Dec. 18 (Bloomberg) -- Statoil ASA, Norway's state- controlled oil company, agreed to buy Norsk Hydro ASA's energy business for about $28 billion as supplies from domestic fields peak and competition intensifies for drilling contracts from Russia to Venezuela.

Combining the two largest oil producers in Norway, the world's third-biggest crude exporter, will give them control of about 70 percent of the country's output, as prices stay above $60 a barrel. A bigger Statoil will be better placed to compete with BP Plc, Royal Dutch Shell Plc and OAO Gazprom for reserves.

``We're getting a large Norwegian oil company that will be more competitive,'' said Tom Rathke, finance director of Vital Forsikring ASA in Oslo, which manages about $9.6 billion in stocks, including 13 million Hydro shares and 7.3 million Statoil shares. ``This is very good for the shareholders.''

Owners of Hydro will get 0.8622 of a share in the new company for each Hydro share, the companies said today at a presentation. They will also keep ownership of Hydro's aluminum company, the world's fourth-largest producer of the metal. Statoil owners will keep their holdings in the new company on a one-for-one basis.

Hydro shares surged 21 percent to 188.5 kroner today in Oslo. Statoil stock fell 1.7 percent to 170 kroner. Norway's government owns 71 percent of Statoil and 44 percent of Hydro.

Government Stake

Shareholders of Statoil will hold 67.3 percent of the new company, with Hydro's owners holding 32.7 percent. The Norwegian state will own about 62.5 percent. It aims to raise this stake to 67 percent ``over time'' and will ask for permission from parliament, a government statement said.

``There's no doubt that the battle for resources is hard, so it's an advantage that they are becoming one large company,'' Norwegian Energy Minister Odd Roger Enoksen said today in Parliament. ``This has strong support from the government. It's an aggressive move.''

Norway gets about a fifth of its gross domestic product and about 61 percent of its exports from the oil and gas industry, according to Norway's statistics office.

Eivind Reiten, 53, Hydro's current chief executive, will become chairman of the combined company. Statoil's current head, Helge Lund, 44, was proposed as CEO and president.

`Strong International Player'

``From a strategic and international point of view, it makes sense'' to combine, said Bjoern Inge Toennessen, an analyst at DnB NOR Markets in Oslo, who recommends buying stock in each company. ``They become a strong international player.''

Statoil and Hydro are seeking new oil and gas deposits abroad to make up for a decline in production at aging North Sea fields. The companies have spent about $6 billion buying assets in the Gulf of Mexico in the past two years.

The combined entity would have oil and gas production of 1.9 million barrels a day in 2007 and reserves of 6.3 billion barrels of oil equivalent, the companies said.

That compares with 2005 production of 4.01 million barrels a day for BP, 3.38 million barrels a day for Shell and 2.49 million for France's Total SA, Western Europe's top three producers, according to data compiled by Bloomberg.

Statoil and Hydro have both cut production targets twice for this year, partly as a scarcity of drilling rigs and offshore services set back development of some fields. Oil prices have more than doubled in the past three years, spurring producers to spend more on exploration and production.

Share Outperformance

``The industry faces an increasingly challenging international landscape,'' a statement from the companies said.

Statoil is paying about $13.70 per barrel for Norsk Hydro's 2.05 billion barrels of oil equivalent, according to Bloomberg calculations. A year ago, ConocoPhillips paid $18 a barrel for Burlington Resources Inc. in a $35.6 billion accord.

Morgan Stanley advised Statoil on the transaction, with Goldman Sachs Group Inc. and Citigroup Inc. working for Norsk Hydro.

Shares of Statoil and Norsk Hydro have outperformed competitors in the past five years, returning an annual average of 30 percent and 22 percent, respectively. Exxon Mobil Corp., the world's biggest company by market value, returned about 18 percent per year in the period.

Mergers and acquisitions in the oil and gas industry have climbed to a record this year as companies seek to add to reserves. The value of transactions this year is about $284 billion, according to data compiled by Bloomberg. That's up from about $273 billion in 2005.

Merger Discussions

Discussions on merging Statoil and Hydro's oil and gas activities first arose in 1999, when the companies bought and split smaller rival Saga Petroleum ASA, sparking a debate on how Norwegian companies could compete in a consolidating industry. Hydro, which was founded in 1905, spun off its fertilizer unit two years ago, prompting speculation about a split of its oil and aluminum businesses.

The CEOs of both companies held talks about an ``industrial structure'' in early 2004, concluding there was no reason to proceed.

The companies' failure to get stakes in Gazprom's Shtokman gas development in October may have triggered today's merger plan, said John Olaisen, an analyst at Carnegie ASA. Statoil and Hydro were among five companies competing to develop the site until Gazprom rejected foreign partners.

``If Hydro had got a large stake in Shtokman, then I don't think this merger would have happened,'' Olaisen said in an interview. Gazprom has since said it may again consider international participation.

Metals Business

Hydro's metals unit will continue under Reiten's leadership and include Hydro's power production business.

The proposed merger must be approved by the companies' shareholders and by regulatory authorities. The transaction is expected to be completed in the third quarter of 2007.

Statoil proposed paying a 2006 dividend of 9.12 kroner a share, or 19.7 billion kroner in total. Hydro suggested paying a full-year dividend of 5 kroner a share, or 6.1 billion kroner.

The cost of credit-default swaps based on 10 million euros ($13.1 million) of Statoil debt rose 2.9 percent to 8,750 euros, according to data compiled by Bloomberg.

Credit-default swaps are financial instruments based on corporate bonds and loans that are used to speculate on a company's ability to repay debt. A price decrease indicates an improvement in credit quality; an increase a deterioration.

To contact the reporter on this story: Bunny Nooryani in Oslo at bnooryani@bloomberg.net

Last Updated: December 18, 2006 12:48 EST