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Shell’s flimsy payout promise: Oil prices would have to bounce back to about $60-a-barrel for BG merger to make any economic sense, says ALEX BRUMMER

Screen Shot 2015-12-30 at 09.11.22If one were Shell and BG directors clutching at straws, seeking to force through a £47billion merger forged in the midst of a dramatic correction in oil prices, you might breathe a sigh of relief at a 2 per cent rebound in Brent crude to $37 a barrel in latest trading.

The very idea, however, that the proponents of one of the UK’s biggest ever mergers is relying on the hope and the prayer of a recovery in crude prices to about $60 to make any economic sense of the combination is illustration of the flimsiness of this deal. 

Not that we can hope to learn much of arguments against from any of the big players in investment banking.

They largely have been silenced by the promise of at least £106million of direct fees (plus all the others from the $30billion of disposals) that are part of the plan for making it pay.

Take the role of Goldman Sachs. It is among the advisers to BG on the deal.

Yet its oil analysts are among the most bearish, forecasting oil at $20 a barrel. That is a figure which would impoverish Shell-BG investors for years to come. We at least conclude the Chinese walls between advisory and research at Goldman are working.

Among the biggest imponderables in the energy market is the return of Iran to global markets as sanctions are lifted as part of the big powers’ nuclear deal with Tehran. Iran wants no truck with any efforts by Saudi Arabia to lower production targets so as to keep oil prices up.

Moreover, what the oil producers’ organisation OPEC and the Middle East have to say about oil production becomes less relevant every month that passes as the US moves towards oil self-sufficiency.

It already has passed that point with natural gas. Traditional forecasting models, on which the Shell-BG deal is based, can no longer be fully relied upon.

As serious for shareholders in both companies is the ability of the Shell management to deliver on its undertakings. Among the big promises are $7billion (£4.7billion) of cost reductions, cutbacks on $8billion (£5.3billion) of investments and $30billion (£20billion) of disposals between 2016 and 2018.

On paper, all looks rosy but the history of mergers is that promised synergies are hard to deliver.

And if the oil price remains weak Shell may end up having to jettison more assets than planned if it wants to achieve disposal targets.

What makes cost-cutting harder for Shell is that it, above all oil majors, likes to think that its procedures are safer than rivals.

At the time of the BP ‘Deepwater Horizon’ disaster in 2010 it sought to reassure anyone who would listen that the explosion was unlikely at its rigs and facilities in that it ‘double proofed’ safety. That also means a higher cost structure than some rivals making delivery of merger benefits harder.

Its biggest selling point for the deal is that it will be good for shareholders because it makes the dividend more easily delivered as a joint enterprise than before.

It lowers the break-even price across the group and should contribute to cash flow.

It is not an argument that has impressed Capital Group, which offloaded £100million of shares in BG and scarpered, or, more significantly, the Qatar Investment Authority, which has picked up its marbles in both Shell and BG (worth around £1billion) and headed to the exit.

That doesn’t show confidence in an early recovery in gas or oil prices from a significant producer.

The big short

Indeed, the Middle East sovereign wealth funds are starting to look threadbare.

In the era of high energy prices the six members of the Gulf Co-operation Council, that includes Saudi Arabia, Qatar and Kuwait, accumulated $2.3trillion of assets.

As the oil price has fallen they are rapidly having to sell assets to fund soaring budget deficits. Goldman estimates that at $20 a barrel the GCC would have to sell down $494bn of holdings in 2016 simply to fund government operations.

Most of the countries dare not make Western-style cutbacks for fear of domestic backlash in a highly volatile region.

Anyone fancy a football club or bloodstock operations?

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SOURCE

By ALEX BRUMMER FOR THE DAILY MAIL: 30 Dec 2015

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