May 28, 2010 / 6:57 AM / 7 years ago

Shell pays $4.7 billion for shale gas company

AMSTERDAM (Reuters) - Royal Dutch Shell (RDSa.L) said it would pay $4.7 billion cash to buy privately held East Resources Inc, giving it more exposure to promising shale gas reserves in North America.

<p>A Shell logo is seen on a pump at a petrol station in London April 28, 2010. REUTERS/Toby Melville</p>

The deal would raise Shell’s daily gas production in North America by about 7.5 percent and give it access to a swathe of the Marcellus Shale, the northeastern U.S. rock formation that is a crucial source of future U.S. gas production.

Shale gas accounts for between 15 percent and 20 percent of U.S. gas production, but is expected to quadruple in coming years, touching off a scramble among producers large and small for access to resources.

Analysts cautioned the deal would put pressure on Shell’s balance sheet at a time the company already is planning to spend plenty of money on other projects.

“Although this is a good move, it will put further pressure on the balance sheet, which is weakening with the high level of organic capital expenditure the group has committed to,” Panmure Gordon analyst Peter Hitchens said in a note.

Hitchens said that weakened balance sheet would keep Shell from increasing its dividend over the next two years.

A Shell spokeswoman said the company was not commenting on how it intended to finance the purchase. Shell had $8.45 billion cash and equivalents on its balance sheet at March 31 and generated nearly $4.8 billion in cash flow from operating activities in the first quarter.

Shell shares rose 0.41 percent to close at 1,822 pence on the London Stock Exchange.

PORTFOLIO UPGRADE

Shell said growing and upgrading the quality of its North American tight gas portfolio would be an ongoing strategy. Tight gas refers to gas trapped in rock and sand formations.

Shell is the latest in a line of international oil players that have bought into the Marcellus, named for a town in New York that sits near an outcropping of the rock formation. They include Statoil (STL.OL), Exxon Mobil (XOM.N), Mitsui & Co (8031.T)MITSY.O and Reliance Industries. (RELI.BO)

The rush for acreage in U.S. shale, however, has met persistent weakness in gas prices. Front month gas prices are down more than 22 percent this year, though after a steady decline they began to bottom out in late March.

Shale gas is also harder and more expensive to extract because it comes from rock rather than traditional reservoirs.

Drilling could also become more expensive due to environmental challenges. Environmentalists say the drilling fluids that crack the rock and free the gas can contaminate drinking water. The industry disputes this.

East controls 650,000 net acres (2,600 square kilometers) in the Marcellus Shale, and 1.05 million net acres overall.

Depending on how they value the acreage outside of the Marcellus, analysts pegged the price Shell is paying per acre between $4,500 and $7,200. Companies have paid as much as $14,000 an acre in recent months to buy into the Marcellus.

Much of the acreage Shell is buying is located in two prime counties for Marcellus drilling, Pritchard Capital partners analyst Ray Deacon said.

“The quality of the assets in Tioga and Susquehanna counties are probably the best in the Marcellus. That’s just based on how much production they’re getting early in the life of the wells -- that really improves the returns,” Deacon said.

Besides its majority owners, East counts private equity firm Kohlberg Kravis Roberts & Co. KKR.AS as an investor and Jefferies & Co. as an adviser.

The acquisition came hours after the U.S. government said it would review Shell’s plans to begin drilling exploratory wells off Alaska this summer, delaying the project.

The already controversial project has faced increased scrutiny in recent weeks in the wake of the massive BP oil spill in the Gulf of Mexico.

“The news (on East) masks other bad news for Shell,” Theodoor Gilissen Bankiers analyst Peter Heijen said in a research note. “That the delay falls right in the summer, just as drilling can happen there, is extra bad.”

Additional reporting by Sarah Young in London and Michael Erman in New York. Editing by Dan Lalor, Mike Nesbit and Robert MacMillan

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