City Watch: Drilling into the Shell and BG Group mega merger

File photo dated 08/04/15 of Shell logos on petrol pumps at a petrol station in London, as the oil g

File photo dated 08/04/15 of Shell logos on petrol pumps at a petrol station in London, as the oil giant announced the sale of 158 service stations in deals with two of the UK's leading forecourt operators. PRESS ASSOCIATION Photo. Issue date: Monday April 13, 2015. St Albans-based Motor Fuel Group is picking up 90 sites with another 68 going to Blackburn-based Euro Garages, which already has a relationship with Shell. See PA story CITY Shell. Photo credit should read: Yui Mok/PA Wire - Credit: PA

Last Wednesday, Royal Dutch Shell announced an agreement to buy BG Group for a consideration of £47bn, a 50% premium to the pre-bid share price.

Oliver Phillips, NW Brown Investment Management Director

Oliver Phillips, NW Brown Investment Management Director - Credit: Archant

The rationale for Shell's offer is that the deal will expand its presence geographically, take advantage of synergies between the businesses, and bolster its ailing 13bn barrels of oil resources by over a quarter. Shell will develop its exposure to geographies such as Brazil, making it the largest foreign oil company in Brazil, as well as cement its position as the global leader in liquefied natural gas. By combining the companies, Shell also estimates savings of $2.5bn per year and the group will divest assets worth $30bn between 2016 and 2018.

Speculation that Shell would acquire BG have been circulating for years but it was not until the recent fall in the oil price that BG's share price was low enough for Shell to make a bid. However, the large 50% premium Shell has agreed to pay means that the oil price must recover in the medium to long term for the deal to be attractive to its shareholders.

Shell is currently one of the highest yielding companies on the FTSE 350 index and if it can maintain its attractive dividend then the deal offers exciting exposure to world class assets. However if the price of oil does not recover to at least $70 per barrel over the medium term, investors will be concerned at the large premium of the bid.

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