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Wednesday, April 15, 2015

Shell’s offer for BG shows how the energy business is changing

Shell and BG A vote for gas Apr 11th 2015 | From the print edition JAM tomorrow, but never jam today. That was long the lament about Britain’s third-largest energy company, BG Group. In recent years it has been notable for its great prospects, troubled operations, wobbly management—and lately its weak share price, down by 20% in the past 12 months. Now Shell, an Anglo-Dutch giant, has pounced, with a £47 billion ($70 billion) cash-and-shares offer which pays BG shareholders a 50% premium on what their holdings were worth just before the bid. The combined companies’ stockmarket value will be around $250 billion. Barring regulatory objections, the merger will be completed early next year. The deal—one of several involving BG that has been rumoured, on and off, for years—shows that for the beleaguered international oil giants, buying reserves, even juicily priced, is cheaper and easier than finding and developing them. It also highlights the scope for consolidation since the fall in the oil price last year, which has sent companies scrambling to cut costs and pacify investors. In November Halliburton, an oil-services company with headquarters in Houston, bought Baker Hughes, a smaller rival, for $35 billion. This deal, far bigger, boosts Shell’s declining oil and gas reserves by a quarter, and makes the new firm the world’s third-largest gas producer (see chart). Among Western-owned oil and gas firms, it will be second only to ExxonMobil by market capitalisation, and by 2018 its output will overtake that of its American rival. That assuages one worry for Shell’s investors—that it is not replacing its reserves speedily enough to secure its long-term future. But it may not quell another (contradictory) one: that a notoriously spendthrift management is splurging (To indulge in an extravagant expense or luxury: splurged on room service.) cash on acquisitions which it could be returning to shareholders. Shell counters this as follows: it has already said it is cutting capital spending by $15 billion; it now says it will raise asset sales to $30 billion in 2016-18. It also insists it will maintain its dividend and raise its share buy-backs, all to its newly enlarged investor base. It expects the takeover to generate $2.5 billion of cost savings, in everything from purchasing to trading. The deal underlines the way the money is moving in the energy industry. Shell managers highlight the increasing attractiveness of midstream (transport) and downstream (refining and distribution) activities, which offer less risk and fatter margins than finding and developing new oil and gas. One of BG’s strengths, for example, is in the liquefaction, transport and storage of gas. Its fleet of giant tankers will boost Shell’s clout in the world gas market. The purchase also demonstrates that gas is a more promising business than oil. Indeed, Shell is now more Gas Giant than Big Oil. This is not easy money: the global gas industry has been plagued by high costs (much gas is in hard-to-reach places such as the Arctic and deep oceans) and low prices (thanks to competition from other fuels and America’s shale-gas glut). But the market is growing, supplies are abundant and the environmental outlook friendlier than for oil. BG has promising offshore assets, including in east Africa, Kazakhstan and Trinidad. Some are troubled: a big investment in Egypt is beset by political difficulties. Others are doing better. A $20 billion Australian project is now producing gas from coal. Having tripped up in shale ventures in China and America, Shell is now betting heavily on offshore gas. Simon Henry, its finance chief, says he doubts the gas glut will persist. In any case, a bigger and stronger company is better placed to ride it out. Other deals may follow, just as the last oil-price crash in the 1990s brought a wave of mergers. Among possible takeover targets are Tullow, a British oil and gas explorer (whose share price rose by 4.5% on news of the BG deal, having fallen by half since last summer). Such small companies with exciting but risky projects are particularly exposed in current conditions. But bigger acquisitions could be on the horizon too, perhaps even involving BP, Britain’s largest energy company, which no longer looks too big to buy. Absorbing BG will keep Shell busy for a while (particularly given its mixed record in managing previous purchases). But the deal could prompt one of its two main American rivals, Chevron or ExxonMobil, to try to regain dominance by making a move on BP. For all their enthusiasm for the deal, Shell and BG are merging mainly from necessity. Though BG had stopped disappointing shareholders, and had brought in a capable new boss, Helge Lund, from Norway, its fortunes were too closely tied to volatile gas prices; and its main oil partner in Brazil, Petrobras, is mired in a corruption scandal. For its part Shell was struggling to replenish reserves and cut costs. Assuming BG delivers, the deal solves both these problems, and strengthens Shell’s cashflow. The fall in the oil price has highlighted the weaknesses of energy companies that place big, long-term bets on difficult production and exploration projects. When times were good they excited their engineers with the technical challenges, and boosted their executives’ egos with ever-bigger balance-sheets. Firms are now dealing with rising debts—those of the largest American and European energy companies have risen by $31 billion so far this year—and falling share prices, down by a fifth since the summer. They are selling assets in a buyers’ market. Behind the Shell-BG deal, and the speculation of more mergers to come, is an even more fundamental shift in the energy industry. Contrary to some expectations, the oil-price fall has not derailed the American shale boom. The small, flexible and innovative firms that specialise in horizontal drilling and hydraulic fracturing are proving better at cutting costs, raising productivity and adapting to market fluctuations than the lumbering giants who have long dominated the industry. Dinosaurs may mate to ensure the survival of their species. But this is an age of mammals. From the print edition: Business

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