The oil price collapse in the first quarter precipitated by the coronavirus pandemic should have put M&A in the electrical power generation and transmission industry on hold, as wholesale energy prices came under pressure. That has not been the case.
On the contrary, there was US$38.7 billion worth of deal activity in the first six months of 2020, a 7% rise on the same period last year. What's more, though volume in the sector over this time declined by 11% to 131 deals, in the wider M&A market, global deal volume dropped 32% year on year as countries entered lockdowns.
Distress can be a dealmaking motivator, but the sector's biggest deals of H1 2020 were more motivated by the longer term trend of energy transition.
The largest, a US$20.3 billion acquisition of Abu Dhabi National Energy (TAQA) by Abu Dhabi Power Corporation (ADPower), was also the biggest of the second quarter across all sectors, and the second-largest of the first half. The acquirer said that the combined entity will play a critical role in delivering the UAE's Energy Strategy 2050, the country's initiative to reduce the carbon-intensity of its power generation.
Second to this by some distance was E.ON’s US$2.7 billion squeeze-out of Innogy’s minority shareholders, taking E.ON's stake from 90% to 100%. The deal’s origins begin with Germany's own energy transition, Energiewende, away from coal and nuclear power in favour of renewables following the Fukushima disaster in 2011. This government policy forced carbon-intensive plants to close. Innogy was initially carved out of RWE—which has historically relied heavily on gas and coal—in 2016 and listed before a €43 billion asset swap was agreed between its former parent and E.ON in 2018. This year's squeeze-out concludes the largest deal to restructure Germany's energy industry to date.
The ongoing move towards less carbon-intensive sources of energy also motivated the sector's third-biggest deal of H1 2020. Indian state-backed utility National Thermal Power Corporation of India (NTPC) acquired another state-backed firm, North Eastern Electric Power Corporation Limited (NEEPCO), from the Indian government for US$1.4 billion. NTPC had been designated by the government as a “renewable energy implementing agency.” The deal gives NTPC access to NEEPCO’s hydroelectric and solar power assets in a region where NTPC operates coal assets.
Government support—including COVID-related responses
Government support plays an important role in energy production and consumption. India in fact increased its oil and gas subsidies by 65% between 2017 and 2019, from approximately US$6.1 billion to US$10.1 billion, according to the International Institute for Sustainable Development, while cutting renewable subsidies by 35%. This decision, which is expected to be only a short-term measure, partly reflects the ongoing fall in the cost of renewables production, which is making the sector more self-sufficient.
It is this long-term fall in prices that has led member states of the European Union, a global decarbonization leader, to start phasing out its feed-in tariff scheme that required participating licensed electricity suppliers to make payments to green energy producers. But the EU is far from pulling support for its climate ambitions and clean energy in particular.
COVID-19 stimulus packages will play an important role in M&A by determining the fundamental growth of sectors and where capital flows. Of the €1.8 billion (US$2 trillion) stimulus fund agreed by the EU in July 2020, a third, or €500 billion (US$572 billion), will be set aside for climate-related purposes, including promoting clean energy production. This aligns with the EU's Green Deal, which has the overarching aim of making Europe carbon neutral by 2050, and should provide impetus for renewables deals in the region.
In the US, a market that has been more supportive of conventional energy production in recent years, the pandemic has encouraged the Treasury to extend the deadline for construction of wind and solar projects to qualify for the production tax credit (PTC) and investment tax credit (ITC). The anticipated revised guidance would qualify wind projects and solar projects for the tax credits provided they are generating power by the end of 2021 and 2022 respectively, rather than by the end of 2020 as initially designed. This expected measure would provide relief for projects contending with construction delays caused by the pandemic.
Why now?
The upturn in renewables deals so far in 2020 may appear to defy logic. The COVID-19 health crisis has depressed consumption and sent the oil price down. Lower energy demand translates into lower wholesale energy prices, which is bad news for renewables producers. However, in a sense this a continuation of a long-term trend—the ongoing need for cost reduction in the clean energy sector in order to compete, as one of the major criticisms of the viability of renewables in the past has been their cost.
In this regard, significant progress is being made. In 2019, the levelized cost of electricity (LCOE) for a typical US onshore wind farm was US$37 per megawatt-hour, below the US$48 per megawatt hour from an average gas turbine plant. Meanwhile, photovoltaic (PV) plants have reached parity with plants burning inexpensive shale gas, according to BloombergNEF. All told, two-thirds of the global population live in countries where wind and sun power generate cheaper electricity than both coal and gas. Another past criticism of renewables, which applies to wind and solar in particular, is their inherent variability and extreme fluctuations in energy output. This too is moving in a positive direction, the LCOE of lithium-ion battery storage falling 4% in 2019 to US$186 per megawatt-hour.
Outlook
All of this points to an optimistic outlook for electrical power generation M&A as traditional utilities and investors adjust their sights on the longer term. Certainly, challenges remain. One of the biggest roadblocks is the uncertainty of the transition of power markets from centralized dispatchable grid-based models to a system that relies on fluctuating, non-dispatchable power sources such as wind and solar. However, given the increased momentum of investment into greener sources of energy, and the likelihood that the price of renewables production will continue to fall relative to traditional power generation, there’s good reason to believe these challenges will be surmounted. As such, the energy transition is likely to remain a strong motivator for M&A in the electric power sector in the foreseeable future.