Shell's Arrow takeover points to big shift

Royal Dutch Shell moved a step closer to shifting the balance of its production in favour of natural gas over oil following a joint A$3.5 billion ($4.5 billion) acquisition of Arrow Energy.

The deal with PetroChina will give Shell access to Arrow Energy's holdings of coal-seam gas reserves, while conventional supplies are either declining or off-limits in other parts of the world.

Chief executive Peter Voser has described Australia as a "key growth" region for Shell.

Shell is focusing investment in Australia, the Gulf of Mexico and US gas that's found in hard-to-reach rock formations. As much as 40 per cent of the company's capital spending in the next few years has been earmarked for the Asia Pacific region.

Shell, which has been adding more gas than oil to its resources since 2005, expects the share of gas as a proportion of output to rise to 52 per cent in 2012.

"This fits perfectly within Shell's strategy to become a gas company that increasingly focuses on Southeast Asia," Peter Heijen, an analyst at Theodoor Gilissen Bankiers NV, said. "It will guarantee a solid cash flow in the future."

Shell isn't alone in seeking to tap Australia's energy resources. The nation's gas fields are attracting more than US$130 billion of investment to supply customers in Asia.

Chevron is leading the A$43 billion Gorgon liquefied natural gas project in Western Australia.

Under the Arrow deal, Shell and PetroChina will gain control of Australia's largest holder of permits to extract gas from coal seams for processing into liquid form for export. It's the biggest Australian coal-seam gas transaction since ConocoPhillips paid US$5 billion for a stake in Origin Energy's gas assets in 2008.

Shell and PetroChina will pay A$4.70 cash a share for Arrow's Australian business. That's 5.6 per cent more than an initial offer of A$4.45 and 35 per cent above the stock's level before Arrow was first approached on March 8.

Investors will also get shares in a new company holding Arrow's gas assets in China, Indonesia, India and Vietnam.

"The Arrow deal is not huge for Shell in relation to their total assets, but looks a reasonable price from Shell's point of view," Ivor Pether, who helps manage US$9.7 billion of assets at Royal London Asset Management, said.

"The partnership with PetroChina is another step in building relationships with an important customer."

Arrow's biggest shareholder, New Hope, supports the acquisition offer, it said yesterday. The coal producer, which owns almost 17 per cent of Arrow, said it plans to vote in favour of the proposal in the absence of a higher bid.

Arrow, which fell 3.6 per cent on Monday in Sydney, reflecting disappointment among some investors who had expected a bigger increase in the bid, dropped a further to A$4.99 yesterday.

The stock had climbed 52 per cent, reaching a record close of A$5.29 on March 18, as investors bet the initial offer would be sweetened.

Shell and PetroChina are paying less than similar deals in the past because of the global recession and weaker demand, according to RBS Morgans, an Australian broker.

ConocoPhillips and Malaysia's Petroliam Nasional Berhad have also acquired coal-seam gas assets in Queensland to feed planned LNG projects.

BG Group paid A$5.2 billion in 2008 for the rest of Queensland Gas, renamed QGC, to gain reserves.

"The world is a different place than it was a couple of years ago," Nik Burns, a Melbourne-based analyst for RBS Morgans, said. "It was a very hot market back then. There were a lot more bullish forecasts for LNG."

LNG prices are typically linked to the average cost of a barrel of oil imported by Japan, known as the Japan Crude Cocktail.

"We were looking at close to oil parity pricing for LNG, and oil prices were up above US$100 a barrel," Burns said.

"In that environment you can see why they were paying a reasonably high price."

Shell and PetroChina's offer values Arrow's proven, possible and probable, or 3P, reserves at 59 Australian cents a gigajoule, compared with BG's acquisition of QGC at 77 cents a gigajoule, John Young, an analyst at Wilson HTM Investment Group in Melbourne, said.

"The price was arrived at after an extremely robust negotiation with Arrow over two weeks," Shell Australia chairman Russell Caplan said.

"This is a good premium for the stage of maturity of this project, with the significant investment to be conducted from now on."

- BLOOMBERG