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Questor share tip: Shell should walk away from BG

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The FTSE 100 oil major has endured a turbulent year after announcing its offer for rival BG, says Questor.

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By John Ficenec, Questor Editor: 22 Nov 2015

SHELL’S [LON:RDSB] deal to buy gas group BG makes perfect sense on paper. But if oil prices remain at these deeply depressed levels, then it could bring nothing but disaster.

The famous Shell dividend could be cut, investors will be diluted and the shares would become a riskier prospect.

Deal logic

Shell is suffering from declining reserves and some well publicised exploration failures such as in Alaska. BG has had its problems, but is just about to greatly increase production at one of the largest natural gas fields in the world off the coast of Brazil. There is a dash for gas around the world as governments increasingly shun coal-fired power stations.

In one fell swoop Shell can use its cash and balance sheet strength to return its dwindling reserves to growth, and underpin its dividend payments for the foreseeable future.

Price premium

It is a compelling story, but the success of any deal ultimately rests on one factor, the price.

Shell has looked into buying BG for 14 years, and there is a risk that when opportunity presented itself back in April it snatched at the chance and overpaid at £47bn.

Shell was funding the deal with about 30pc in cash and 70pc in new Shell shares. To cover the cash amount it will sell about $30bn (£19bn) of assets during the three years from 2016, and to reverse the dilution effect of the new shares it plans to launch a $25bn share buy-back from 2017.

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Since the day of the deal, the oil price and the gas price have fallen by more than 20pc. Shell will become more indebted, and if oil prices stay where they are then the cash the company makes won’t cover the dividend payments and any idea of a buy-back appears fantasy.

Value under question

The deal is stumbling toward completion regardless. Last week it got Australian regulatory approval and that follows the US, the EU and Brazil and just leaves China to rubber-stamp proceedings.

The merger only really makes sense if the oil price recovers to above $80 per barrel, and is only compelling to investors at above $90. BG wants the deal, the advisers want it, even Shell’s management seems wedded to the idea, but let’s not forget who is paying here: Shell’s shareholders.

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Opec meeting looms

When the deal was announced, we said that investors should wait to see what happens to the oil price as there was no need to rush a decision. Now oil prices are expected to stay lower for longer and the message is clear – at current prices this deal destroys value and puts investors at greater risk.

Investors buy Shell shares for its conservative management and regular dividends. If they had wanted exposure to the recovery in the oil price, they could have bought BG shares themselves.

The Opec meeting on December 5 could send oil prices even lower and should mark the death knell for this bold bet.

Note: UK investors should buy Shell’s “B” shares, not the “A” class shares, to prevent potential problems with double taxation.

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