Shell and PetroChina Go Down Under for a $3 Billion Deal

The global energy business has seen a gradual shift from petroleum-based fuels to unconventional sources. Major companies are using their huge cash hoards to pull off deals that reflect this shift. The biggest deal so far has come from ExxonMobil (XOM), which recently agreed to pay $41 billion for XTO (XTO). The acquired company extracts natural gas from shale rock, which is no easy feat.

Since then, the global markets have been active with other deals. For example, this week Royal Dutch Shell (RDS.A) and PetroChina (PTR) made a $3 billion offer for Arrow Energy, a coal-seam gas producer in Australia. Shell already has a 30% interest in Arrow's holdings in Queensland and a 10% stake in its global operations, as a result of a $700 million deal in 2008.

Essentially, coal-seam gas is methane that's trapped in coal seams, which generally have much more gas than traditional sources. Interestingly enough, this gas was considered to be a safety issue for coal mining. But then scientists realized it was actually a good source of energy. Based on current estimates, Australia has 15.1 trillion cubic feet of coal-seam gas.

Over the past couple of years, major energy companies -- like BG Group, ConocoPhillips (COP) and Petronas -- have poured roughly $20 billion into Australia's coal-seam industry. This is not only for extraction but also to build LNG (liquefied natural gas) plants, which make it possible to ship to other countries.

Politics Could Get in the Wayof Economics

Arrow has the largest coal-seam gas acreage in Australia, and more than 90% of its holdings haven't been certified, which means there could be even more reserves. The company has also developed sophisticated technologies to extract the gas. However, it will take billions of dollars to capitalize on this opportunity. So, joining forces with major oil companies makes a lot of sense.

The economics of the Shell-PetroChina certainly add up. But the politics may get complicated. PetroChina, which is controlled by the Chinese government, will probably cause some concern.

Look at Chinalco's proposed $20 billion investment in Rio Tinto (RTP). The deal fell apart in 2009 because the Australian government didn't want to give control of a strategic asset to a foreign power. Moreover, PetroChina has also had recent problems in Australia, as with its stalled deal to purchase $40 billion in liquefied natural gas from Woodside Petroleum.

What to do? Well, by combining with Shell, PetroChina is likely to soften the concerns and help move the deal forward.

At the same time, the consolidation should continue. Already, there's buyout speculation regarding a variety of Australian coal-seam operators, like Eastern Star Gas and Oil Search.