Home' Trinidad and Tobago Guardian : April 23rd 2015 Contents BG14 COMMENTARY
BUSINESS GUARDIAN www.guardian.co.tt APRIL 2015 • WEEK FOUR
The were three articles in last
week s Business Guardian
that referenced the proposed
acquisition of British Gas by
Royal Dutch Shell. The Min-
ister of Finance was quoted
as saying that while it was
too early to tell, the balance of probability
suggests that it would be a net positive for
There was also an article that suggested
that the Shell-BG deal may negatively impact
the Australian natural gas market and then
the final piece from the Energy Chamber that
spoke in a broader context that falling energy
prices will push energy sector companies
towards mergers and acquisitions in order to
This article will seek to expand on some of
the points raised last week as it is a subject
that is relevant to all of us in T&T and one
which we will do well to understand.
Why would the Shell BG deal be positive
for T&T but maybe not so for Australia?
How may we be affected if at all, by any
push for synergies and cost efficiencies?
What are the risks inherent in the transaction
which can negatively impact what will likely
be the largest operator in T&T?
Starting at the beginning, long before this
transaction was announced many of the oil
majors announced spending cuts spread over
varying periods. Exxon announced cuts to
their exploration and production (E&P) budgets
(capex) of US$4 billion. BP s cuts of US$3
billion would probably have caught the head-
lines but Shell itself had announced plans to
cut capex by US$15 billion and Chevron a
whopping US$35 billion.
Cuts in capex were coming at a time when
many of the majors were struggling to replace
reserves. Appreciate that shares in an E&P
company is essentially a depleting asset as
energy reserves are extracted and sold. Replen-
ishment of reserves is therefore a key issue
and a fundamental input into the valuation
model for companies in this sector.
Both BP and Shell have faced challenges in
replacing reserves in the recent past but not
so Chevron. This will account for the disparity
in capex spending cuts as Chevron has less
of a need to engage in E&P activities especially
given the uncertain energy environment. At
lower oil prices it becomes more difficult to
replace reserves as the cost of exploration in
more remote areas may not meet the target
rate of return. At some point, it becomes
cheaper to acquire another company than to
go out and explore for new reserves with all
the inherent risks in the latter option.
This is what we are witnessing as this trans-
action will boost Shell s oil and gas reserves
by between 25 to 28 per cent. If oil prices stay
lower for longer there could be more merger
and acquisition (M&A) activity. Prior to the
deal with BG, the analyst community saw BP
as a potential takeover target given its recent
challenges. Speculation was that it would
probably take a company with the balance
sheet of Exxon Mobil to effect such a deal.
While purely hypothetical, the thought of
such a deal should give us cause for reflection
as to the speed with which our landscape can
change where the two major energy players
in the country can change hands resulting in
a new set of dynamics. Of course, BP is of a
size where it can also be an acquirer so there
are many different permutations for the energy
landscape going forward.
Returning to the reality of the Shell-BG deal
we need to be aware that Shell is making some
very aggressive assumptions in this deal. If it
works out history will record it as a brilliant
move. If not, then we in T&T can experience
some knock on effects.
At US$70 billion, this deal is being financed
in part by a US$20 billion syndicated loan.
Adding leverage at a time of potentially lower-
for-longer oil prices creates challenges and
Shell has prioritised the repayment of debt in
the post acquisition scenario.
There is also the suggestion that Shell would
have paid the full price if not a premium for
BG as it entails a 50 per cent premium on
BG s share on the day before the announce-
The counter to this argument is that BG s
stock is down by 50 per cent since the start
of the oil price decline so ostensibly Shell is
betting on oil prices returning to US$90 to
US$100 per barrel. A report from Bloomberg
says as much in that it reports the deal is
structured around oil prices at US$75 per barrel
in 2017 and then US$90 through 2020.
This is not outside the realm of probable
scenarios, however, if it does not materialise
then asset sales will come into play in order
to bring about the necessary financial flexibility
that shareholders will demand.
This is where it can get tricky for T&T
depending on how strategic and core our oper-
ations are to the combined and larger entity.
Even with higher oil prices the company will
be seeking to liquidate US$30 billion worth
of assets over the next three years. Caution
is the word until we in T&T have a better
appreciation of the lay of the land.
It may not be well understood but prior to
the announcement of the deal Shell was often
seen as a defensive stock. This is because it
is a big dividend payer consistent with most
European stocks. The dividend yield on Shell
is around six per cent and in a zero interest
rate environment that is gold.
In order to maintain the same type of share-
holder base going forward Shell will have to
execute extremely well over the next three
years and part of the plan also includes share
buybacks from 2017 in order to maintain the
dividend yield dynamic.
However it is not all in the company s hands.
Energy is global and is strongly influenced by
geopolitics so getting into a situation with
little current wiggle room is reflected in the
stock declining in the period post the
As Shell has stated, oil in this deal is not
necessarily the core motive with liquefied nat-
ural gas (LNG) being the main driver of syn-
ergies going forward. The synergies from this
deal will move Shell and BG from a current
14 per cent to 19 per cent of the LNG market
in 2018 based on current demand.
It is well understood that LNG is difficult
to store, difficult to transport (when compared
to oil) and the market itself is not as deep or
as transparent as oil. Add to the mix the poten-
tial for significant oversupply at varying times
and challenges can ensue.
This is the possible scenario in Australia
where both Shell and BG have huge interests
in LNG projects but it is quite possible that
gas can be brought on stream without an off
take contract. This could result in sales on the
spot market which can push prices down
adding to already depressed prices.
China and Japan have been the marginal
buyers of LNG over the recent past. However
last week we got concrete data that suggests
that China is slowing down and this is where
the Australian gas would have been earmarked.
The challenges of China and Japan along with
the increasing strength of the US dollar, a
trend that is likely to continue will create some
stress for the economies of South East Asia.
These are key LNG markets.
Add to the mix the fact that Russia is quickly
becoming a rogue state but a rogue state with
huge gas supplies. Their increasing alienation
by the West pushes them into the arms of
China and there is already a deal for Russia
to supply China with gas, this time using the
cheaper option of pipelines as opposed to hav-
ing to ship on tankers.
The bottom line is that at the strategic level
the deal makes sense but there are a lot of
operational details that have to fall into place
before the benefits of that strategy can be
realised. Even then global geopolitics can put
a spoke in the wheel. The Minister of Finance
is therefore correct in his assessment that it
is too early to tell. However given the risks
involved T&T would do well to have contin-
gency plans in place in the event that the soon
to be biggest energy player in T&T no longer
sees us as strategic.
Ian Narine is a broker registered with the
Shell & BG
The post-acquisition scenario
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