With the large decline of energy prices, in particular oil prices, it was inevitable that there was going to be at least one major acquisition in the energy sector, and that is exactly what we got, with Royal Dutch Shell acquiring BG Group. The merger is for £47 billion at a 50 percent premium to its closing price on Tuesday, and is one of the biggest deals of the year so far, subject to being approved by shareholders and regulators. The combined group would be the biggest producer of liquefied natural gas in world by far.
The terms of the deal state that BG shareholders will receive £3.83 in cash and 0.45 Shell B shares for every BG share they own. This means that each BG share has a valuation of £13.50, which works out as a 52 percent premium to the average price of the shares over the past 90 days. BG shareholders will end up owning roughly 19 percent of the combined group. In my opinion, a deal like this was inevitable as BG’s share prices fell 30 percent in the last year, and the company themselves were struggling financially as a result of oil prices declining by almost 50% to $59.10. They were not the only ones, with shares in Tullow Oil falling a whopping 65 percent and shares in Premier Oil down 55 percent.
In Egypt, gas reserves were diminishing rapidly and this also pushed BG’s profits down to $915 million in the three months which ended on December. The writing was on the wall quite some time ago, in actuality, as BG was forced to take down its oil and gas assets by $9 billion in February and paved the way for new chief executive Helge Lund from Statoil a month early. His arrival makes him the third chief executive in as many years, and BG had no boss for almost 12 months after Chris Finlayson departed after the release of poor results. This showed tremendous instability, in my opinion, which was not good for shareholder goodwill and was a contributing factor in the declining share price.
This deal will be highly beneficial for Shell, if not only for expanding their reserves of oil. It is estimated that Shell have already spent around $6 billion searching for oil in the seas off northern Alaska, with no result. As such, this recent acquisition means that Shell can expend their reserves without spending a significant amount of money on exploration for oil, and while the deal may be a somewhat more expensive alternative, it means that Shell have a large reserve base, with their oil and gas reserves increasing by 25 percent and its production capabilities by 20 percent. They know they can utilise these, and surety of thought is always good, not least when running one of the biggest energy companies in the world.
In the words of Shell chairman Jorma Ollila, the deal will result in a “more competitive, stronger company for both sets of shareholders in today’s volatile oil price world”. This is true as no-one knows where oil is going to go at the moment, and opinion is divided on whether it will go down to $30 a barrel or come cascading up to $100 a barrel. As such, this bigger company formed by the merger will be an even bigger player than Shell on its own was, and thus can cope with lower, volatile oil prices much better than they could have otherwise.
On the assumption that oil prices will be $67 per barrel in 2016, $75 per barrel in 2017 and return to $90 per barrel between 2018 and 2020, Shell expects a 15-$20 billion cash flow per year. While upstream operations including downstream refining, will add another $15-$20 billion , on-stream activity will see an additional $10 billion of cash flow per year. This means that Shell will see a return on their investment in the fourth year, which is quite good and means that the share price of Shell should continue rising. All in all, a great deal for both parties.