Shell’s output hole is a reason to gulp down Galp 

Dec 4 (Reuters Breakingviews) – Shell’s status as Big Oil’s safest pair of hands has its limits. The $212 billion UK major’s dividend is relatively more secure against oil price slumps than peers, its net debt is a low 21% of total capital, and operating costs are over 10% less than two years ago. Yet Shell also has an awkward strategic headache: it is running out of barrels.

According to its current targets, boss Wael Sawan wants to keep oil output flat and preserve a production “funnel” through 2035. On current trends, though, output could fall to roughly 2.4 million barrels of oil equivalent a day (boed) by 2035. That implies a 500,000 boed hole that needs filling, UBS analysts reckon. But big exploration wins are hard to come by – especially after years of underinvestment. No surprise the company has begun signalling, a greater openness to M&A.

Galp Energia is an obvious candidate. The $14 billion Portuguese producer has been supercharged by its Mopane discovery in Namibia, where more than 10 billion barrels of oil equivalent are estimated to be in place. Assuming a standard 30% recovery rate, that points to an oilfield of around 3 billion barrels. With a net present value at $4 a barrel, per Citi analysts, Galp’s 80% stake is worth about $10 billion.

Galp lacks the heft to fund such a project on its own, however. That’s why it’s selling down part of the stake. Chevron and TotalEnergies are seen as front-runners. With the first barrels from Mopane estimated to be due around 2031, Shell could charge into the fray too.

Still, buying a slice of Mopane doesn’t completely stop the rot. Acquiring all of Galp, which already produces 110,000 boed in Brazil and expects 40% annual growth in the next few years, would be punchier. But it would remain manageable for a company of Shell’s scale.

Imagine Sawan offered a 30% equity premium for Galp and assumed 1.2 billion euros of net debt – an enterprise value of around 17 billion euros. With 2.4 billion euros of operating profit forecast for 2028, per Visible Alpha, and 700 million euros of potential synergies from cutting a quarter of Galp’s non-production operating costs, Shell could earn an 11% return on invested capital post tax, according to Breakingviews calculations that assume a 40% tax rate. That’s above Galp’s cost of capital of around 10%, according to Bernstein analysts.

Galp’s strategic importance to Portugal, especially its refineries, complicates a full sale. But Shell could leave these with the group’s shareholders which include Portugal’s Amorim family and Parpública, a vehicle for the Portuguese state’s equity holdings. That would still allow it to buy the oil production assets.

Shell investors may groan at a big-ticket deal just as buybacks are flowing. But doing nothing leaves Shell’s future production looking thin. If Sawan wants to plug the looming output hole, gulping down Galp – or at least its Namibian jewel – may be the simplest fix.