Shell-BG And The Implications For Australia’s Energy Sector

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– Shell, BG big Australian gas players
– Implications for specific local companies
– Wider industry implications
– Brokers assess other possible targets
 

By Greg Peel

It is assumed that Royal Dutch Shell’s US$70bn cash/scrip bid for BG, formerly British Gas, representing a 52% premium, is an opportunistic one based on just how far oil prices have fallen. Shell boasts a more enviable balance sheet position, and as Macquarie suggests, the bid is perhaps an indication the oil & gas industry is starting to recognise value in the context of medium term planning assumptions.

Shell produced 44mtpa of LNG in 2014, representing 18% of global demand. With a raft of new LNG projects nearing completion, mostly in Australia, Shell was at risk of losing market share. A takeover of BG would provide Shell with 46mtpa of LNG capacity by 2018 or around 13% of the broker’s supply forecast.

While Shell and BG are both global Big Oil operators, Australian interests form a significant part of each company’s portfolios. BG’s primary interest is in the Queensland Curtis LNG facility which began production late last year. BG also has a stake in an unconventional gas prospect in the Cooper Basin in a joint venture with Drillsearch Energy ((DLS)) and an 8% stake in Drillsearch itself.

Shell has many fingers in Australian LNG pies, but moslty in the west. These include stakes in the long-operating North West Shelf (NWS) and the nearing-completion Gorgon, along with Prelude, assumed to start up in 2017, and Browse and Sunrise, which have less certain start-ups, but also includes a 50% interest in Arrow Energy which holds a stake in Queensland CSG reserves The east-west divide means Shell is unlikely to run into any issues with the ACCC.

Shell also has a remaining 13.6% stake in Woodside Petroleum ((WPL)) which it unsuccessfully tried to unload via an unpopular buyback arrangement last year. Woodside is also primary stakeholder in Browse and Sunrise and a partner in the North West Shelf.

Of immediate interest to analysts are the Arrow gas reserves, which Arrow owns in a joint venture with PetroChina. Arrow previously abandoned plans to build its own LNG facility, hence the reserves are largely up for grabs. To date, the most obvious customer has been Santos ((STO)), which has been having more difficulty securing gas for its nearby Gladstone LNG project than BG has for QCLNG.

While BG does not need Arrow gas for its initial trains at QCLNG, Shell may decide to hang onto the Arrow reserves for future expansion, leaving Santos out in the cold.

Then there’s Shell’s Woodside stake. Shell declared this stake to be non-core some time ago and last year tried to offload it in a deal which drew the ire of Woodside shareholders, and thus did not proceed in full. Given Shell is stumping up a substantial amount of cash to buy BG, as well as scrip, maybe Shell will now be happy just to dump the remaining Woodside stake. That would not be good news for Woodside holders.

However if Shell is looking to exploit low oil prices to pick up BG at a good price – Macquarie notes Shell is using a long term oil price of US$90/bbl in valuation – then what it gains on the swings it would lose on the roundabout of offloading Woodside  shares while they’re cheap.

Less significant to Shell is BG’s stake in Drillsearch. With Drillsearch putting its Cooper unconventional plans on the backburner until prices are more favourable, presumably BG’s 8% Drillsearch stake would be surplus to Shell’s plans. This would not necessarily be a bad thing for Drillsearch shareholders given Seven Group ((SVW)) also holds 8% and Beach Energy ((BPT)) 3.6%, and hence if the 8% BG stake came up for sale, there may well be eager buyers.

So on face value, a Shell acquisition of BG may have negative implications for Santos and Woodside, and arguably balanced implications for Drillsearch. On the other hand, consolidation of this scale offers up more significant implications for the industry as a whole.

For starters, it appears Shell is confident the oil price is at or near the bottom of its cycle. Morgans notes Shell is basing its valuation metrics on forecast average Brent prices of US$67/bbl in FY16, US$75/bbl in FY17 and US$90/bbl in FY18-20. Such an outlook provides share price support for all beaten down oil & gas stocks.

Secondly, such consolidation is typical at the bottom of any industry cycle, and rarely is M&A activity restricted to one deal. Typically, the first deal triggers a rush of activity when other potential suitors fear missing out. This puts all of Australia’s extensive list of oil & gas companies in the frame.

The bad news, nevertheless, is that analysts do not see any of Australia’s big players as potential targets.

UBS states the obvious in that Shell has been trying to sell its stake in Woodside for some time and has found no interest. Macquarie adds that while Woodside offers a high quality LNG portfolio which includes the operational NWS and Pluto assets, it offers little in the way of production growth, which appears to be what Shell is after.

In terms of cheap share prices, the big fall in heavily geared Santos and the company’s near completion GLNG project appear to offer a very attractive combination. If only Santos didn’t also own a long list of other assets which UBS believes most potential suitors would see as non-core. Macquarie agrees that GLNG, Santos’ Moomba infrastructure and incumbent position as provider of east coast gas would make it a target, if not for that long tail of assets which would be hard to divest of.

Arguably the jewel in the “Australian” LNG crown is PNG LNG, 29% owned by Oil Search ((OSH)). PNG is up and running and looking towards expansion to three LNG trains. But not only is this why Oil Search’s share price has not fallen as far as Santos’, for example, but Oil Search’s major shareholders include the PNG government, with 10%, and Abu Dhabi sovereign wealth fund IPIC, with 13% and a convertible bond position. These stakes would impede a full takeover attempt.

Brokers have made no mention in their assessments of Origin Energy ((ORG)), major stakeholder in the other Queensland CSG LNG project, Asia Pacific. Interestingly, BG tried, and failed, to takeover Origin a decade ago and in so doing alerted the world to the perceived value of CSG. Of course, with Origin you get the whole downstream electricity and gas distribution business as well, which is not really the source of consolidation interest. BG has no downstream interest in Australia, and Shell divested of its final Australian downstream interest only last year.

But there are potential ramifications for Origin’s downstream competitor AGL Energy ((AGL)), Deutsche bank points out. The Moranbah gas field is a major source of Arrow’s aforementioned gas reserves, but Arrow only owns a 50% stake. AGL owns the other 50%, and has been looking to sell.

Given the assumed lack of interest in distribution, Deutsche does not believe a Shell-BG tie-up would have any notable impact on Caltex Australia’s ((CTX)) competitive position.
 

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