Why Shell's acquisition of BG could herald an oil M&A boom

Shell is buying BG for £47bn as it tries to boost its reserves, while the sector slides on cheap oil.

by Adam Gale
Last Updated: 28 Sep 2015

Shareholders of oil exploration firm BG Group will have woken up to a pleasant surprise this morning. After months of speculation about a possible acquisition by the mighty Royal Dutch Shell, a £47bn deal has finally been announced.

Shell is paying £13.50 in cash and its own stock for each BG share, a 52% premium on its average price this year. BG Group shares immediately shot up 36.7% to £12.45, while Shell’s fell 4.9% to £21.

On the face of it, you’d be forgiven for thinking Shell just overpaid, but there’s method to the madness. The whole sector has been under assault since July, when the oil price began to slump on the back of the US fracking boom and weaker Chinese demand. Things only got worse when OPEC refused to intervene to protect the price. US crude is now selling for $54 a barrel, down from over $100 last summer.

Shell said in January that it would cut spending over the next three years by £10bn, while BG Group suffered a full year loss in 2014 and wrote down its asset portfolio by £8.9bn in February.

This deal, the two firms think, could help them weather this storm. ‘Bold, strategic moves shape our industry,’ said Shell chief executive Ben van Beurden. ‘BG and Shell are a great fit.’

BG’s strengths are in exploration and liquefied natural gas (LNG), and both of these could be useful for Shell. The biggest of Britain’s oil giants is running relatively low on proven reserves, having spent billions exploring in the Arctic so far for little gain. BG’s exploration off the Brazilian coast and elsewhere would add 25% to Shell’s proven oil and gas reserves and 20% to its productive capacity.

Shell is already strong in LNG, but the combined company would control an impressive 16% of the global market, according to Biraj Borkhataria of investment bank RBC Capital Markets. Shell also thinks the deal would also produce cost-cutting ‘synergies’ of up to $2.5bn (£1.5bn) a year. You’ve got to love those synergies.

Dr Christian Stadler, an academic at Warwick Business School, has worked with Shell for 15 years and thinks this deal could be the beginning of a new wave of mega-mergers in the sector. ‘Just as in the late 1990s the oil price has plummeted, though then it reached $10 a barrel. Now it is at around $50 and with cost pressures acquisitions are an obvious way to maintain growth,’ Stadler said.

There have already been a few warning tremors of a possible M&A earthquake. At the end of last year, Halliburton bought Baker Hughes for $35bn and Repsol acquired Talisman Energy for $8bn, while ExxonMobil has made noises about being open to a deal.

The oil price collapse has hit the whole sector, but some firms have lost more market value than others, opening them up to takeovers.

There are of course reasons other than growth for beasts like Shell and ExxonMobil to want to gobble up smaller oil firms. The collapse in the crude price has sent shares tumbling across the sector, but the exploratory firms have fallen harder than the major producers. Shell, for instance, had lost 12% of its value since July by the time the deal was announced, while BG group had lost 33%. Perhaps Shell and the other big firms are seeing this period of hardship as a good chance to pick up smaller, less resilient companies.

Whether it will be worth it is a different matter. If the oil price stays low this year and into next, and the combined £200bn firm can’t actually find those ‘synergies’, paying 50% over the apparent market value may seem like a mistake.

Either way, BG Group boss Helge Lund will be happy. He’s only been in the job since February, having received a rather sweet £12m golden hello, and could shortly walk away with an even bigger golden goodbye. BG chairman Andrew Gould told reporters that Lund would 'probably move along' after the deal. A job well done, eh.

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