Market commentary: The merger that could reshape the oil sector for the next decade

Investors and the oil industry were taken by surprised earlier this week when Royal Dutch Shell plc, the largest European oil and gas producer, announced to have reached an agreement to buy BG Group plc, making the takeover the largest energy sector’s M&A activity in more than 15 years.

Oil giant Shell will pay as much as $70 billion, to acquire BG Group in a cash and shares deal that is likely to create the world’s largest liquefied natural gas (LNG) player, while also consolidating Shell’s position among the larger oil producing firms.

The move does not only aim at preserving Shell’s market share, but it also represents an important bet on natural gas as the upcoming preferred energy source. In fact, by acquiring BG, a predominately gas company and a major player in that sector, Shell is expected to increase its LNG sales by 32% immediately, and by as much as 80% by 2018.

Upon completing the takeover in 2016, the newly combined company will control around 15% of the entire world’s traded LNG, giving Shell access to natural-gas assets in Australia, US and Tanzania, while also providing the Anglo-Dutch firm with a foothold in Brazil’s largest deep-water fields, adding to the company’s oil reserves.

With emerging markets increasingly attempting to move from coal and oil towards cleaner sources of energy and Japan shutting down the majority of its nuclear energy capacity, demand for NLG is expected to witness exponential growth in the coming years. And the newly combine company will be in a strategic position to supply China, through its LNG liquefaction plants in Australia, Europe, through its Canadian plants, and the rest of Asia by developing Tanzania as NLG trading hub.

Although the recently announced acquisition it is expected to reposition Shell’s portfolio towards NLG and deep-water production, both activities seen as having the highest growth outlooks, the deal has also encountered a fair amount of shareholders’ scepticism. In fact, investors seem to be afraid that the $70 billion price tag may prove a too large commitment for Shell, putting in danger the company’s dividend and capital expenditure capabilities.

In addition, by paying for the transaction with cash and shares, Shell’s earnings per share are expected to face an immediate 7.1% dilution in 2016, while the acquisition is not expected to drive any meaningful contribution to the firm’s bottom line until 2017, and it heavily relies on a quick oil price rebound to $90 by 2018.

Confirming shareholders’ scepticism, Shell Class B shares, to be used in the transaction, lost around 8.6% on Wednesday, making Shell the largest loser within with the oil sector and on the London Stock Exchange.

This acquisition has attracted investors’ attention not only for its size and players involved, but also for the consequences it may have on the entire oil and energy sector. In fact, an increasing number of analysts is starting to compare this merger with the surprise acquisition of Amoco by BP back in 1998, which prompted a series of mega-mergers that reshaped the oil industry into its current state.

With Shell consolidating its position and becoming the dominant player within the NLG market, other major oil producers such as ExxonMobil and Chevron are also expected to seek acquisitions in order to maintain their market shares and take advantage of the current low valuations environment within the oil industry.

Some analysts are also recalling the similarities with the late 90s oil price slump, and the fact that the last round of large consolidations within the industry also marked the bottoming of the oil price and the beginning of the commodity’s rebound. If history was to repeat, in the coming months investors could very well see both, an uptrend in oil prices and the announcement of important mergers.

In fact, this could be a rather convenient time for major oil producers to boost their declining oil and gas reserves by acquiring smaller exploration and production firms that have been heavily investing in developing new oil fields. In an industry were buying out reserves have proved to be cheaper than building and developing them from scratch, the prolonged oil price slump may have finally closed the gap between what major players are willing to pay and potential targets’ valuations that have followed oil declining across the board.

This article was issued by Paolo Zonno Trader/Analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Calamatta Cuschieri & Co. Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this website

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