Shell rolls the dice on BG takeover

April 9, 2015, 2:32 PM UTC

Joining the ranks of such previous oil industry megadeals as the Exxon-Mobil merger, in 1994, and Chevron’s Texaco acquisition, in 2000, Royal Dutch Shell’s plan to acquire natural gas giant BG Group marks the biggest oil merger in a decade and could herald a new round of industry consolidation in the face of sluggish prices. More than that, it signals a huge gamble by new Shell CEO Ben van Beurden, who took over the venerable Anglo-Dutch company last year pledging to right a prolonged period of costly stumbles. Shell’s efforts to drill for oil in the Arctic have been set back by the cost of production in such harsh conditions, and in February the company announced it was indefinitely postponing development of a new mine in the tar sands of northern Alberta.

“This transaction fits with our strategy and our read on the industry landscape around us,” van Beurden told reporters and analysts on the Wednesday morning call announcing the deal. The second part of that statement is, presumably, true; the first part is demonstrably false. The BG buy represents a major strategic shift for Shell—both in the company’s use of acquisitions and in its commitment to liquified natural gas—and one that will take years to play out.

Shell has mostly stayed on the sidelines of the huge M&A deals that have transformed the oil industry over the last three decades and left, essentially, three supergiants presiding over it: ExxonMobil (XOM), Shell (RDSA), and ChevronTexaco (CVX) (other oil majors include BP (BP)and Total(TOT), both of which are second tier compared to the three titans). Shell’s largest previous purchase was the $7 billion buyout of Shell Canada, in 2006.

Worth nearly $70 billion, the BG acquisition, which will make Shell the largest producer and seller of liquefied natural gas in the world, by a wide margin, dwarfs that takeover. And in today’s era of persistent low prices, ratcheting carbon emissions regulation, and volatile geopolitics, it represents a serious roll of the dice for the apparently mild-mannered van Beurden.

BG Group, which Shell is buying at a 50% premium to its recent share price, is one of the oldest petroleum firms in the world, having begun as the Gas & Coke Co. in London in 1812. It has rich reserves of natural gas in Australia and Africa. It has a major stake in the deepwater reserves off the coast of Brazil, one of the biggest potential oil finds of the last 10 years. A Shell-BG merger has been the subject of industry rumors for nearly two decades, and for Shell, which has seen its share price fall by nearly one-third as world oil prices have tumbled and which just last month was forced to write down $9 billion in oil and gas assets, the acquisition represents an audacious bet on the future of the industry and, more specifically, on the emerging global market for LNG.

Whether it’s a shrewd one is another question. BG lost $1.1 billion in 2014, and its own share price has fallen by 30% in the last year. Its promising Brazil play has been caught up in the corruption scandal surrounding Petrobras, the Brazilian national oil company. Its East African oil finds could fall prey to the turmoil engulfing many countries in the region including Kenya, the scene of a deadly university attack that claimed 147 lives last week. And its huge Australian gas project is set to come online at a time when gas prices continue to scrape near record-lows.

Essentially, Shell is paying a premium for a money-losing company whose prized assets are subject to a high degree of both market and political risk. That’s hardly a formula for guaranteed success, particularly at a purchase price of $70 billion.

“We think the market will be skeptical about this deal,” wrote BMO Capital Markets in a research note responding to the deal, “and we believe Shell will have to work very hard to convince shareholders that the strategic benefits outweigh the premium offered.”

The fact is van Beurden had to act to shore up Shell’s reserves and its future exploitable assets, if not its balance sheet. And the other oil majors will almost certainly be looking to strike similarly bold deals going forward, particularly as the shale gas revolution continues to unfold. One of the most intriguing questions raised by the Shell-BG merger is, how will it affect the LNG export plans of shale gas producers in North America? The last few years have seen a frenzy of ambitious plans to build liquefaction facilities and export terminals along the Gulf and the West coasts, to ship LNG to thirsty economies in Europe and Asia. Shell’s takeover of BG Group, which will bring on vast LNG production capacity in Australia and elsewhere in the coming years, raises questions about whether those projects will live up to their planners’ profitable dreams.