Shell, BG Merger Comes as LNG Prices Fall in Main Market Asia
Three-quarters of global LNG demand comes from Asia
SINGAPORE—The world’s two biggest producers of liquefied natural gas, Royal Dutch Shell PLC and BG Group PLC, are planning a tie-up valued at nearly $70 billion just as conditions for the fuel in Asia, the region that consumes more LNG than any other, are at their worst in years.
Until recently, prices for the gas—supercooled so it can be liquefied for export—have been much higher in Asia than in either the U.S. or Europe. In part, that is because demand for gas has been growing in countries such as China and Japan. Three-quarters of the world’s LNG demand comes from Asia, according to the International Group of Liquefied Natural Gas Importers.
But LNG prices have tumbled in recent months in tandem with the slide in global oil prices. Sales of LNG in Asia are often based on long-term contracts, often around 20 years in duration, with prices linked to oil. About 25% of sales are on a shorter-term basis, with spot prices pressured by both cheaper oil and new supplies.
Spot Asian LNG prices now have fallen to levels last seen before the 2011 Fukushima nuclear accident led to a rise in Japanese gas demand. They dropped from a peak of about $20 a million British thermal units in February last year to less than $7 a million BTUs, roughly in line with gas prices in Europe though still higher than prices in the U.S.
Shell and BG didn’t respond to questions Friday, but their executives dismissed concerns about falling LNG and oil prices at a news conference Wednesday. BG Chairman Andrew Gould echoed the opinion of some analysts who say an LNG behemoth could withstand the industry’s problems.
“In the lower-price oil environment that this industry is facing, there will be strength in scale,” Mr. Gould said.
Shell’s acquisition of BG would create the world’s dominant producer and supplier of LNG and is a bet that countries such as China and India will eventually use less coal and more cleaner-burning natural gas. Together, the two companies produced 45 million tons of LNG last year, nearly 20% of the total global output.
But the companies’ strategy is linked heavily to energy prices and doesn’t produce significant profits until oil prices recover to about $90 a barrel, from $57.87 on Friday for Brent crude, the global benchmark.
The merger also comes as demand for LNG in Europe has been declining since 2011, due to recession. In 2014, European consumption fell to a 10-year low, according to recent figures from BG. Last year, European demand was about 14% of the global market, BG said.
BG said last month it expects LNG prices to become more volatile over the next few years, even as a wave of new supplies begins reaching Asia and new markets in Egypt, Jordan, Pakistan, the Philippines and Poland.
The weakness in Asia’s LNG market is expected to reverse in the longer term, but the price drop has, for now, put the economics of some major global LNG projects in question—including those owned by Shell and BG.
In December, BG reached a milestone when it shipped the first LNG cargo from its Queensland Curtis facility in Australia, or QCLNG, in which it invested $20.4 billion. But the company had to take a $4.1 billion write-down on the project this year, driven mainly by a reduction in the company’s assumptions about future energy prices.
“When you get married you don’t choose all of the relations. They just come as a set,” said David James Hewitt, head of Asian oil-and-gas research at Credit Suisse. “I don’t think anyone would pretend that the [QCLNG] asset is attractive from an economic-return perspective.”
BG’s QCLNG plant already had been bedeviled by cost overruns. Australia remains one of the world’s most expensive places for gas projects, with the cost of projects rising fourfold in the past decade. Currency fluctuations, high commodity prices and a labor shortage amid high demand contributed to the steep rise in costs.
BG also is feeling the effects of lower LNG prices in Asia in its trading business. Like other oil-and-gas producers, BG makes money not just from producing gas, but also by contracting for LNG supplies from other producers and selling them into higher-priced markets.
BG’s revenue and other operating income fell 32% in the fourth quarter in its LNG shipping and marketing business. In the quarter, BG supplied 30 cargoes into Asia, compared with 37 in the year-earlier quarter.
With Asia no longer commanding premium prices, BG also may have trouble finding a market for the first LNG exports from the U.S. later this year.
“The portfolio players were betting on an expensive [Asian] market, to buy low and sell high. Now they have to buy high and sell low,” said Vivek Chandra, chief executive officer of Texas LNG, a project lining up to export LNG from the U.S. “There are simply lesser margins for them to play with.”
Write to Eric Yep at eric.yep@wsj.com and Selina Williams at selina.williams@wsj.com
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