Brazil is the big prize for Shell in BG deal

Speculation that Royal Dutch Shell would buy BG Group has been doing the rounds of the oil industry for at least the past 20 years. On Wednesday, it became reality.

Shell unveiled plans to acquire BG for £47bn excluding debt, a 50 per cent premium to its current share price. BG was, said Ben van Beurden, Shell’s chief executive, a “terrific fit” for the Anglo-Dutch major. “It is bold and strategic moves that shape our industry,” he added.

And there is no arguing that Shell’s move is bold. By acquiring its smaller rival, it will become the largest foreign oil company in Brazil, one of the world’s most highly-prized oil provinces, and cement its position as the global leader in liquefied natural gas, the increasingly popular clean-burning fuel.

Analysts at Jefferies said by 2018, the combined company of Shell and BG will produce more oil and gas than ExxonMobil, currently the world’s biggest non-state oil group.

BG may have been on Shell’s radar screen for decades, but was long seen as too expensive a target. That all changed when the oil price started to slide last year, dragging down the valuations of all the world’s energy companies, including BG.

But even before that, a string of operational disappointments, profit warnings and management upheaval had knocked the company’s share price off the highs reached in early 2012.

So it was that Mr van Beurden called up BG’s chairman Andrew Gould, the former chief executive of oil services company Schlumberger, on Sunday, March 15 to propose a deal. Within weeks they had engineered one of the largest oil and gas transactions in history.

Mr van Beurden stressed the oil price effect in a call with reporters. The idea of a tie-up with BG had always made sense, but “in the last months it has also become a compelling deal from a value perspective”, he said.

Some investors expressed concern that the Shell offer was too generous, and that the company was making too big a bet that oil prices will recover from their present lows. Shell’s B shares closed down more than 8 per cent in London at £20.20 on Wednesday.

But Mr van Beurden denied Shell was overpaying. A premium of 50 per cent was “quite acceptable and normal” in oil M&A deals, he said.

Some investors agreed. The oil majors have to grow, and these days the easiest route to growth is by buying rivals. “Given the industry’s lack of exploration success over the last 2 [to] 3 years, inorganic reserve replacement is absolutely crucial to sustaining these companies going forward,” said Charles Whall, who manages Investec Asset Management’s global energy fund.

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The deal is transformational for Shell. Its reserves will increase by about a quarter and its production rise 20 per cent. It will gain access to BG’s big gas discoveries off the coast of Tanzania, and also its enormous Queensland Curtis LNG project in Australia.

But Brazil is the key prize for Shell with the BG deal. Mr van Beurden said the enlarged group’s output from Brazil would be 550,000 barrels a day by the end of the decade — four times more than their current production. Wood Mackenzie, the energy consultancy, estimated that by 2025 Brazil will be the biggest single country position in the Shell-BG portfolio.

The deal will also cement Shell’s dominance of the business of producing, exporting and trading LNG. By 2018, Shell-BG will control sales of 45m tonnes per annum of LNG, making it easily the largest seller of the fuel in the world.

Shell was at pains to stress the financial strengths of the combined company. There would be savings of $2.5bn a year by 2018, and the enlarged group would divest assets worth $30bn between 2016 and 2018.

But for Shell shareholders, said Jason Gammel of Jefferies, there is a downside. He highlighted that the transaction will be dilutive in terms of earnings per share in 2016 and 2017, and that Shell’s net debt position will grow to about $61bn after the deal.

There was some concern among shareholders that the deal would strain Shell’s balance sheet and potentially put its dividend at risk.

Another potential hazard: antitrust issues. Mr van Beurden acknowledged that Shell would face competition questions in Australia, Brazil, China and Brussels, though the company had so far not identified any “insurmountable” problems.

But despite the risks, most investors saw the logic of the tie-up, and expressed admiration for Mr van Beurden’s boldness. “Any of the majors who don’t make such a move in this environment will regret it,” said Mr Whall. “Exxon really missed out here.”

Additional reporting by David Oakley