On the 8th April 2015, Royal Dutch Shell PLC announced a $70bn mega-merger with smaller rival BG, the third largest oil and gas merger ever. In the current low interest rate environment and falling oil prices, this should not come as a surprise. As OPEC and mainly Saudi Arabia have decided not to reduce their crude production and are trying to force US shale production out of the market, WTI oil price has dropped by more than 44% to settle these days in the USD50 per barrel area. Smaller players, typically having higher cost structure and weaker balance sheet, can not sustain the pressure and are being consumed by energy major like Exxon Mobil or BP. We can see the same drivers in oil-field services as Halliburton recently announced a merger with Baker Hughes for USD$34.6bn. What about Australia? We can see some ramifications here as Chevron recently sold its 50% stake in Caltex for $4.62bn. While we do not see any impact on Caltex itself as its recent transformation into a more marketing and distribution oriented company means it is not relying as much on its ties with Chevron. We see this sale as preparation and back maneuver in the grand scheme of things. The Caltex stake sale frees up a sizeable amount of capital for Chevron if it wants to respond to Shell’s and other majors moves and finance future transactions, as it is widely expected that following Shell’s first bold move, the other majors won’t remain on the sidelines. The rationale of Shell for its acquisition of BG is more of interest and reported to be two fold:
- The deepwater assets of BG in Brazil; and
- Its intention to increase its LNG capacity.
We believe the second reason is of interest notably for companies like Origin Energy, which is reportedly trying to sell its LNG pipe business, like what BG did with APA. Other players in Australia that could come into the picture are BHP Billiton which have LNG assets or Woodside Petroleum (not covered). Although Moody’s recently confirmed Origin Energy’s credit rating and removed them from on review for downgrade, it kept it on Outlook negative and highlighted the pressures on Origin’s cash flows as long as its Australia Pacific LNG project in Queensland is not on stream and contributing to cash flow generation. As highlighted in our 1H15 results commentary, management is focusing on conserving cash flows by limiting or deferring capital expenditures and accelerating its costs reductions. Potentially, this wave of M&A, triggered by the recent Shell-BG merger might provide an opportunity for an exit if Origin wanted or needed to find a suitor for some of its LNG assets. For the moment, we keep our recommendation on Origin Energy Subordinated Notes to Sell as the current low oil price environment (USD56.23 for the WTI Crude oil at the time of writing) is set to continue, but we are watching this space carefully for any turning point.