Royal Dutch Shell Plc  .com Rotating Header Image Supermajors face M&A conundrum: Europe’s biggest oil companies are under pressure to merge graphic 

David Rothnie
20 Jul 2007
Europe’s supermajor oil companies may be forced to merge under pressure from shareholders to generate growth after more than two years of flat performance.

 Ian Howat, a managing director in energy and power investment banking at Merrill Lynch, said: “Finding ways to grow is one of the biggest challenges to resources companies and M&A is an optimal route.”

The sector has been transformed with the emergence of a new generation of national oil companies from China, the Middle East and Russia.

Last week, the chief executive of Russian energy group Gazprom said the company aimed to be the first company in the world to have a $1 trillion (€725bn) valuation.

A research report by Morgan Stanley says: “If one accepts that the national oil companies are now in a dominant position given the concentration of available resources in a few countries, then one must also accept that the supermajors will lose market share in energy over time.

“Energy demand growth is projected at about 3% a year. If they lose market share in that environment then they will grow at less than 3% over the long term. That is below global GDP and relatively dull by market standards.”

Gazprom is leaving European rivals trailing in its wake. In the past two years, its share price has grown at more than three times the rate of BP, Eni, Shell and Total, which together make up the biggest oil companies in Europe by market capitalization.

The four are struggling to keep pace against a fall in replacement oil reserves, lack of volume growth and rising costs. Morgan Stanley concluded in its report that Shell was undervalued by $120bn, citing the “relentless” derating of the supermajors for the past four years.

Bankers believe the conditions are right for the first wave of consolidation among the supermajors since the merger between Chevron and Texaco in 2000, but are waiting for a catalyst. One head of European oil and gas said: “If one of the supermajors decides to do something, others will follow suit. Another catalyst would be if the Russians or Chinese decide to be more aggressive.”

However, Morgan Stanley warned in its report: “Waiting for the catalyst in the oil sector is a pretty sure way of missing the party. No one forecast that BP was going to take over Amoco, or that a construction company was going to take a stake in Repsol.”

Combinations that would have been unthinkable a few years ago are now being talked about, with broad acceptance among bankers that BP and Shell have discussed a merger. One banker reported “active” conversations between US and European companies. He said: “Transatlantic co-operation is the most likely outcome.”

Bankers believe the biggest barrier to a deal is whether oil companies can put aside their travails and contemplate a significant deal. They may be willing, but they are not able.

One banker added: “Shell has fallen foul of the regulators while BP’s new chief executive Tony Hayward is spending 120% of his time on internal matters and on what to do in Russia.”

Analysts believe large oil companies should follow the example set by the mining sector, which is in the middle of an M&A boom following a sustained rally in commodity prices. The banker said: “The mining sector is a proxy for the oil sector and one in which we are witnessing the emergence of super-supermajors.”

In the meantime, bankers see domestic consolidation among national champions companies seeking scale. This started at the end of last year when Statoil and Norsk Hydro agreed a $31bn merger. Meanwhile, Austrian oil group OMV is trying to buy Hungarian rival Mol in a deal that would create a regional champion.

Among the risks of a mega-deal is that it may fail to produce a sufficient boost to share price.

Goldman Sachs painted a downbeat picture in a research report last week, when it said the equity market would not reward mega-mergers.

It said the market “does not have the appetite for mega-caps that it had in 1998-2000”. Instead Goldman said oil companies should focus on buying service companies, “giving them the technology, skilled assets and enabling assets to deliver the new legacy assets on time and on budget”.

That said, bankers believe Europe’s biggest oil companies may be running out of options and that before long one of the supermajors will take the M&A initiative.

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