Is Royal Dutch Shell Up For The Challenge?

By: MICHEAL KAUFMAN: Published: Apr 10, 2015 at 10:33 am EST

he energy sector’s mega deal between Royal Dutch Shell Plc (ADR) (NYSE:RDS.A) and BG Group Plc (ADR) (OTCMKTS:BRGYY) is now under close scrutiny by China and other countries, as well as by investors. When asked about the details of regulatory concerns, both parties refused to comment, says the Wall Street Journal. The merger has been valued at $70 billion.

The CEO of the Hague-based Anglo-Dutch company, Ben van Beurden and BG’s Chairman, Andrew Gould had claimed on Wednesday they didn’t expect any major regulatory issues, except from a few countries. Although they did they expected the completion to be delayed until early 2016 while regulatory matters were settled.

China’s reaction is an unknown at the moment. Its Commerce Ministry has become more hardline with time. The country, which is fast becoming a huge buyer of liquefied natural gas has blocked two deals in the past which included non-Chinese companies, including one where the deal had been approved by US and European regulators.

Portfolio Manager at Thornburg International Value Fund, Bill Fries, noted that China, being a buyer of LNG, would not be keen on a massive consolidation as it could directly affect its bargaining power.

As for investors, part of their concern on Royal Dutch Shell lies in the regulatory problems surrounding the deal. The major worry seems to be the premium that Royal Dutch Shell has agreed to pay for BG Group and the company’s ability to maintain its future dividend payouts.

The Anglo-Dutch oil company had asserted before the deal that it would improve its focus on investor return. Furthermore, the company had assured investors that 2015 dividends would remain committed to $1.88 per share. However, investors are skeptical about the claim, predicting the company’s balance sheet would be stretched out of proportion following the deal.

Brazil is the biggest prize in this deal for Royal Dutch Shell as BG Group has a huge oilfields base in the country. On the flip side, this would bring Shell face-to-face with the state-run oil and gas company, Petroleo Brazileiro Petrobras SA ( ADR) (NYSE:PBR). It’s a fact that hasn’t escaped the attentions of prudent analysts such as Andy Brogan, oil and gas transactions leader at Ernst & Young (E&Y) who expects endless disappointments in Brazil, saying it would be difficult to operate in the country despite BG’s vast reserves there.

The list of risks in entering the Brazilian market stretches further than regulatory approvals and state control. The ongoing Petrobras bribery scandal means harsher policy measures have affected the supply chain along with a massive cost inflation on the back of the depreciating Real.

Shell has promised investors the deal would result in significant increase in earnings per share from 2018. Investors however, are wary of the claim as one of the underlying assumptions in the promise is the return of oil prices to $90 per barrel, double current prices.

Barclays Plc (ADR) (NYSE:BCS) viewed Shell as the strongest company to confront the crude oil market crash, based on its solid balance sheet. The new deal is expected bring Royal Dutch Shell’s gearing ratio from 12% to 20%, prompting Fitch Ratings to place the company’s AA credit rating under review on Wednesday.

Jefferies Group LLC (NYSE:JEF) analyst Jason Gammel told WSJ that they had a very defensive view of Royal Dutch Shell’s stock in this low crude oil price climate, but following the deal, that view now stood annulled.

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