What’s Behind Qatar’s $2.3 Billion Bet on Shell’s BG Takeover?

April 27, 2015 by Loch Adamson

#Qatar Investment Authority Bets Big on BG-Shell Deal #oilandgas
#QIA Buys $2.3 billion of Shares in #BG and #RoyalDutchShell
Potential #M&A Boom in #Energy Sector May Attract Further SWF Interest
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The Qatar Investment Authority amassed major positions in both Royal Dutch Shell and BG Group after the two companies agreed to merge earlier this month. What’s its game?

The oil and gas industry is primed for an M&A boom. And on April 8,Royal Dutch Shell announced it was offering to buy Reading, U.K.-based BG Group, the former exploration and production arm of British Gas, in a deal worth £47 billion ($70.2 billion). Among the biggest recent takeovers, the deal would create an energy giant with an estimated market value of $300 billion. The news led to a flurry of activity. Rumors about other suspected takeover targets in the energy industry spread.

Sovereign wealth funds’ responses to the proposed deal in the week following the announcement were largely ignored by the media. Norges Bank Investment Management, the arm of Norway’s central bank that manages the $861 billion Government Pension Fund Global, added BG shares to its portfolio, which also includes a 5 percent stake in Shell. China’s State Administration of Foreign Exchange, an arm of the People’s Bank of China that has about $500 billion under its belt to invest in non-treasury assets, played the markets to very modestly cut its stake at a profit after BG’s share price jumped.

But these transactions paled in comparison to a huge play by the Qatar Investment Authority (QIA), which has an estimated $304 billion in assets under management. Filings to the London Stock Exchange in the days following the takeover suggest that the Qatari fund bought 67 million shares in Shell (a 2.75 percent stake) and 12 million in BG (a 0.39 percent stake) in the wake of the deal. The total cost? $2.3 billion — big money even for the Qataris. QIA has had a busy 2015 to date, completing multi-billion dollar deals for 8 Canada Square and the wider Canary Wharf financial district.

Bullish Statement

QIA, which is among the most opaque of the major sovereign wealth funds, is clearly bullish on the Shell-BG merger. Whether it’s wise for a state-owned investor from a hydrocarbon-dependent economy to pour such sums into oil and gas is another matter.

The consensus is that Shell overpaid. "It was an extremely generous valuation," says Rob West, London-based analyst at Redburn Partners, a brokerage firm, who says the deal’s $70 billion price tag assumes $95 a barrel Brent crude: more than $30 above recent prices. The market seems to agree; Shell’s shares tumbled on the day of the announcement, closing at £20.84 per share, down 5 percent on April 7. BG shares were up 40 percent, at £12.98.

In a research note dated April 9, sector director Stephen Simko of Morningstar, the Chicago-based financial publisher, wrote that the deal was a "pricey acquisition," pointing out that Shell, based in the Hague, paid 11 percent more than the firm’s "fair value" estimate and 52 percent above where BG’s shares were trading on April 7. The deal, Simko wrote, is "at best fair… unless long-term oil prices trend well above our $75 Brent [crude] midcycle forecast."

Aside from the price, there may be issues with the logistics of the deal. Multi-billion dollar mergers of this type inevitably involve disruption and bring significant organizational risk and uncertainty. Shell has said it will make some $30 billion of asset sales over the next month to fund the takeover, but has not yet decided on specific divestments. Neither have regulators granted approval. QIA initially appeared to have taken steps to hedge against any problems, buying put options on BG shares on April 15 at exercise prices ranging from £10.80 per share to £11.30 per share, well above where they traded before rumors of the deal surfaced. These options would have enabled QIA to sell shares at those prices, and mitigate any potential losses, if the takeover failed and BG’s shares plunged. In the event, the fund soon unwound those positions, indicating its bullish stance on BG.

Choice Assets

Why did QIA wager such a large sum on the merger? The fund may have been taking the long view, betting that the acquisition of BG will enable Shell to restructure its languishing portfolio to achieve higher growth over the coming years. Sound enough reasoning.

Indeed, Pascal Menges, who manages a global energy fund at Geneva-based financial services firm Lombard Odier, says the takeover "makes a lot of sense" for Shell, despite the price. "Over the last decade Shell and the other large integrated oil and gas companies were generally behind the curve when it came to investing in high-cost projects — they were late to the party in investing in shale resources in the US, for example."

