The news that Royal Dutch Shell (RDS.A; RDS.B) will buy BG Group for 47 billion pounds ($70 billion) should not really come as a surprise for investors. In fact, it may just be the first in a series of mergers and acquisitions in Europe's crowded energy sector. Years of quantitative easing have pushed down corporate bond yields for the biggest companies -- Shell's bonds, just like Nestle's, have seen negative yields at certain times -- and big corporations are awash with cash. The low oil prices are another factor encouraging mergers, because they have forced the energy sector in "survival of the fittest" mode. Currency plays may also be considered, as revenues in the industry are generally in dollars.
So get ready for more mergers and acquisitions in Europe, with the biggest actors poised to look for prey. The main playground for this will be the UK, where the blue-chip FTSE 100 index is dominated by oil and gas companies, with many other, smaller firms scattered everywhere in the London Stocks Exchange. An obvious candidate here to look for mergers is BP (BP), which even after having to deal with the fallout from the Macondo disaster still makes up 4.63% of the FTSE 100, the second-largest component after HSBC (HSBC) and just ahead of third-ranked Shell, which represents 4.55%.
BP saw profit fall in the fourth quarter of last year to $2.2 billion vs. $2.8 billion in the same 2013 quarter, mainly due to the rapid fall in the price of oil. It sold its participation in Russian venture TNK-BP and it has further plans to divest around $10 billion of assets in total for 2014-2015, which would make it easy for people to dismiss it as a company that is shrinking, not increasing. And yet, in the words of CEO Bob Dudley during the company's 2014 earnings presentation, BP's portfolio is "constantly under review." The company remains "alert to opportunities for investing in assets that fit our core strategy that could arise in the current market conditions." Alternatively, BP could be the target of U.S. giants, a possibility that sent its shares higher by around 1.5% in London.
One interesting trend that seems to emerge in investor expectations, at least looking at the share price action, is consolidation among companies working in the frontier markets, and especially the African energy sector -- a fast-growing market that's full of potential, but also a highly risky one because of frequent violence, under-developed infrastructure and local bureaucracy and corruption.
Smaller firm Tullow Oil, which specializes in exploration and production in Africa, was knocked out of the benchmark FTSE 100 index last month, when its price dropped further because of the continuing weakness in oil prices. Worries that a border dispute between the Ivory Coast and Ghana could delay one of its West Africa projects also weighed on its shares -- but this could make it attractive to predators, and its shares jumped nearly 9% in London trading on Wednesday.
Afren, the mid-cap oil producer focusing on rapidly-growing Nigeria, saw an increase of more than 3% on Wednesday after the Shell/BG news. However, its shares -- which had lost 97% over the past year -- had already jumped 6% on Tuesday on news that the company appointed industry heavyweight Alan Linn as its next chief executive.
A small oil exploration and production firm listed in London, Ophir Energy, saw its shares surge by nearly 8%. Ophir has exploration interest across East and West Africa, including Gabon, Senegal, Tanzania and Kenya. Tower Resources, a highly speculative play listed on London's AIM market -- reserved for high-risk, high-reward shares, of which many disappear through bankruptcy relatively often -- was up by more than 1% in morning trading on Wednesday. The company owns half of an offshore exploration in Namibia and its stock had lost more than 95% of its value over the past year.
Outside of Africa but staying in frontier markets, shares in Gulf Keystone Petroleum, a company focusing on oil exploration in the Kurdistan region of Iraq, rose 4.4% after the news. The former head of the company said at the beginning of the month that he had been talking to several interested companies, including Exxon Mobil (XOM), about a possible sale.
Of course, it is quite difficult for American investors to gain direct exposure to London-listed shares unless they have ADRs listed in New York, which none of the smaller stocks have. One option, depending on the cost and risk/reward appetite at an individual level, would be to open an account with a London-based broker. Another is to just be aware of the trend and get wider exposure to the fast-growing frontier economies via an ETF, like, for instance, the Market Vectors Africa ETF (AFK), or a mutual fund such as the Nile Pan Africa A (NAFAX). Funds specializing in UK small-cap stocks would also be a way to get in, but bear in mind they offer exposure to other sectors as well. One such example is the iShares MSCI United Kingdom Small-Cap (EWUS) ETF, which is dominated by consumer discretionary stocks.