A super energy giant expected to rival ExxonMobil is set to be born! Shell and BP PLC are brewing an epic merger

According to the Zhitong Finance APP, if European energy giant Shell (SHEL.US) acquires another European energy giant BP (BP.US), it would become one of the largest transactions in European history and create a European oil giant capable of challenging global oil industry leaders—ExxonMobil (XOM.US) and Chevron (CVX.US). The integrated oil and gas supergiant's upstream oil and gas production would reach nearly 5 million barrels of oil equivalent per day, potentially significantly exceeding the aforementioned two oil industry leaders.

Despite BP's current unfavorable situation—its stock price has fallen nearly one-third over the past year, significantly underperforming European benchmark indices and peers in the oil and gas industry—investors generally lack confidence in its energy transition and turnaround plans. However, this potential large-scale acquisition would be disruptive for Shell.

Nonetheless, this super-sized merger will face significant challenges, including BP's own high debt and liabilities, potential antitrust competition issues, and the need to be forced to sell off a large number of assets, all of which could become obstacles to this large-scale transaction.

Recent reports from media citing informed sources indicate that as international oil prices remain weak due to a new round of global trade wars initiated by the Trump administration, Shell's management is evaluating this potential large acquisition. Since then, analysts have begun to assess the pros and cons, particularly what it means for Shell's fundamentals and performance outlook. Here are their main conclusions:

A New Oil Giant is About to Emerge

The analyst team from UBS Group pointed out that after the merger of the two London-based oil giants, their overall upstream oil and gas production will approach an average of 5 million barrels of oil equivalent per day, an 85% increase from Shell's current approximately 2.7 million barrels/day, thus becoming the largest oil and gas production giant belonging to investors globally. In comparison, the largest oil and gas producer in the world, ExxonMobil, had an average production of about 4.6 million barrels/day in the first quarter of this year, while another American oil giant, Chevron, produced about 3.4 million barrels/day.

If BP's shale subsidiary BPX in Denver, USA, is formally incorporated into Shell's business portfolio, it could somewhat compensate for Shell's regret in selling its Permian Basin business to ConocoPhillips in 2021, subsequently missing out on the oil industry's boom. At that time, the upstream business head, Wael Sawan, is now the CEO of Shell.

LNG Dominance

The analyst team from RBC Capital Markets stated that the latest statistics show that Shell is already the world's largest liquefied natural gas (LNG) seller, and if it acquires BP, its business will be "pushed to new heights." The combined annual LNG sales of the two companies will exceed 90 million tons, accounting for over 20% of the current global LNG market.

Such a vast global layout will release more trading opportunities and business optimization chances—this is key to LNG business profitability amid volatile natural gas prices. Additionally, the merger of both companies' substantial LNG fleets will significantly save on high LNG transportation costs Expansion of Trading Business

BP and Shell are already among the largest commodity traders globally, with their extensive physical assets, from refineries to transportation pipeline networks, providing unique advantages for comprehensive market insights.

Although the trading divisions' information is opaque, some oil and gas companies have disclosed key value clues: over the past five years, BP's overall trading division has averaged a capital return increase of about 4 percentage points; over the past decade, Shell's trading division has also seen a return increase of between 2% and 4%.

It remains unclear whether the merger can raise the return rate enough to offset the acquisition premium. RBC's analyst team even questioned, "Does Shell, which already has its own trading organization, still want to pay a high price for another commodity trading platform?"

High Costs

RBC's analysis team estimates that acquiring BP may require a premium of about 20% on its £57 billion market value to complete the acquisition.

Some costs can be partially offset through synergies, but the amounts involved are relatively small. Preliminary forecast data from RBC indicates that the merger will bring about $1 billion (after tax) in synergies in the first year, potentially increasing to $2 billion in the second year; additionally, capital expenditure synergies are expected to yield about $1 billion in the first year and about $1.5 billion in the second year.

Measured by the free cash flow per share, which Shell CEO Wael Sawan considers the "North Star," RBC believes that due to significant synergies and capital reductions, the transaction could enhance Shell's free cash flow per share starting in 2026.

Debt and Compensation

One major challenge of this large-scale acquisition is BP's long-standing weak balance sheet. UBS noted that when accounting for leases and hybrid leveraged capital, BP's leverage ratio reached as high as 48% at the end of the first quarter, the highest among oil and gas giants.

Moreover, BP still needs to pay annual compensation for the 2010 Deepwater Horizon oil spill in the Gulf of Mexico until 2033.

The RBC analyst team stated, "The combination of BP's debt, hybrid capital, lease obligations and commitments, along with the Macondo liabilities, poses a 'poison pill' for Shell's traditionally conservative balance sheet."

Antitrust Competition Review

UBS stated that this large-scale merger would increase Shell's retail network of refined oil by about 48%, adding over 21,000 stations, bringing the total to over 65,000 stations. In some markets, the combined market share of the two oil giants may be too high, raising concerns from antitrust regulators, which could force the sale of certain assets.

If Shell chooses to sell BP's market and retail business as a whole, the RBC analyst team predicts that this business segment would be valued at approximately $30 billion to $40 billion.

Asset Divestiture

The RBC analyst team believes that Shell may also divest BP's significant upstream assets in countries such as Azerbaijan, Iraq, India, and Abu Dhabi, as Shell's management may find many of BP's other assets not worth retaining. However, the potential scale of divestitures could itself become an obstacle to the acquisition deal "The actual scale of non-core assets may be too large for the balance sheet to digest, which means Shell needs to undertake another large-scale asset sale plan. A large conglomerate repeatedly 'leaving money on the table' in M&A projects is not a good sign for the fundamentals," the RBC analyst team pointed out