Menges is upbeat on the proposed merger. "In buying BG, Shell has been more pro-active," he says. "The deal gives them a nice pipeline of projects and enables them to delay the execution of more expensive developments until prices rise and they become more feasible."

He also points to some choice assets in BG’s portfolio. The company owns a stake in what are believed to be vast oil reserves offshore Brazil, for instance, which may pay rich dividends, so long as the corruption scandal currently engulfing Brazilian oil company Petrobas does not hold up the development process for too long.

"Marketing Capability"

BG’s Brazilian oilfields are likely to be highly productive and relatively inexpensive. The company expects its Santos basin project to yield 1.5 million barrels per day once it comes online between 2016 and 2018. It will have a break-even price of only $40 a barrel, so it is likely to be profitable even if the price of crude continues to wallow.

Potentially as important, BG owns natural gas assets, with stakes in Australia’s Queensland-Curtis LNG, a pioneering project to turn gas trapped in coal seams into liquid natural gas (LNG), and a share in the massive recent offshore gas finds in Tanzania and Kenya. These will be combined with Shell’s own resource assets and its facilities for producing LNG — many of which are located in Qatar, where the company has built up a major presence in recent years. Accordingly, the merger could create a global LNG behemoth. Redburn’s West says that may be the real reason behind QIA’s purchases.

"With this deal you’re generating what will be the largest LNG marketing entity on the planet, with around 67 million tons of total LNG sales capacity by the time the existing project pipeline is completed," West says. "Qatar is the biggest LNG exporter in the industry and they’ll be looking for a way to get access to that market, so it makes sense to seek for a linkage there. It certainly looks like Qatar has seen value in that LNG marketing capability."

M&A Possibilities

QIA’s $2.3 billion investment looks like an element of the strategic shift signaled by Tamim bin-Hamad bin-Khalifa al-Thani, who acceded as Qatar’s emir following the abdication of his father in June 2013. The new leader was clear that he wanted to focus on putting Qatar’s great hydrocarbon wealth to work in the domestic economy, instead of using QIA to promote the emirate’s reputation abroad.

While QIA has not stopped hoovering up international assets, its support for a big LNG business with strong domestic ties makes sense given Qatar’s reliance on gas exports. Qatar is the world’s second-biggest exporter of LNG, after Russia, and LNG sales account for more than 50 percent of the emirate’s GDP.

What lies ahead for QIA? Having shown willingness to spend on oil and gas businesses in the face of volatile energy prices, the fund will likely be closely monitoring similar opportunities. Indeed, its investments in BG and Shell may suggest the fund is tactically positioning itself to profit from a potential surge in M&A activity across the sector.

Speculation is rife that the Shell-BG deal will kickstart a wave of activity akin to the flurry of mergers in the early 1980s and late 1990s which contributed to the creation of today’s hydrocarbon leviathans. BP, San Ramon, California-based Chevron Corp., and Irving, Texas-based ExxonMobil continue to dominate the global energy industry.

World Prices

The Shell-BG deal is certainly no one-off. Houston-based oil-field services provider Halliburton is buying its smaller rival Baker Hughes for $37.2 billion. Roy Behren, a managing member at Valhalla, New York-based asset manager Westchester Capital, which specializes in M&A, says there will be more acquisitions. "We expect [M&A activity] to pick up at current oil and gas prices," he says, citing ExxonMobil and Houston-based ConocoPhilips as two oil majors with the "deep pockets" required for such deals.

QIA may be interested in one other integrated oil and gas company — France’s oil major Total, of which it owns around 3 percent. Redburn’s West says that, like Shell, Total faces challenges with its pipeline of projects that will stunt its ability to grow organically and force it to become more acquisitive to accelerate production growth.

What’s more, like Shell and London-based BP, Total has a presence in the Qatari natural gas sector. It is part of the Qatargas consortium that operates four LNG projects across the emirate. If Total does decide to make a move for a smaller rival, it seems probable that QIA would buy shares.

For now, however, we have only QIA’s mammoth bet on the BG-Shell merger, which seems to reflect both commercial and strategic imperatives. Whether it pays off will depend on the hydrocarbons and the price the world is willing to pay for them.

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