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Why A BP Shell Merger Is Not A Sensible Option

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Why A BP plc (BP) Royal Dutch Shell Merger Is Not A Sensible Option

Bidness Etc discusses how lower oil prices have impacted BP’s stock price, and why the merger with Royal Dutch Shell is not on the cards

Published: Jan 6, 2015 at 9:46 am EST

Crude oil prices have declined sharply this year. West Texas Intermediate (WTI) has already fallen below $50 per barrel for the first time in nearly five-and-half years, with Brent crude hovering around the same level. Several US oil companies are fighting for their survival, especially after the Organization of the Petroleum Exporting Countries (OPEC) decided to maintain its current level of production. WTI and Brent crude were trading at $49.56 and $52.57 per barrel, respectively, during pre-market trading today.

Smaller companies are finding it difficult to survive, as oil and gas exploration activities continue to become less profitable. Larger companies are relying on mergers and acquisitions (M&A) to get them through this downturn. Total M&A activity in 2014 was estimated at $3.5 trillion, which is considered to be the highest since the financial crisis. One potential merger that investors and markets observers always seem to speculate is that of Royal Dutch Shell plc (ADR) (NYSE:RDS.A) and BP plc (ADR) (NYSE:BP).

Much of the speculation is attributable to problems surrounding the British oil major. The company has been a main subject in US courts over the Gulf of Mexico oil spill in 2010, with the US government pushing for $16 billion in damages. In addition, the sanctions imposed on Russia could hurt the company, as BP has a 20% stake in the Russian oil giant Rosneft Oil Co (OTCMKTS:RNFTF).

Plummeting oil prices have also made it difficult to engage in oil exploration and production activities. BP shares are currently trading at their lowest level since June 2012, which has caused many analysts, including Jason Kenney of Santander, to predict that the company will draw bids. BP stock was down 5.30% as of Monday’s market close, trading at $36.10.

Lord Browne, former CEO of BP, had earlier revealed in his memoirs that he intended a merger with Shell in 2010.

However, despite the speculation, Jeremy Warner of the Telegraph believes the merger makes little sense. He claimed that BP, at the moment, was not considering a merger option seriously.

He is of the opinion that there is an inverse relation between the performances of the two companies. When one company is doing considerably well, the other ends up facing problems. For instance, when BP acquired a 20% stake in the Russian state-run company of Rosneft Oil Co in 2013, the prospects looked good for the company. At the time, however, the Hague-based Royal Dutch Shell was involved in an accounting scandal, and several environmental concerns had been raised about its drilling practices. Many feel the company made the wrong decision in exploring Nigeria, rather than looking for new reserves in Siberia.

The tables have turned, with BP facing considerable problems due to its Russian investments.

BP is currently valued at 140 billion pounds. Shell is quite better off, and has about double market value. Shell stock was down 4.75% as of Monday’s close, trading at $63.8.

Mr. Warner believes that a merger between the two entities should only take place if both are certain the deal will bring about considerable benefits in terms of cost savings. He added that the companies should have little trouble combining their upstream production and reserves. The question, however, remains as to how much reserves each business will have access to after the merger.

He also pointed out that the downstream sector faces heavy competition, and the overall cost savings could be minimal for the merged entity. The merger could also involve several complexities and transaction risks, which could potentially outweigh the gains. He further outlined that there were better and cheaper alternatives for both companies to increase their reserves.



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