Shell-BG Deal Could Face Regulatory Sanctions, But Shell Will Do Everything It Can To Save Deal

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RDSA: Royal Dutch Shell logo
RDSA
Royal Dutch Shell

Ever since announcing the $70 billion deal to acquire BG Group Plc. (LON:BG) back in April, Royal Dutch Shell Plc. (NYSE:RDSA) has been busy these last few months obtaining the required merger related approvals from various regulatory authorities. After obtaining the required clearances in Brazil, the U.S., and Europe, the process hit a snag in Australia. This is not surprising as Australia is significantly more affected by the deal in comparison to the other countries. We believe that the Australian competition authority could ask Shell to divest some of its holdings before giving the necessary clearance to the deal and the company could face similar demands from Chinese regulators as well. We also believe that Shell will agree to the conditions imposed (if any) as the company stands to benefit from the merger in the long run. The deal will allow Shell to consolidate its leadership position in the global Liquefied Natural Gas (LNG) market and increase its exposure towards the exploration and development of deepwater hydrocarbon reserves, primarily the pre-salt reserves offshore Brazil.

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Shell-BG Deal Hits Roadblock In Australia

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Shell announced it was acquiring BG Group last April and has spent the last few months obtaining the required approvals from various regulatory authorities. The deal has already received clearance from competition authorities in Brazil and U.S. and was recently approved by the European Commission after a brief investigation. [1] However, the deal has hit a roadblock in Australia as the country’s antitrust regulator, the Australian Competition and Consumer Commission (ACCC) has decided to delay its decision by about two months to November 12. [2] The ACCC’s main concern is that Shell’s influence in the local LNG market will increase once the deal is complete and the company could resort to suppressing local supply in favor of exporting to more rewarding destinations such as Asia. The company already owns the largest known undeveloped gas reserves in eastern Australia through its 50% stake in Queensland-based Arrow Energy. [3] On the other hand, BG owns the Queensland Curtis LNG project, which started exporting gas early this year. The Australian regulator’s preliminary view is that Shell’s takeover of BG would align Arrow’s reserves with the Curtis LNG plant, with Shell preferring to export LNG instead of meeting domestic gas needs. The lack of supply from Arrow could push up gas prices in the local market. The situation is compounded by the fact that Origin- and Santos-led rival LNG projects will also begin exporting gas in the near future, further reducing the supply in the local market.

Our Views On What’s In Store For Shell

It is not surprising that the Shell-BG deal has hit a roadblock in Australia while securing regulatory approvals with relative ease in Brazil, U.S. and Europe. Australia is significantly more affected by the deal in question and was bound to put the deal through more scrutiny. Shell, for its part, has defended the BG deal to the Australian authority, stating that the merger will lead to accelerated supply of LNG, leaving enough gas for domestic consumption as well as for export purposes. [2] The company has further stated that it will continue to work closely with the regulatory authority in order to dispel any concerns regarding the issue. While the ACCC has called this an “amber light concern”, we believe that the authority could ask Shell to divest its stake in Arrow before giving the necessary clearance to the deal.

Shell could face additional heat when the proposed merger comes up for review in China. The country has become an important consumer of LNG over the years and will look to safeguard its interests. The Commerce Ministry, China’s main competition watchdog, has increased its level of scrutiny in recent years, going as far as blocking two deals involving non-Chinese companies in the last few years. [4] The regulatory body rejected a collaboration between three of the world’s largest shipping companies last year even after the collaboration had received European and U.S. clearance. [4] It also made Glencore sell one of its copper mines to a Chinese company before approving the Glencore-Xstrata transaction. [4] Shell also needs to get the deal approved from its shareholders. The company seems confident of getting the required clearances and has repeatedly tried to calm the deal-related fears among the investors. [5] We believe that Shell will agree to the conditions (if any) that are imposed by the Australian and Chinese regulators as the company stands to benefit from the merger in the long run.

How Shell Will Benefit From The BG Deal

We believe that with this deal, Shell is essentially making a long-term bet on the growth in global LNG demand and the development of pre-salt crude oil reserves offshore Brazil. [6] At 26 million tons per annum, Shell’s current LNG capacity stands at around 11% of the total LNG supply worldwide. If we add BG’s net liquefaction capacity to that, the combined entity would hold a market share of around 14% in the global LNG market. With the completion of the new liquefaction facilities under construction by 2018, the companies expect their combined net LNG capacity to be around 45 million tons per annum, significantly more than the second largest player in the industry, Exxon Mobil (NYSE:XOM). As Shell is positioning itself as the out-and-out market leader in terms of net LNG production, it makes sense for the company to place a long-term optimistic bet on the outlook for global LNG demand. Additionally, Shell is probably confident of long-term growth in LNG demand because the company has experienced first-hand the challenges associated with tapping shale gas reserves in China, and it believes that the country’s reliance on LNG would only increase in the long run. The chart below depicts how China’s share of the global LNG demand has grown over the past few years. [7]

Source: BP Statistical Review of World Energy 2014

In addition to consolidating its share of the global LNG market through this deal, Shell will also be able to increase its exposure to the exploration and development of pre-salt hydrocarbon reserves offshore Brazil. The company’s crude oil production from Brazil stood at just around 50,000 barrels per day last year, but with BG’s non-operating interest in the ongoing development of pre-salt reserves in the deep waters of Brazil, it’s expected to grow to around 550,000 barrels per day by the end of this decade. Overall, while we do believe that Shell’s broader strategy of acquiring BG to increase its focus on LNG and deepwater development projects is spot on, it has probably valued the target company a bit too aggressively and generating incremental returns from this investment might not be an easy task, at least in the short to medium term. (Read in detail – Shell’s BG Deal: It’s All About LNG and Pre-Salt Development)

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Notes:
  1. EU Approves Shell’s Takeover of BG Group, September 2, 2015, Wall Street Journal []
  2. Shell’s Takeover of BG Faces Hurdle in Australia, September 17, 2015, Wall Street Journal [] []
  3. Australia watchdog queries Shell-BG £43bn deal, September 17, 2015, ft.com []
  4. Shell’s $70 Billion Deal for BG Group Faces a Few Hurdles, April 9, 2015, Wall Street Journal [] [] []
  5. Shell CEO Tries to Calm Fears Over BG Deal, September 9, 2015, Wall Street Journal []
  6. Recommended Cash and Share Offer for BG Group Plc. by Royal Dutch Shell Plc., Shell Investor News []
  7. Shell Trims China Shale venture on Sichuan Population Challenges, Bloomberg []