Royal Dutch Shell, the venerable Anglo-Dutch oil company that rose from humble origins trading seashells to become an oil giant, is looking to secure future growth with a big bet: buying UK rival BG Group in a $70 billion deal. The BG acquisition, if successful, would be the biggest oil and gas deal in a decade.
Like other oil companies, Shell needs access to new and cheaper oil and gas reserves, not only to offset the natural decline in the volume of its older reserves, but to compensate for the high cost of developing shale and some conventional reserves, given that oil prices have plummeted over the past year. In order to stay competitive, it also needs to bulk up its portfolio of high-margin hydrocarbon processing assets, such as transportation and distribution.
In the current environment, without fresh sources of asset and revenue growth, the company will find it hard to meet its capital investment and shareholder dividend commitments with operating cash flow, and will be forced to make drastic cuts. Shell argues that it is cutting capital spending by $15 billion and will raise asset sales to $30 billion between 2016 and 2018. It also points out that the BG acquisition will generate $2.5 billion of cost savings in operational efficiencies (purchasing, trading, and other factors).
Cost-cutting and operational efficiencies aside, at the heart of the BG deal is not just a purchase of hydrocarbon reserves, but the opportunity to expand Shell’s role as a global natural gas player, especially in the offshore gas area.
BG has promising offshore gas assets, especially in Africa, Kazakhstan, and Trinidad. It has a $20 billion Australian project producing gas from coal.
BG’s Brazilian oil fields and Australian gas projects, as they ramp up, offer Shell the near-term cash flow growth that it currently lacks.
The deal also highlights the increasing attractiveness of midstream (transportation) and downstream (refining and distribution) activities, which are lower-risk/higher-return plays compared to upstream activities (exploration and production of new oil and gas reserves). One of BG’s strengths, for example, is in the liquefaction, transportation, and storage of natural gas. Its fleet of giant tankers will bolster Shell’s standing in the global gas market.
Shell is also betting on oil prices to rise to $80-$90 per barrel within three years in order to justify the 50% premium it agreed to pay for BG.
British editorial veteran Stuart Hampton has been covering oil and gas companies for Hoover’s since the Neogene-Quaternary period. Well, actually, since the early 1990s. For the best overview of the oil industry and its history, he recommends Daniel Yergin’s The Prize.