon said. Shell said its deal is predicated on oil reaching $75 a barrel in 2017 and then $90 through 2020.

Among the top oil producers, ExxonMobil is the most likely to strike a large deal, according to Paul Sankey, an analyst at Wolfe Research. In addition to Occidental and Pioneer, he highlighted Concho Resources Inc. and Continental Resources Inc. as targets that may entice the company.

“Is ExxonMobil going to see these guys as nipping at their heels and look to do an acquisition?” said Chris Pultz, a money manager at Kellner Capital, an event-driven investment firm in New York. “With the large E&P deals, these guys have had a pretty good success rate of calling the bottom in oil. This could be an interesting opening salvo.”

US Looks Attractive

Reuters suggests the Shell-BG deal might be the signal that other dealmakers are eying the U.S. shale sector where there are literally dozens of shale oil and gas companies. Many have responded to the oil price slide by announcing spending cuts of 25-70% in a bid to conserve cash and show investors they have staying power.

But analysts believe that any of the companies, especially those with prime acreage in oil-rich shale fields in Texas, North Dakota and Colorado, could be up for grabs if a sweet enough offer is made. Analysts at Capital One Southcoast said BG’s U.S. shale assets will become likely candidates for divestiture after the Shell deal closes. Shell, in buying BG, has made a conscious choice to double-down on global LNG projects and de-emphasize U.S. shale.

There could easily be consolidation among shale companies, or purchases of them by the largest Western oil giants, though none would likely get close to the size of the BG mega-deal, the bankers said.

“There are already a lot of M&A discussions going on,” the global head of oil and gas at a top investment bank said recently, before reports had even surfaced about the BG deal. “You’re probably going to see a much bigger flow of announcements in the second half of the year because by then people will have adjusted to the new environment.”

Independents Face Uncertainty

To be sure, some prominent shale oil producers have made clear they would like to remain independent, while acknowledging their fiduciary duty to shareholders requires they entertain offers that may arise. Whiting Petroleum Corp., the largest oil producer in North Dakota, held a new round of capital raising to shore up its balance sheet in March and quashed talk it was for sale.

John Christmann, the new CEO at Houston-based Apache Corp., told Reuters in March he plans to be in his job for a long time as the company transforms itself to show it can be profitable even if U.S. oil prices do not recover soon from current levels.

ExxonMobil CEO Rex Tillerson recently said there were no limitations on what his supermajor might buy in the downturn. While the XTO acquisition increased ExxonMobil’s shale know-how, it was criticized for increasing the company’s exposure to natural gas, which has been less lucrative than oil.

So the oil giants, which have been under pressure for several years to return more cash to shareholders while clamping down on costs and lifting growth, need to be especially selective.

“A smaller oil shale acquisition (for ExxonMobil) may make some sense to help jumpstart volume growth,” said Brian Youngberg, who follows the company for brokerage Edward Jones in St. Louis. “I believe investors want the company to primarily focus on its organic opportunities rather than a big acquisition.”


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