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It’s M&A time for resource sector

Shell’s US$70 billion deal to buy BG Group is a complex global deal, but the underlying logic of buying a business at a low point in the commodity cycle makes plenty of sense. The same logic could apply to many other companies in the resource and energy sectors in Australia.

Rio Tinto may have the Treasurer’s skirt to hide behind, but Glencore is once again free to attempt a second tilt at the big miner if it so wishes. A lot has changed in six months so it is not a fait accompli that Glencore has the fortitude to re-visit such a bid but everyone is watching.

In Rio’s favour was a fairly decent full year result in 2014 which saw the dominant iron ore business predictably decline but a resurgent aluminium business overtake the copper division as the second largest contributor.

After swallowing Xstrata in 2012, Glencore hasn’t made a move of any real magnitude since but its natural instinct is to make deals. Whether Rio is the right deal now is open to question but it remains a possibility.

At the other end of the scale, the small resource companies are feeling the financial heat Atlas Iron has suspended itself from trading while it investigates asset sales, capital structure and operational aspects of its business. AGO has $169 million in cash but also has $327 million of debt. The company is likely to be making operating losses at current iron prices and needs to stem the haemorrhaging quickly.

That situation must be playing out at the other junior iron ore miners leaving them all vulnerable to acquisition activity.

Just as intriguing will be the path that Fortescue Metals Group chooses to follow. An embarrassing fail over its recent bond sale has weakened market confidence in what the company can or will do next. Perhaps it will revisit the idea of selling part of its rail infrastructure business called TPI (The Pilbara Infrastructure Co.) which was being investigated back in 2013.

Lurking in the background is Queensland-based rail group, Aurizon, which has tried hard to expand its rail infrastructure assets in Western Australia in recent years.  Could this be the ideal time for AZJ to begin serious discussions with FMG about a stake in TPI? It could provide a nice solution to the embattled junior miners who have struggled to gain third party access to TPI in order to lower their cost of moving product from mine to port.

The scale of the erosion in market capitalisation across the junior iron ore miners is horrendous. FMG was valued by the market at $16.3 billion at March 2014 but has given up $10.6 billion of value since then to $5.7 billion. In aggregate, the other junior iron ore miners have been slashed from approximately $6 billion down to $2 billion today. Many of them, like AGO, are likely trading below the value of the cash on their balance sheets.

The oil and gas sector has already seen a spate of acquisition activity including Apache exiting all of its Australian assets.

The Shell/BG deal raises plenty of questions around Shell’s remaining assets in Australia at the same time as throwing the gas cat amongst the LNG pigeons on Queensland’s east coast.

Courtesy of belligerent Woodside Petroleum shareholders, Shell still owns 13.6% of WPL (worth around $3 billion) following its foiled attempt last year to flick the stake. It also owns 50% of Arrow Energy  which has a big lump of 2P gas reserves (8,619 PJ to be precise) that previously looked like it might head down a pipeline to the Gladstone LNG plant which is 30% owned by Santos.

As Shell now has its hands on BG’s various interests in the QCLNG project, that gas asset may find a new home. It’s too early to know how this will play out but the STO Board will be getting nervous.

Oil Search continues to look like a good option in the sector with the significant ramp up in cash flow from the PNG LNG project providing the company with firepower to accelerate development of its other assets in the region.

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