Energy M&A: Is an Overhaul of the Past Required to Facilitate Future Growth?

In the short-term, the COVID-19 pandemic has impeded the growth of various industries, including the energy sector, which has exhibited a bearish outlook in 2020. However, more broadly, the energy industry is being hit by slower global growth, notably in the US, as a result of political and geopolitical risks across the world. Nevertheless, the sector remained active, in an environment rife with opportunistic behaviour.

 

Amidst travel restrictions and government-imposed lockdowns, US oil prices dipped below zero for the first time in US history in April 2020. A research report from the International Energy Agency (IEA) found that as a result of a decline in transport mobility, global oil demand plummeted in March 2020 at the height of the pandemic. This slump was further compounded by the ramifications of the Russia-Saudi Arabia oil price war whereby neither party agreed to curtail their oil production. The significantly lower demand for oil due to disrupted shipments and reduced air travel, complemented by excess supply, led to a sharp decline in the price of Brent oil from 66 USD per barrel at the start of the year to a two-decade low of 19.33 USD in April last year. However, notwithstanding the fluctuations of oil prices, M&A activity in the energy sector has not appeared to have been affected as November 2020 recorded 190 deals, 3 more than in November the previous year.

 

It thus seems that the pandemic has accelerated both the transition to a more digitalised world and the shift from ‘dirtier’ fuels to cleaner energy. Throughout 2020, shifts to green and sustainable bonds have been made by countries across the globe. Despite the fall in overall energy investment, figures compiled by Moody’s showed that global sustainable bond issuance, consisting of green, social and sustainability bonds, totalled 288.2 billion USD over the first nine months of the year, 24% higher than the corresponding period in 2019 with European powerhouses like Germany launching its first two sovereign green bonds this year and France accounting for approximately 20% of Europe’s clean energy M&A activity in 2020. Another example is that Indonesia issued its 2.5 billion USD Sukuk (green Islamic bond). Furthermore, Lazard’s annual Levelized Cost of Storage Analysis illustrates that the cost of supply for onshore wind and utility-scale solar energy has decreased by 9% and 2% respectively and is becoming increasingly competitive with traditional energy sources such as coal, gas and nuclear energy.

 

With an increasing number of countries joining the much-anticipated revolution to renewable energy sources, the transition to cleaner sources of energy seems inevitable – the US has pledged greenhouse reduction goals of 26% by 2025 and the European Union has set a goal of a 40% reduction by 2030. Especially following President Biden’s victory in the US elections, the newly-elected administration has pledged to re-join the Paris Agreement and aims to ensure the US economy achieves a 100% clean energy economy and net-zero emissions by 2050. However, questions have been raised regarding how quickly this transition can happen.

 

Berkshire Hathaway Energy’s (BHE) acquisition of US utility company Dominion Energy in July 2020 challenges how quickly global economies will be able to make this progression and rely primarily on new greener energy sources. The 9.7 billion USD deal was advised by Morgan Stanley and Barclays and saw the US-based multinational conglomerate expand on its existing 100 billion USD portfolio in the Energy sector. The acquisition will see BHE acquire a total of approximately 7700 miles of natural gas transmission lines in multiple states, 20.8 billion cubic feet of daily transportation capacity, and 900 cubic feet of operated natural gas storage, as well as potential synergies. This will enable Berkshire Hathaway to consolidate and significantly expand horizontally to many eastern and western US states, as well as Canada. BHE’s market share of natural gas distribution is expected to increase from 8% to 18% post-acquisition.

 

Due to the fluctuating prices of oil over last year, valuations for energy assets decreased significantly, which is why Dominion Energy was an attractive and undervalued asset at a bargain price. Additionally, the company has an extensive portfolio of natural resources assets, with CEO Tom Farrell boasting plans to invest over 55 billion USD in the next 15 years on emission-reducing technologies, gas distribution line replacement and renewable natural gas. This adds to the reason why it makes for such an alluring prospect.

 

This acquisition, though at a cut-price, does pose several risks. Biden has promulgated his 2 trillion USD clean-energy and carbon-free plan to eradicate natural gas usage by 2035, although the plausibility of his intentions remain under question. Attempts by California to ban natural gas usage at home, amongst various other impediments, could complicate BHE’s plans to integrate its newly-purchased pipeline assets with its existing portfolio. If the transition happens quicker than Warren Buffet anticipated, the outcome of the acquisition may disappoint. However, given Dominion has been shifting away from the natural gas sector of the energy market and seeking to become more renewable in recent years, this acquisition still has the potential to have success in either scenario. Thus, it will be interesting to observe how governments’ handling of the transition to clean energy affects the energy market in order to evaluate the success of the acquisition.

 

By Jesper Chin

Sector Head: Venkat Rajasingham

 

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