Shell may use BG acquisition to rewrite the rules for LNG

Royal Dutch Shell’s $70 billion acquisition of BG, announced on April 8, will help the former to boost reserves. But the deal will also give the combined company a production pipeline of 40 million tonnes of LNG a year, which makes up about 16% of the global LNG market, making it a global leader in the space.

Credit: MsLightBox

The industry was surprised by the announcement on April 8 of the deal between the Anglo–Dutch oil and gas company Royal Dutch Shell and the integrated natural gas company BG Group, partly because - among the “super majors” - Shell had appeared the least interested in growing by acquisition.

However, after the takeover was announced, reports emerged that it had been in preparation for so long that some of the executives working on it has retired before it finally went through.

The question then arose as to what Shell found so fascinating about BG

The opportunistic element was provided by BG’s well publicized troubles over the past year. These included a profit warning after production problems in Egypt and Brazil, and the departure of Chief Executive Chris Finlayson after only 16 months in the post.

Marc Kimsey, senior trader at stockbroker Accendo Markets told Upstream Intelligence: “Shell will have had a strategy in place for a long time. So when BG’s shares dropped 30% in the past year it was enough for them to say ‘yes please’”.

Low-cost supply

However, there were other important factors in play.

In one respect the takeover was defensive: over the past three years, Shell has replaced only 67% of the oil it produced with new discoveries, and that figure fell to 26% in 2014.

Thanks to the BG deal, Shell has now boosted its future pipeline by 25%. Although takeovers are not without risk, they are being seen as a safer way to acquire reserves than exploration.

As well as boosting the quantity of reserves at Shell’s disposal, the deal also improved the costs associated with producing them.

Pascal Menges, manager of the Lombard Odier Global Energy Fund in Luxembourg, told UI that the takeover was the “inevitable response to the fact that many integrated oil companies have invested heavily over the past 10 years in very complex, very capital intensive projects such as deepwater and Arctic offshore fields and oilsands”.

As a result, they are struggling to compete with cheaper sources of hydrocarbon, particularly from “good” shale beds, where production costs are falling rapidly as companies master the technical challenges involved in hydraulic fracturing.

A new way of selling LNG

Shell has now inherited a lot of assets both oil and gas-related, and the rhetoric from top brass is that it’s more of a tactical play to build the gas portfolio, although they’ll be happy to inherit the oil that comes with it,” said Kimsey (Accendo Markets).

The deal gives the combined company a production pipeline of 40 million tonnes of LNG a year, which makes up about 16% of the global LNG market and makes Shell the clear global leader in this area.

In addition, it will acquire a number of large, and largely untapped, deposits in Tanzania. Menges argues that this kind of market power gas element was a principal attraction of the deal for Shell.

“If you want to be competitive in the low price environment, you have to have a portfolio that goes down the cost curve,” Menges said. 

Fifty percent of the value of BG is oil off the coast of Brazil, which is one of the lowest cost basins in the world, and could where Shell is already producing the deepwater Libra field.

Menges said that the degree of control that Shell has now acquired allows it to break free of some of the traditional restraints on companies that produce LNG.

“The story around gas is different because it’s about Shell building up a global network. LNG today has a very defined value chain – you discover gas resources and you look for clients to sign up for it, then you build the stuff you need and then you sell to those clients, so there is a very defined value chain,” he said.

“With this deal Shell has expanded its portfolio very widely. This means that Shell has solved the conundrum of having to find clients before it can develop gas resources,” he continued.

“It will have a global portfolio of clients that it can sell to everywhere and so it will be able to take the decision to develop whenever it wants, so I think it’s changing the dynamics of the whole market,” Menges added.

The race is on

One likely effect of the Shell deal on the remainder of the industry will be to accelerate a number of trends that are already under way.

The move from oil to gas, the move from upstream to downstream investment – represented in this case by BG’s Lake Charles gas treatment facility in Louisiana, recently expanded with a $9.6bn liquefaction plant – and the need to diversify in renewable technology.

Richard Hunter, head of equities at Hargreaves Lansdown stockbrokers, told UI that a consideration behind the deal was that it allowed Shell to take over BG’s research and development work in renewable and alternative energy fields.

“Obviously oil is a finite resource, and research into wind power, solar power and fracking, which BG has developed with varying degrees of success over the years, is obviously something that Shell are looking to capitalise on,” he said.

The other super majors will be now be under pressure to respond to Shell’s swoop, and industry watchers and investors are in a state of “feverish anticipation” as to what it might be.