What Stays, What Goes

It was a headline that definitely opened eyes and definitely perked up ears. News that supermajor Shell was in the process of reviewing its holdings in the largest US oil field – the onshore Permian basin – came as a shock. On one hand, why was Shell looking to sell off its assets in the prized US shale patch only months after naming it one of its nine ‘core’ upstream areas? On the other hand, the prospect of taking over Shell’s sizable acreage in the Permian has set its competitors operating in the same shale patch sniffing around for opportunities.

The answer to the former has been most influenced by a recent judgement at a court in The Hague, where Royal Dutch Shell is headquartered. The court ruled that Shell’s carbon plans – which calls for a reduction of greenhouse gas emissions to net zero by 2050 and an absolute 20% reduction by 2030 – was insufficient and not in line with the climate change goals of the Paris Agreement. Instead, the court ordered that Shell must reduce its emissions by 45% from 2019 levels by 2030, siding with environmental NGO Friends of the Earth which brought on the case by claiming that Shell was violating human rights with its current plan. Crucially, and unusually, the court applied the verdict to Shell’s entire global operations, spanning multiple jurisdictions, rather than limited to just Dutch holdings. Shell has announced plans to appeal, which could drag the process on for years in higher courts. But on the off-chance that this judgement remains binding, it is perhaps looking for ways to shave off carbon-intensive assets.

Why else would chatter suddenly surface that Shell was considering selling off its collection of prime Permian acreage located in the prolific Delaware basin? After all, just a few months ago in February, Shell announced that it was planning to reshape its upstream business to focus on nine core areas that generated 80% of its revenue – Brazil, Brunei, the Gulf of Mexico, Kazakhstan, Malaysia, Nigeria, Oman, the UK North Sea and, of course, the Permian Basin in the US. Although Shell is not among the largest Permian players, its 260,000 acres are still sizable and its output of some 60,000 b/d ranks Shell among the Permian’s 20 largest producers. Valuations suggest that the sale could fetch as much as US$10 billion, which is a lot of cash that Shell could redirect to clean energy initiatives if the aim is to conform to the court order. Because Shell is not exactly in fire-sale mode; its asset divestment program to hive off non-core assets to pay for its US$53 billion acquisition of BG Group in 2015 was already complete.

To be fair, for all the activity in the Permian, sustained profitability has proven elusive. Not just to Shell, but other major players there as well. The rapid drop-off in well productivity after the first two years means that players have to be constantly drilling and discovering, while a large-scale traditional crude oil field could last for decades after initial production. Shell is also not the only one to consider shedding assets; Chevron and ExxonMobil are also rumoured to be considering divestment as well. And why not? With crude prices at their highest point since late 2018, it is a good time to fetch the best price for oil assets. Most Permian deals in 2021 have closed at between US$7,000 and US$12,000 per acre – already a major increase from 2020 and 2019 – but Shell’s prime 260,000 acres acquired from Chesapeake Energy and Anadarko in 2012 would fetch a major premium, possibly almost as high as US$40,000/acre that would be in line with Pioneer Natural Resources’ acquisition of DoublePoint Energy in April 2021. Any sale would definitely exceed Shell’s initial investment of US$1.9 billion, fetching a tidy profit. Of course, the move would also shrink Shell’s US footprint, limiting it to the Gulf of Mexico (where the Whale field FID is expected soon) and a single oil refinery (Norco), after selling its stake in the Deer Park refining site to Pemex from an unsolicited bid.

If the sale goes through – and it is still a big if at this point – then Shell’s loss will be someone else’s gain. Who would that be? Potential bidders include ConocoPhillips, Devon Energy, Chevron, EOG Resources or even private equity firms that have not been scared off by the potential debt burden of Permian assets. Shell is likely to be looking for an all-cash deal for the entirely of the asset, but is reportedly open to also parcelling up the land into multiple packages. According to sources, a data room with full information on the assets has already been opened.

Looking at the location of Shell’s Permian assets, synergies exist with ConocoPhiliips and Chevron, which both own acreage close to the Shell holdings. Other potential buyers that operate in the Delaware region of the Permian include Occidental and EOG, with Devon Energy being the smallest company that could likely afford a purchase. But Occidental is still busy adjusting after outbidding Chevron in a blockbuster acquisition of Anadarko, which could preclude a purchase by Shell’s partner in its Permian operations. Pioneer Natural Resources might also be excluded as a potential buyer, given that it primarily focuses on the Midland region east of Delaware. But even if the desire is there, there are additional hurdles. Given the immense focus on climate change and the industries that contribute to it, capital is increasingly a challenge, since the financing of fossil fuels is under massive pressure.

Not that those hurdles are insurmountable. The pressures facing a supermajor like Shell – or even ExxonMobil and Chevron – do not necessarily apply in the same measure to other players. If Shell is willing to sell, then there will be plenty of willing buyers vying for the assets. But what is also certain is that recent climate change moves that are ongoing in the boardrooms of energy giants are starting to have very concrete implications and applications on operations. The heat fuelling merger and acquisition activity in the Permian is about to get a lot hotter.

End of Article

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Market Outlook:

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-       Both global crude benchmarks – Brent and WTI – cross the US$70/b threshold, recording the highest level of crude prices since October 2018, as the market focuses on the sustained improvements in fuel demand heading into the crucial summer season in the normal atmosphere that typically boosts road and air travel

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-       OPEC+ is predicting that oil demand growth will jump by 5 mmb/d in the 2H21 from 1H21 levels, setting the stage for further easing of the OPEC+ supply quotas; Iran’s return to international crude markets is likely to be further afield as talks to revive the 2015 nuclear deal enter into roadblocks

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