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Shell Betting on LNG and Brazil with BG Group

Last week, Royal Dutch Shell (RDS-B) put in motion a huge takeover offer for BG Group (BRGYY) at a cool $70 billion.

The Shell-BG deal is the largest in the sector since 1998, when Exxon bought Mobil.

If completed, the acquisition will add about 25% to Shell’s oil and gas reserves and 20% to its level of hydrocarbon production.

What this acquisition really means, though, is that Shell is placing a long-term bet on two key areas of the energy sector: liquid natural gas (LNG) and deepwater oil, specifically offshore of Brazil.

The results of this move are expected to be impressive. In fact, by 2020, Shell expects these two segments of the company – LNG and deepwater oil – to produce anywhere from $15 billion to $20 billion in cash flow.

Gambling on LNG

Shell is already a profitable player in natural gas. In 2014, the company reported earnings of $10.4 billion from gas, which is up 470% from the company’s natural gas earnings just five years ago.

But soon, Shell will make even more from natural gas. BG Group owns the rights to the first sizable shipments of LNG from the United States to overseas buyers, thanks to its agreement with Cheniere Energy (LNG).

By 2018, the combined companies will be able to produce 45 million tons of LNG. That’s 20% of the global output. That will be almost double the capacity of rival ExxonMobil (XOM).

In effect, the deal is a bet that Asian demand for LNG will grow. The continent accounts for three-quarters of global LNG demand already.

It’s an interesting gambit considering the deal comes at a time when LNG prices in Asia are tumbling to less than $7 per million BTU, levels not seen since 2011, before the Fukushima nuclear disaster. The tumble is due to the fact that the majority of LNG in Asia is sold in long-term contracts tied to the price of oil.

But Shell clearly believes that major LNG-consuming countries in Asia, like China and India, will continue moving away from dirty coal to cleaner-burning natural gas. Shell expects this increased demand to eventually push up LNG prices in Asia again.

What BG Brings to the Table

Click to enlarge

So, in the longer term, this seems to be a reasonable bet.

Exxon estimates that global trade in LNG will more than triple by 2040 to nearly 100 billion cubic feet per day. Exxon also expects Asian countries to import half the natural gas they consume, with LNG making up 80% of that amount.

Rolling the Dice on Brazil

However, the second part of Shell’s gambit is a lot more questionable…

You see, the deal will make Shell the leading foreign investor in Brazil’s vast deepwater oil basins.

BG owns assets in Brazil’s Santos Basin in conjunction with Petrobras S.A. (PBR), the oil giant that has been buried under a corruption scandal.

Energy consultancy Wood Mackenzie says that, by 2025, Brazil will be the largest country position in Shell’s vast portfolio. At the moment, that seems to be a dubious distinction.

Shell believes it will be able to increase its acquisition’s oil output in Brazil to 550,000 barrels per day by the end of the decade. That would be a rise of more than four-fold.

But the risks of major delays, thanks to Petrobras’ troubles (including its solvency) are very real.

So, Good Deal or Bad Deal?

The Financial Times reports that many European oil analysts think that Shell needs oil to be at least $70 per barrel in the coming years for the deal to be a winner.

That may look like a stretch at the moment. But, historically, periods of low oil prices don’t last for long periods of time. So, Shell may have time on its side.

That is, of course, if the deal gets the final okay from regulators around the globe. Chinese regulators may, for instance, demand that Shell divest some assets before giving approval for the takeover. Shell is probably hoping that China doesn’t want it to divest its juiciest LNG assets.

And the chase continues,

Tim Maverick

Tim Maverick

, Senior Correspondent

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