Shell's £47bn agreed offer for BG might have been speculated on for at least 20 years, but when it finally came this morning it was still a surprise. We are less than a year into the collapse of the oil price, there were no substantial leaks (save finally to the Wall Street Journal last night), and the UK is right in the middle of an election campaign in which the future of capitalism and business is a potentially acrimonious theme. The timing therefore indicates that the consolidation of the global oil and gas industry, to cope with the new low price environment, has begun and Shell must have feared that it did not move for BG now, somebody else would soon.
The rationale is very clear, as Shell says in its statement, the combined group will focus on deep water, LNG and Shell’s existing downstream business, one of the best in the world.
From Shell’s perspective, it is paying a full price – a 50% premium, or £13.67p a share, of which only 383p is in cash and the rest in shares. This will be part funded by a $25bn buyback to be commenced in 2017. No wonder Shell’s shares are down over 5% this morning to £20.88. The deal would not be earnings accretive until 2017 and the numbers are premised on the oil price recovering to $90 a barrel by 2019. There will also be divestments.
However, the price is not as compelling as it first appears. Some of BG’s massive deep water and natural gas projects are on the cusp of coming on stream, so its much-delayed period of free cash generation is about to commence. Canacord, for instance, has already said that the offer values BG’s 6.5bn of 2P reserves at just $12.44 a barrel, “not especially aggressive bearing in mind how highly cash generative BG’s production from Brazil should be at US$90/bbl in 2020 when net output should reach c.500kboe/d.” Investec also says that “we suspect that Shell is pouncing on BG’s imminent free cash flow to protect its burdensome dividend payout”.
This raises the prospect that somebody else, such as Exxon, BP, CNOOC of China or Chevron could make a rival offer. It would be surprising if they did not look at it. Interestingly, there is a massive $750m break fee payable by Shell if it itself withdraws.
Finally, from a UK perspective this is yet another reminder of the commendable openness of the British economy. But it is surprising that neither BG’s Reading HQ – employing 2,500 of the world’s most expert exploration and production professionals, nor the North Sea, where both companies have operations, get a mention in the statement. In a low price energy environment, the risk is that the high cost, high tax UK is simply not competitive either as a hydrocarbon basin or as an energy hub. Nor can the agitation over Scottish independence help. What a pity if leadership in oil and gas is yet another competitive advantage the UK is about to squander.
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