What does Shell's merger with BG say about oil?

Shells merger with BG is less about oil than it is about LNG.

When oil prices collapsed in the late 1990's, oil producers responded with a merger frenzy that led to a consolidation of the industry and the formation of a handful of 'supermajors'; giants who could marshal the capital and technology needed to extract oil from increasingly tight spots around the world.

Another oil price collapse could well prompt the same response. Shell (ENXTAM:RDSA) and BG (LSE:BG) will merge in a US$70bn deal to create an industry titan and the world's largest producer of LNG.

After years of poor production and stagnant reserve growth, Shell is an eager buyer.  BG will instantly lift reserves by almost 30%. In the current oil price environment it is far cheaper to buy reserves than to replace them with exploration so, in that sense, the deal has some merit.

Yet it doesn't solve the dilemma that the supermajors have been in for years. Returns on capital are falling as oil is replaced with gas and capital intensity increases. Jim Chanos famously noted that Exxon, the biggest of Big Oil, is more like a liquidating trust than a colossus, with reserves depleting faster than they can be replaced.

Shell says what every big company says when it takes over another big company: that there are plenty of 'synergies' – over US$2bn in this case – and that a bigger group can pursue bigger opportunities. While many will cheer that the combined group now has the capital to pursue development of new discoveries offshore Brazil, the sexiest part of BG, the deal is more likely triggered by LNG than by oil.

Shell has developed world class LNG technology that it can utilise over much of BG's gas reserves and its failed Queensland LNG project will provide valuable gas for BG's own underachieving project to lift total returns. In aggregate, the new group will be the largest producer of LNG, a fact provokes another question: with so few new discoveries, has Big Oil given up on oil? The actions of the supermajors, who are spending cash on gas and LNG, suggests so. 

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