Shell and BG: shelling out

Babe Ruth, the baseball great, swung for the fences. His style made his name synonymous with home runs. Few remember he also led the league in strike outs. History favours bold moves. Royal Dutch Shell, too, has gone for glory. It made an aggressive play by announcing an $82bn (including debt) cash and shares bid for UK-listed BG Group on Wednesday.

The two complement each other. Both depend on natural gas projects for production growth, mostly in liquefied natural gas. Shell has strength in the Asia-Pacific while BG has strong positions in the Atlantic basin. More important, these projects (though capital intensive) tend to have very long lives, well beyond the roughly 10 years for most oil projects. Moreover, both have deep water oil reserves, overlapping in Brazil with projects such as Lula (BG) and Libra (Shell). There is a reason that rumours about a Shell bid for BG have surfaced regularly over the past decade.

One threat to the deal could come from competition authorities. Shell and BG might gain some pricing advantage on LNG, in Europe particularly. The combined company would become the world's largest natural gas producer. Both companies plan to continue with asset sales - they have $30bn planned for 2016-18 between them. It is possible that regulators may ask for more or different divestitures. Getting the divestitures done at favourable prices will require a bounce in the oil price.

By acquiring BG Shell will add more than a quarter to its ailing 13bn barrel oil reserve base. This is important: Shell has replaced only about 80 per cent of the reserves it has consumed over the past three years. Rivals Exxon and Total have more than replaced their reserves over that period. The deal will also will lift Shell's production by over a fifth.

Yet while Shell needed to take some bold action, it has paid a high price. At a 50 per cent premium to the undisturbed price, the multiple of enterprise value to 2016 cash flow (adjusted for financing costs) approaches 11 times, double Shell's multiple.

Even accounting for the depressed earnings in the sector, Shell needs to hit a home run. It has promised a lot on assumptions of $90 oil in a few years' time. What makes those assumptions plausible is unclear. To truly score, this deal must make sense near the current oil price.

Email the Lex team at [email protected]

© The Financial Times Limited 2015. All rights reserved.
FT and Financial Times are trademarks of the Financial Times Ltd.
Not to be redistributed, copied or modified in any way.
Euro2day.gr is solely responsible for providing this translation and the Financial Times Limited does not accept any liability for the accuracy or quality of the translation