BG Group's (BG.) share price has held up remarkably well despite news that none of its Egyptian gas production was exported during the first quarter of 2014, but was instead diverted for low-margin domestic consumption. Admittedly, BG's shares have been at a pretty low ebb since the group declared Force Majeure on its Egyptian LNG agreements in January, but given that chief executive Chris Finlayson had departed less than a week earlier, the resilience of the shares is slightly baffling. It may well be that the market attached more importance to the fact that BG swung into positive free cash flow during the period, or perhaps it reflects renewed speculation over a possible bid approach.
BG's operations in Egypt have accounted for around a quarter of its production volumes in recent years, but the deteriorating political landscape has undermined the group's LNG pooling arrangements with local energy suppliers. The fact that existing quotas on exports have not been honoured is unsurprising given that Egypt's army is obviously keen to ensure a steady supply of power to the national grid. And those diversions could continue for a while longer. It might sound flippant, but with an average summer temperature of 33°c in Cairo, an already fractious situation would likely boil over if the city's air conditioners were to suddenly go on the blink.
Despite strong pricing in Asia, the problems in Egypt resulted in a 7 per cent decline in operating profits from the group's LNG segment. Group profits - at just over $2bn (£1.2bn) - were down by 6 per cent on the corresponding period in 2013, but were actually 13 per cent in advance of the consensus estimate. The average daily production rate of 630,000 barrels of oil equivalent (BOE) was broadly in line with expectations, although BG has some heavy North Sea maintenance commitments through to the end of the third quarter. As a result, daily production guidance is being pitched at the lower end of a 590,000-630,000 boe range for the full year.
It should be noted that BG is gradually increasing the proportion of crude oil within its product mix. This should help to underpin margins to an extent, ahead of new contributions from projects in Brazil and Australia. These developments are coming onstream according to plan, if not to budget. And the imperative to secure new revenue streams and cash flow will intensify if, as expected, group net debt-to-equity widens to 48 per cent this year, from 35 per cent in 2013. Andrew Gould, BG's chairman, who picked up the cudgel, albeit temporarily, following Mr Finlayson's hasty departure, revealed that the board intends to accelerate asset sales in order to keep borrowing in check and fund new exploration projects.
There's no shortage of energy companies hawking-off non-core assets at present, so BG will essentially be operating in a buyers' market. Mr Gould insists that "everything is on the table", but would the board seriously countenance diluting BG's average (27.5 per cent) stake in the five large pre-salt oil discoveries in Brazil's Santos Basin: Lula, Iracema, Sapinhoá, Iara and Lapa. We have our doubts. There's always the possibility of a deal linked to the group's Queensland Curtis LNG business. Intriguingly, Royal Dutch Shell (RDSB) recently revealed that it is in advanced talks with a rival gas developer in Queensland on ways to monetise its stalled Arrow LNG project. Aside from BG, the only other players that fit the bill are Australia's Origin Energy (ORG: AX) and Santos (STO: AX).
A successful sell-off of some of BG's non-core assets could also make the group more appealing to a potential suitor, but any resultant merger would have to be among the biggest oil deals in history - perhaps the biggest. Last year, Rosneft (ROSN: ME) stumped up around $28.8bn in cash and shares to secure BP's (BP.) half of the TNK-BP joint venture, but we doubt that any of the majors, including ExxonMobil (NYSE: XOM), currently have sufficient clout to broker a deal for BG, particularly given the latter's $51bn enterprise value.
Historically, BG has traded at a premium to peers across a range of profit multiples. Last July, in the aftermath of the coup d'état in Egypt, we ventured that this could rapidly evaporate. BG's shares, then trading at 1,206p, initially retraced before hitting a 12-month rolling high of 1,356p in January. A week later, the shares fell by a quarter on the Force Majeure announcement, but have since partially recovered - an indication that investors are buying on weakness in spite of current difficulties.
