New Shell-BG better able to dampen LNG swings
Madrid
IT'S a tough time for liquefied natural gas. Demand is weak and the market looks oversupplied. So why is oil and gas major Royal Dutch Shell doubling down on LNG by buying its smaller rival BG Group for a headline US$70 billion? Adding BG would give Shell just under a fifth of the global LNG market, twice the next private competitor. It would join the likes of Qatar in the LNG top flight.
About 10 per cent of the world's gas supply is delivered in the LNG network. Asia dominates the demand side of the equation but overall deliveries have been effectively flat for the past three years. Asian spot prices have also halved, exacerbated by the falling price of crude. Meanwhile, 2015 will see the biggest surge in supply since 2011, according to Merrill Lynch estimates, with projects coming on stream in Australia and the United States.
Like Shell, BG produces its own LNG. It also buys from third-party suppliers, as well as spot cargoes around the world. BG's portfolio is attractive, however, because it is tied to relatively few long-term contracts that are linked to oil prices. A lot of BG gas can be shipped to the highest bidder. In the first quarter of this year, for instance, a cold snap in the United States led to higher prices in certain markets. Having bought cheaper elsewhere, BG netted US$100 million in extra Ebitda. Bernstein analysts reckon that over the past five years, BG has made four times as much revenue per cargo as rivals such as Woodside.
Shell also has a strong LNG trading business, so joining forces would allow the two to take better advantage of pricing differentials across regions.
Added scale will help too. With its larger tanker fleet, Shell-BG will find it easier to satisfy demand wherever it arises. Capacity optimisation benefits are hard to quantify, but Barclays reckons Shell could bump up margins by three percentage points on LNG assuming a price linked to US$90 per barrel of oil. That would add up to about US$1 billion a year.
Given the lumpiness of supply, BG reckons the LNG market will become more volatile in the next few years. With greater flexibility and added scale, a combined Shell-BG will be better able to dampen the impact of the swings. It might go further, and draw palpable advantage from others' inability to respond.
