Energy

Chris Hughes is a Bloomberg Gadfly columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

Royal Dutch Shell Plc is selling more than half of its North Sea oil production. It may be a big pullback from Britain for the Anglo-Dutch oil major. But it's clear the assets are better off with new owners and Shell is better off with the cash.

Running North Sea fields makes more sense for small firms that specialize in extracting every last bit of oil from mature acreage, leaving giants like Shell to focus on bigger, riskier projects elsewhere. The acquirer here, Chrysaor Holdings Ltd., is backed by U.S. investment fund EIG Global Energy Partners and run by seasoned North Sea experts. The chair is former Shell executive Linda Cook. Clearly for Shell this was a trusted buyer.

The terms look favorable to Chrysaor. It will pay $3 billion upfront, plus potentially a further $780 million depending on output and the oil price. Shell retains a $1 billion liability for future decommissioning costs, is providing a loan and some small insurance against oil falling. At the minimum price, the deal is worth $8.60 for each of the 350 million or so barrels of crude acquired. Chrysaor says operating costs will be under $15 per barrel so it will make $40 per barrel profit at the current oil price.

Oil's Well
The price of Brent crude has ticked up since touching 2004 levels in January 2016
Source: Bloomberg

Those returns will be amplified thanks to a benign fiscal and regulatory regime in the U.K., which allows Chrysoar to count spending on previous failed projects against what it makes here. 

As for Shell, it needed a meaningful disposal. The company's priority right now has to be to pay back a big chunk of the borrowings it took on to fund its $43 billion acquisition of BG Group last February. Net debt was $78 billion at the end of the third quarter. Gearing -- net borrowing relative to total capital -- was 29 percent. That's uncomfortably high for a business exposed to commodity price swings.

Alpha From BG
Shell has outpaced European peers since buying BG Group in February 2015
Source: Bloomberg

Shell's ability to generate surplus cash is improving thanks to the partial recovery in oil prices, but not enough to make a big dent in its borrowings. The group should cover its $25-30 billion capex needs and estimated $13 billion cash dividend bill while ending with a small cash surplus this year. But the most effective lever for strengthening the balance sheet is its $30 billion disposal program. At least $6 billion should have been achieved last year.

This is a very helpful transaction for all concerned. It looks good politically in Britain that the North Sea is attracting U.S. capital. The assets sold are strategically insignificant for Shell and the proceeds are meaningful. But Shell still needs many more deals like this.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Chris Hughes in London at chughes89@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net