After its $54 billion acquisition of BG Group, Royal Dutch Shell Plc (NYSE:RDS.A) (NYSE:RDS.B) had its credit rating cut after the huge increase in debt. Now it has reportedly entered into talks with interested parties in order to raise about $30 billion from the sale of assets, according to Bloomberg, citing sources not wanting to be identified.
The report said the bulk of the assets in question are from the BG acquisition, with the majority of the assets located in the high-cost North Sea region. In March, other unidentified people said Shell was also shopping assets in India and Trinidad and Tobago, along with the U.S. pipelines.
Among companies asserted to be interested in the assets are Neptune Oil & Gas and Ineos Group AG.
The recent uptick in the price of oil has given Shell a better bargaining position, but I think it's still a buyers' market for North Sea assets. There is no certainty or guarantee the price of oil has reached sustainable support levels, and Shell has to be careful not to enter negotiations with the idea that is how it'll play out. With its huge debt load and lower credit rating, it can't afford to sit on these assets; that is especially true with the strong possibility oil will reverse direction once again.
How well the company will do with its divestitures will be determined by the oil price outlook of its potential suitors and how badly they want the assets. I don't see why any company would pay a premium price. The major upward move in oil has already happened, and there is little more on the upside that would justify spending too much.
North Sea oil costs have come down, but there still needs to be more improvement before they're sustainable.
As mentioned, Shell has the goal of selling about $30 billion in assets, with the time frame being over a period of three years. It has the weaker position in the short term, but if it's able to hold out longer, there is a good chance it can get a good price for its better assets. I don't see that being the case at this time.
That being the reality, I would think Shell will try to offload some of its weaker assets in the near term, with the idea the price of oil has a better chance of adding value to its stronger assets further out. Doing that would assuage some of its shareholders' concerns over having to sell at too low of a price. If the price of oil does start to plunge, this could be all thrown out the window. Under those circumstances, it would add a lot of risk to Shell, which would either have to sell much lower or hold the assets without having a lot of options to meet its debt obligations.
Since the price of oil has rallied, it may have convinced some potential buyers it may be time to get in before the price of oil goes higher. I don't believe that's how it'll play out, but if those looking for oil assets believe it, Shell may do better than expected. If I was a buyer, I would wait it out. The price of oil has soared too high, too fast for me to believe it's going to continue to climb.
The other factor will be how many companies are interested in the North Sea assets in particular, and if it generates a competitive bidding atmosphere, that would of course be beneficial to Shell.
Profitability in the North Sea
Fortunately for Shell, the oil fields in the North Sea have improved since January 2015, when $50 oil was required to make a profit. When Shell announced the deal in April 2015, the offer was 50 percent over the average share price of BG Group for the three months prior. It would be surprising to see any company pay a similar premium even with an improved cost structure.
In March 2015, Oil & Gas U.K. said if oil were to linger at the $30 mark through the remainder of 2015, about 50 percent of oil fields in the U.K. would probably be "operating at a loss."
To give an idea of what potential buyers are looking at on the cost side, it has fallen by about 25 percent. From the $50 profit point of last year, that should bring it down to about $37.50. According to Craig Shanaghey of Amec Foster Wheeler, "in order to make it sustainable, we need to see 30-60% savings." That was back in the middle of March, so it's already passed that on the lower end of the savings range.
In that regard, Shell is smart to start feeling the market out because of the disparity of views and outlooks. It can point to the numbers above and sell the sustainability point. If it convinces buyers, it may do fairly well. The problem is I think we're close to a ceiling on oil for now, and Shell would have to make some quick deals before the price turns back down.
Does Shell have to sell?
As time goes on, Shell would lose its bargaining position if the price of oil reverses direction or it remains range bound. Then, the question arises as to whether or not Shell will be pressured to divest of assets at bargain prices.
Even though market conditions have improved some, there is no doubt Shell has to generate revenue through divesting of some of its assets. Over the 12 to 18 months, I don't see a lot more upside to the price of oil on average, although we'll still see some wild price swings. Shell won't be able to get a better price based upon temporary upward moves that are considered temporary.
If oil remains level and price momentum pulls back, potential buyers would consider it more risky because of the strong probability of a decline in prices.
While Shell could decide to sit on most of its assets, its bargaining position would continue to deteriorate. I don't think anyone believes Shell will be able to retain these assets for any significant period of time; it has to eventually sell.
The company isn't going to allow any sense of anxiety to publicly show, but it is making its move now in hopes it will attract bullish buyers who think oil has turned the corner and will go sustainably higher. If it's able to make a deal with those types of buyers, it could surprise to the upside on its sales.
I don't see that happening, but there are a lot of irrational things happening in the market now, and anything could come about.
Shell has wisely chosen this time to test the market's outlook concerning its North Sea assets. The entirety of the process will be determined by how companies view the outlook for oil prices going forward.
More than likely Shell will push for sales as soon as it can, before the price of oil drops again. With little upside risk - in the sense of it losing money if the price of oil surprises by going higher for longer - the company may be in the strongest position it will be through 2017. There isn't much chance in my view that there will be a sustainable rebalancing of the market until the latter half of 2017 at best.
Shell Chief Financial Officer Simon Henry said earlier in May the company wasn't going to "jump into fire sales in a market which is clearly weak at the moment because of the $45 oil price."
That seems to me to be a negotiation ploy, now that soon afterwards it has been made known it is seeking buyers. If Henry considered the market weak at $45 oil, it's difficult to understand why he thinks it's much different between $48 and $49 per barrel.
No matter how it's spun, Shell needs to sell some of its North Sea assets. It's in position to get a better price than a couple of months ago, but the longer it takes to make a deal, the more risky it will grow.
Yet, as with all negotiations, it depends on who wants to make a deal the most. Under these conditions, no smart company would pay a significant premium for Shell's assets; they know the company needs capital and must slash its debt load. But as mentioned earlier, if atmosphere of competitive bidding can be engineered, Shell could in theory do better than expected.
This could be why Shell is in contact with privately-held companies in the initial stages of the process, as it would be under less pressure if they decide to pay a higher premium than a publicly-held company would that had to answer to its shareholders.
While Shell is able to hold out longer, it could do much better later if it proves its holdings in the North Sea have cut costs to the point of offering an asset that has the ability to spend for future growth. As it is, I'm not that optimistic on what it can get for its North Sea fields.
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