Edmund Shing: Shell's bumper BG deal could start wave of oil and gas takeovers

Has a rush to buy up oil and gas companies just started? Royal Dutch Shell is set to become by far the largest FTSE 100 member by market capitalisation at 7.6% of the index (Figure 1), worth nearly £160bn (€222bn, $233.7bn) and 35% larger than the second-largest company, HSBC, once it completes the £47bn purchase of BG later in 2015.

In the late 1990s, the oil price plunged to $10 per barrel and set off a wave of oil industry mega-mergers: Exxon with Mobil, Chevron with Texaco, BP with Amoco.

Fast forward to April 2015 and once again the oil price has plunged, more than halving from $110 per barrel in July 2014 to just $50 by January this year.

Now we have a new oil and gas mega-merger, Royal Dutch Shell taking over BG (the gas-dominated exploration and production arm of the former British Gas). This is in fact the second big oil company merger announced in the past few months, after US oil services company Halliburton announced a merger with rival Baker Hughes in November 2014.

Why is Shell buying BG?

With this purchase of BG, which has been beset by fundamental problems for some time, Shell is buying access to oil and gas reserves in Brazil and Liquefied Natural Gas (LNG) capability. These assets allow Shell to grow its oil and gas reserve base (replacing oil and gas currently being produced) and to be a dominant player in the growing LNG market, alongside the state of Qatar.

The basic idea is this: the oil and gas-producing assets of BG are cheaper for Shell to buy in principle than developing new oil and gas fields and putting them into production – the so-called "replacement" cost. Why take the risk of developing new oil fields (which may not even produce as expected), when you can buy proven, producing oil and gas reserves off the shelf?

Who else could be looking to buy oil and gas assets?

While Shell has already chosen its prey, which other mega-oil companies could also be looking to buy up cheap oil and gas reserves? As the oil and gas market is global by nature, we have to look abroad for potential acquirers.

In the US, ExxonMobil and ChevronTexaco are the two largest integrated oil companies with the financial muscle to do big deals. In Europe, Total of France and Statoil of Norway stand out as huge integrated oil companies that might find it easier and cheaper to buy up oil and gas reserves via acquisition of companies rather than by developing new oil and gas fields from scratch.

Who could be next to succumb to oil merger mania, BP?

In the UK, there are both big and smaller potential acquisition targets in the oil and gas sector. In a previous IBTimes UK article I highlighted the attractions of the ailing BP (hurt by the 2010 Gulf of Mexico Macondo disaster).

BP could be an interesting target for the two US mega-oil companies Exxon and Chevron, given its huge asset base in the US/Alaska. I should note BP has gained over 10% since I discussed it back in December 2014 and BP's market size is only 35% of Exxon and 63% of Chevron (Figure 2).

Other potential UK-based targets: Tullow, Premier Oil, EnQuest, Ithaca Energy

Otherwise, oil exploration and production companies Tullow Oil (total company value £5.2bn; code TLW) and Premier Oil (total company value £2.2bn; code PMO) have both been cited as potential acquisition targets, and look cheap when comparing their total company value (the value of all shares + value of debt) to the number of barrels of oil they hold as Proven + Probable (2P) reserves in their developed oil fields (Figure 3).

For instance, Premier Oil is currently valued at just $13 per barrel of 2P oil reserves following a drop of more than 50% in its share price from September 2014 to now (from 348p to 159p). Could an integrated oil giant swoop to acquire these now-cheap oil reserves?

Both Tullow Oil and Premier Oil have global oil and gas interests, spanning from West and North Africa to Pakistan and the Falkland Islands.

Closer to home, other acquisition targets could include the smaller, North Sea-focused oil exploration and production companies EnQuest (code ENQ, current share price 42p) and Ithaca Energy (code IAE; current share price 46.5p).

Both of these companies also look like potentially cheap acquisitions for larger oil company predators, at values of only $6 and $14 respectively per barrel of oil held in their various North Sea oil fields, and benefit from the reduction in North Sea oil taxes in the latest UK budget.

There you have it: five UK-listed oil companies of varying sizes that could become tasty acquisition targets for global oil companies.

Edmund Shing is the author of The Idle Investor (Harriman House), an expert columnist and a global equity fund manager at BCS AM. He holds a PhD in Artificial Intelligence.