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Nick Cunningham is a freelance writer on oil and gas, renewable energy, climate change, energy policy and geopolitics. He is based in Pittsburgh, PA.

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Shell Betting Its Future On LNG

Shell Betting Its Future On LNG

Could the largest energy deal in over a decade begin a new wave of mergers and acquisitions? Is LNG really the future? How Will ExxonMobil Respond? And perhaps more importantly, does the mega-deal between Royal Dutch Shell (RDS.A) and BG Group (LON: BG) portend the end of the bear market for oil?

Shell announced on April 8 that it agreed to buy BG Group for an eye-popping $70 billion.

The move was surprising, in the sense that a lot of companies in recent years have reined in their spending on high-cost projects outside of North America. Shell, in the midst of its own two-year $15 billion divestment campaign to shed unwanted assets, was thought to be trying to make itself leaner and meaner. Having passed on the U.S. shale revolution, it is interesting that Shell’s big splash once again avoided North America.

LNG is the Future

Above all, the deal for Shell was a massive bet on natural gas and LNG, of which BG is a major player. Adding BG’s assets will grow Shell’s oil and gas reserves by 25% and its production by 20%.

Here is how BG will turn Shell into a global LNG giant.

Australia. The Queensland Curtis LNG (QCLNG) project is one of BG’s most important. It is the world’s first facility to turn natural gas from coal seams into LNG for export. It will consist of two LNG trains each with the capacity to liquefy 4.25 million tons per annum (mtpa), for a total of 8.5 mtpa. After several years of construction, the first shipment was loaded up in December 2014. Capacity will continue to ramp up in the coming years, allowing BG (and now Shell) to export to the lucrative markets in Japan and China. Related: What’s Really Behind The U.S Crude Oil Build

LNG1

East Africa. BG also has promising assets in East Africa. In Tanzania BG is planning another LNG export project. Sitting offshore of Tanzania are vast reserves of natural gas. BG Group, together with its partner Ophir Energy (LON: OPHR) are developing the gas fields and a liquefaction terminal. As a major driver of the region’s first LNG export facility, BG Group has positioned itself at the forefront of East African energy exports. Tanzania is strategically located to take advantage of Asian demand for energy. Much of the work is in the early stages, but Shell apparently has bullish views on the future of Tanzania.

LNG2

United States. Although Shell isn’t going upstream with BG, the deal will give Shell access to BG’s rights to take LNG from Cheniere Energy’s (NYSE: LNG) volume from its soon-to-be-completed Sabine Pass liquefaction facility on the U.S. Gulf Coast. This puts Shell at the very beginning of American LNG exports.

Brazil. As for oil, BG also gives Shell some attractive assets in offshore Brazil. BG has partnered with the beleaguered Petrobras in five offshore oil discoveries in the Santos Basin, off the coast of Rio de Janeiro. These fields – Lula, Iracema, Sapinhoá, Iara and Lapa – are located beneath a thick layer of salt at great depths in the Atlantic Ocean. BG is using floating production, storage and offloading (FPSO) vessels to develop the fields. BG has about 6 billion barrels of oil equivalent under its control in Brazil. By 2025, Brazil could account for the largest investment in Shell-BG’s portfolio. Related: Could We Finally Have A Meaningful Oil Price Rally?

LNG3

BG’s portfolio will add to Shell’s existing assets in LNG, again with a strong focus on Australia. Shell has a major stake in several Australian LNG projects already, including Gorgon LNG, a 4.3 mtpa project in Western Australia, and the enormous North West Shelf project, which accounts for 40% of Australia’s total oil and gas production. On top of Australia, Shell has positions in LNG export terminals in Brunei, Malaysia, Nigeria, Oman, Qatar, and more.

Also, Shell is already building one the world’s first major floating LNG (FLNG) projects. The Prelude will be a state-of-the-art vessel that will drill for natural gas 200 kilometers off of the coast of Australia, liquefy that gas, and load it onto ships for export. The project marks a new era for LNG, in which onshore liquefaction facilities and pipelines are no longer needed.

All told, the purchase of BG will give Shell twice the amount of liquefaction capacity as ExxonMobil (NYSE: XOM) within the next three years as new BG projects reach completion.

Is LNG Really the Future?

Considering the purchase of BG, Shell is clearly going long on LNG. It is not clear that the move is a smart one. Besides the fact that Shell paid a hefty premium for BG – which is making investors nervous – the LNG market is in a down cycle without light at the end of the tunnel. Spot prices in Asia are less than half of what they were from just a few years ago, having fallen below $8 per million Btu (MMBtu) for April delivery, a 59.8% decline from April 2014. With lower than expected demand in China, and the potential for Japan to power up some shuttered nuclear reactors, the demand picture for Asia is uncertain. More importantly, however, is the overbuild in LNG markets. Supplies are set to come online at a rapid clip for the next three years, expanding by about one-third. Demand is not growing at that pace, so there will be an overhang for quite a few years. Still, Shell is betting that a growing trend towards cleaner energy and lower emissions will position natural gas as the key source of global energy for decades to come. Related: North American LNG Export Dream Evaporating

ExxonMobil Next?

Now that Shell is set to become supreme commander of LNG, what is next for ExxonMobil?

ExxonMobil’s last major purchase of XTO energy, a bet on U.S. shale gas, came at a highpoint for shale speculation. ExxonMobil, having been late to the party, overpaid in that instance. That could make the Texas-based multinational a little more conservative this time around. The rumor mill has been floating the idea of a takeover of Anadarko Petroleum (NYSE: APC), which would not exactly be a replica of the Shell-BG deal. Buying Anadarko would be more like the XTO purchase rather than BG. That’s because Anadarko would be a major bet on U.S. shale. With assets in Pennsylvania, Colorado, Texas, plus offshore in the Gulf of Mexico, Anadarko would be a much more conventional path to adding reserves and production. The same would be true of other names thrown around, such as Continental Resources (NYSE: CLR). The plus side of Continental is that ExxonMobil could probably gobble it up at a decent price.

The Shell-BG deal could usher in more mergers

That is what happens during a downturn. Mega-deals often suggest that the big players feel that the market has hit bottom as they seek to buy up assets before prices and values rises again. The BG purchase could indicate that Shell sees a revival in the coming months. EIA data demonstrating a slight decline in oil production backs up the view that oil prices could be poised for a rebound. With all of that said, Shell is taking the long view with its purchase, betting that BG’s LNG assets will pay off in the next decade.

Shell will soon be the largest LNG player on the planet. Whether or not ExxonMobil follows in its footsteps in an attempt to keep up, depends entirely on how bullish the company is on the future of LNG in general. Shell’s play on LNG is not guaranteed to pay off. ExxonMobil could try to outcompete on the LNG front, or it could double down on North American shale. ExxonMobil’s next move will explain a lot about its strategy.

By Nick Cunningham of Oilprice.com

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