Why Shell bets big on LNG and BG Group

Susan L. Sakmar's picture
Susan L. Sakmar, Independent consultant, author and adjunct law professor, University of Houston Law Center
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With the drop in energy prices over the past year, it’s no surprise that merger and acquisition (M&A) activity is up as energy companies reposition themselves to remain competitive in a low-oil price environment. That said, Shell’s $70 billion acquisition of BG Group is a bit of a surprise since mega deals like this are rare and therefore always a little startling.

The main take away from the deal is that Shell is upping its bet on LNG as a fuel for the future. For the past couple of years, the LNG industry has been relatively flat or “stagnating” in the words of the GIIGNL in their recent report on “The LNG Industry in 2014.” Over the long-term, however, the outlook for LNG remains positive as more and more countries look to natural gas to meet increased energy demand with cleaner burning fuels. By acquiring BG’s strong portfolio of LNG projects, Shell has positioned itself to be a major LNG player in the coming years and its portfolio will be almost unrivaled in terms of flexibility and access to the global LNG market.

The acquisition will also make Shell the largest foreign investor in Brazil’s deepwater, pre-salt basin. At the moment, this seems a riskier bet than LNG since these projects are operated by Petrobras, which is currently mired in the largest corruption charges in Brazil’s history. Over time, however, these issues will be resolved and Brazil could provide Shell with significant reserve growth.

Perhaps the most significant immediate benefit for Shell is that the acquisition will instantly expand Shell’s oil and gas reserves by 25 percent and add 20 percent to its annual production. Reserve replacement and the ability to “book” reserves is the name of the game for energy companies. Valuations of major oil and gas companies have plummeted in recent years as discoveries dried up and reserves became harder and more expensive to replace. With oil as low as it is now, it’s probably cheaper to acquire reserves than drill for them.

If the price of oil remains low, there are likely to be more strategic deals like this one. It’s difficult to predict who will be next but some of the US LNG exporters might be targets for companies looking to add LNG to their portfolios. While the exporters won’t be attractive from a reserve standpoint, some of them offer significant cash flow. The cash flow might also open up opportunities for US exporters to make strategic acquisitions themselves. Other acquisitions for reserve replacement are likely to take place in the US shale industry where high indebtedness has made some operators vulnerable. These deals will be much smaller than the Shell-BG deal and it’s hard to envision another deal out there this large. But in today’s environment, it seems that anything could happen!

Susan Sakmar will be joining us at Gastech Singapore in October. To attend, click here.

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