Rix Oil Market report April 2015

Big oil companies and their shareholders tend to panic when oil prices plummet and the result is often a splurge of corporate mergers. Indeed, it was the low oil price at the end of the 1990’s, that led Lord Browne (then head of BP) to first merge with Mobil and then buy the American oil giants Amoco and ARCO in quick succession. At about the same time, Exxon bought out the remnants of Mobil, Chevron merged with Texaco and Total gobbled up Elf and PetroFina.

So it was no surprise that on the back of the momentous drops in oil prices that we witnessed at the turn of the year, a big merger would soon be in the making. And we didn’t have to wait long, as April saw the mighty Shell swoop for BG (what was British Gas) - Britain’s 3rd biggest energy company – in a £47bn takeover. If approved, the deal would be one of the biggest of 2015 and create a company valued at more than £200bn. The new combined entity will be an energy Leviathan – particularly when it comes to gas. In fact, the new company will be the 3rd largest gas producing company in the world, after Gazprom (Russia) and the Iranian State Gas Company.

And it is the importance of gas in this merger that makes it so interesting and really highlights a massive sea change in the energy landscape. Whereas the mergers of the 90’s were all about the economies of scale of oil exploration, here we have blue-blooded oil aristocracy (in the form of Shell) spending all of their money on a gas takeover. Why? Well…to put it bluntly, it is gas and not oil that represents the future of the fossil fuel industry.

In many ways, the ascendance of gas is rather good news for the oil majors. In recent times they have increasingly found themselves on the fringes of oil exploration, toiling away on cost-heavy and inhospitable fields (deepwater reserves, polar regions etc), whilst the National Oil Companies (Saudi, Iran, Iraq, Venezuela) enjoy lower exploration costs in more accessible places. Gas on the other hand is a much more open playing field, where the majors seem to have the upper hand when it comes to newly discovered fields. Not to mention (AGAIN!), the shale miracle, which of course represents just about the most openly-accessed energy market in the world and where there is hardly a National Oil & Gas Company in sight.

But the main reason why the oil majors (who should probably nowadays be called “oil and gas majors”) are rushing headlong into the gas world, is its relentless growth as an energy source. True, the graph attached shows that crude oil demand will continue to grow going forward until 2040, but the rate of growth for gas is far more impressive, meaning that by 2040 consumption of oil and gas will be more or less equal. There are 3 main reasons for this. Firstly, gas has over recent history been, and looks likely to continue being, cheaper than oil. Secondly, burning gas generates unrivalled energy efficiency and finally, linked to this second point, the leaner hydro-carbon chains (lower carbon content) means that gas is by far the greenest fossil fuel on the planet.

Here is a graph showing the oil and gas consumption, since 1990 to present day, with a forecast up to 2040:

That’s why it is already projected to overtake coal as the world’s largest power generation source by 2020 – a remarkable fact when you consider that at present, the world’s largest energy user (China) relies on coal for 70% of its power generation and gas for only 5%. But overall, demand for gas in the East is booming and Asian consumption is set to quadruple over the next 30 years. This is a massive modal switch in global energy demand and it is therefore hardly a coincidence that when considering a major acquisition, Shell looked for a company with huge gas operations, rather than another oil major with a portfolio of elaborate and engineeringly complicated oil plays (they have enough of them already!).

That being said, gas is not ready to displace oil just yet and without doubt, it is likely to lag behind oil usage for several years to come – especially in the transportation sector where the infrastructure required for mass gas supply is enormous. Here crude and refined oil have huge advantages, for although flammable, oil transportation is pretty straight-forward. Gas on the other hand requires liquefaction plants, compression pipelines, specialised (pressurised) rail cars, not to mention roadside refrigeration and regasification facilities if it is to become the prevalent fuel grade at petrol forecourts. But for a blue-chip oil & gas major, a few years is but a short period of time to wait, particularly when the tea leaves seem to predict that one day, gas will triumph over oil as the world’s main energy source. In this light, Shell’s latest acquisition represents both a prudent and canny long-term bet.