In this handout picture Andrew Gould, left,, Chairman of BG Group and Jorma Ollila, Chairman of Shell shake hands as Royal Dutch Shell and BG Group announce their takeover deal at the London Stock Exchange in London on April 8, 2015.LAURA LEAN/AFP / Getty Images
There is something curiously old-fashioned about the proposed takeover of BG Group by Royal Dutch Shell. It's the biggest-ever hydrocarbon merger and the first mega-energy deal of the 21st century but it has nothing to do with North American shale or frontier Arctic exploration and you can forget about new energy technologies.
This seems to be all about cost, buying oil and gas reserves in a price downturn, hoping that you struck your deal when the market bottomed out. Shell, like most of the majors, has been struggling to raise its exploration game and BG has been struggling to turn some impressive discoveries into cash fast enough to please its shareholders. Put the two together and Shell can do the neat trick of filling up its tank and funding the group's expensive dividend. Indeed, if we looked for comparisons, we could go back to the 1990s oil price collapse when BP bought Amoco and Exxon picked up Mobil.
However, something has happened in the decades since those deals were struck which explains Shell's ambition and why the company seems to be paying a very significant share price premium – 52 per cent to win over BG's investors. The offer price of £47 billion ($87-billion Canadian) values BG's 6.5 billion barrels of oil and gas at more than $9 per barrel, a cost that looks a lot more testing at today's oil price than it might have 12 months ago.
What has changed in the past two decades is the creation of a new energy market – liquefied natural gas. When BP bid for Amoco and Exxon tilted for Mobil, both companies were looking for cheap reserves but they were also hoping to acquire very strategic assets. One of Mobil's jewels was Arun, a massive refrigerator in Indonesia which was built to chill natural gas into liquid, capable of being transported by ships equipped with cryogenic tanks to power station customers in Japan. BP was also fascinated by the new LNG market and the big prize offered by Amoco was Atlantic LNG, another natural gas refrigerator, this time located on the Caribbean island of Trinidad.
These were the early days of LNG trade and it was a business that Shell targeted aggressively, its biggest success being the development of Nigeria LNG, a project first designed as a desperate attempt to squeeze some more cash out of the gas flared from its oilfield in the Niger Delta, which is now a hugely profitable enterprise. Shell is now the market leader in LNG among the non-state energy players, delivering some 34 million tonnes per annum of LNG to customers. But something else interesting has happened in this business. LNG was once just a quirky addition to a natural gas market made of long-distance pipelines. It was about long-term contracts with prices fixed to indexes based on oil prices. LNG vessels were seen as floating pipelines, convoys of ships built to travel one route.
Today, LNG trading is now a reality and spot cargoes can be bought and sold. According to GIIGNL, the association of LNG importers, some 69 million tonnes of LNG are traded globally on spot or short-term contracts. That's more than a third of the total LNG market, up from 20 per cent as recently as five years ago. Shell would love to control more of this market, and BG is a big player. It was an original investor in Atlantic LNG, the Trinidad business founded with Amoco; it owns Lake Charles, the LNG terminal on the U.S. Gulf; and it has a stake in Dragon LNG, a terminal in the U.K. It has LNG production in Egypt and Australia and is developing a new plant in Tanzania, strategically positioned to feed East African gas into Asian markets. BG will add another 11 million tonnes of market share boosting Shell's market position in the Atlantic Basin and East Asian markets.
What we don't know is how interested antitrust authorities will be in the emergence of such a powerful player in a nascent energy market. Over all, Shell's enlarged position in LNG may not be big enough to excite competition authorities, but the devil is in the detail. As Gazprom, the world's biggest gas exporter, knows very well, you can control a country's energy future with just one strategic pipeline. LNG opens the door to real trade in natural gas with spot cargoes changing ownership and destination, but the barriers to entry in this business are enormous. The vessels and liquefaction plants are billion dollar investments. With some 50 LNG carriers and almost 50 million tonnes of LNG the larger Shell will have a commanding position, and it might not be too much of an exaggeration to say Shell has the potential to become the Gazprom of the floating gas market.
Carl Mortished is a Canadian financial journalist and freelance consultant based in the U.K.