As 2019 comes to an end, how does Energy M&A activity in the power and oil and gas sectors compare to previous years? And what does 2020 hold for the industries?
To answer this Power Technology spoke to two members of US legal firm Sidley Austin LLP about the future of deals in the US power and oil and gas markets in the presidential election year. We discussed the importance of the energy and climate debate as the US goes to the polls in 2020, along with problems in the natural gas market.
Ken Irvin is the co-lead of the group’s global energy practise area team whilst Cliff Vrielink is a partner who works in the firm’s M&A and Private Equity practises.
Jack Unwin (JU): How would you summarise M&A activity in 2019?
Ken Irvin (KI): I would call it a modest year. I don’t think there has been a tremendous amount of M&A activity, our market is not in recession but it’s not growing terribly strong either.
Over the past year we’ve seen some M&A activity on the electric and gas side but it seems to me that it isn’t as much compared to others year when we’ve seen a lot of utility or power producer mergers.
Cliff Vrielink (CV): I would agree with that. There were some in the oil and gas space, Oxy and Anadarko was a big deal but otherwise it was quiet on a lot of fronts.
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There was a lot of cheap capital that moved into the energy space in the last ten years, but investors are now getting to the point where they’re looking at what the returns have been.
Certainly in oil and gas they have been disappointing, and that has caused a lot of capital to take a pause and be a bit more demanding in terms of what they want.
There has also been a lot of existential turmoil in terms of climate change and people in O&G feeling pressure from their investors. On the renewables side you don’t face the same turmoil, instead they have a bit of a tailwind from policy priorities and a long run of available capital.
I’d say it was a modest year with some activity with some parts of the O&G landscape being completely dead, acquisitions and divestitures slowed down to a trickle in 2019, it hasn’t been a banner year for that.
JU: Liquid natural gas seems to be going through a tough period, what are the reasons for this?
KI: It’s a combination of supply and demand fundamentals. We’ve seen prices as low as $2 per MMBtu in some parts of West Texas and this year prices are very low.
Another aspect has been the absence of demand. A lot of pipes were built to take the gas to Mexico but they haven’t come online as fast as people wanted and the demand for gas in Mexico hasn’t developed as quickly as expected as well, leading to an abundance of backed-up gas in West Texas.
In many of our markets natural gas is a marginal fuel in an ocean of electricity. It is the last of the resources that are dispatched to meet the demand for electricity, demand that has been steady if not declining for several years due to improvements in efficiency and demand response.
Domestic demand for natural gas has also been moderate which has led to remarkably low prices. A decade ago people were predicting $8-12 MMBtu of gas and now it’s $2, it’s an amazing course of events.
JU: The phrase existential turmoil was used in regards to the climate debate, how much of an impact has it had in the US?
CV: Obviously everybody thinks about those issues pretty seriously, and I think the industry is trying to be very responsible in terms of their development but what I think has changed is that there is a lot of public pressure to move to less fossil fuels.
New York, California and other states are trying to lead the charge in terms of setting targets for reducing the use of fossil fuels. This has created a lot of challenges for permitting projects and getting the requisite approvals in order to build the infrastructure, even though the industry has customer demand.
So you have a bit of a dichotomy which influences companies when they’re making long term investment for projects they’re building.
JU: It’s a presidential election year in 2020, will that have any impact on the market?
KI: It’s definitely not going to be in the background! The presidential election is going to capture a lot of headwinds, maybe even closer to gale force winds depending on how the election goes.
There is a spectrum of possible outcomes with the number of candidates and the various positions they espouse right now. Energy has become a kitchen table issue, it will definitely be a central discussion point for the campaign.
JU: How important will energy be as an election issue?
CV: It’s hard to say. It’s certainly something that is very much in the dialogue and the conversation. There is also a sector of the populous and non-governmental organisations (NGOs) that are extremely well organised and focused on this issue.
There are lots of important issues in every election, but the energy debate is different from the ones from 10-15 years ago. Back then the conversation was around dependence on foreign oil and high fuel prices, but nobody talks about them anymore because of the shale revolution.
We are also no longer a net importer but a net exporter and high fuel prices were addressed by the shale revolution. It’s very curious that the top two concerns around the energy industry have been solved by the industry itself, but now it is facing a larger challenge.
JU: A key trend seems to be bankruptcies and restructuring in the energy industry, is this likely to continue?
KI: Bankruptcy is rather commonplace for the energy industry, usually because it is a very capital intensive industry.
It is also a commodity industry so with the volatility of commodity prices any given company business plan could be in or out of the money. So you can find yourself in a situation where the company has borrowed money or collected investors on the hopes of strong commodity markets but then it shifts and goes into degradation, followed by restructuring through a chapter 11 bankruptcy.
Our bankruptcy process is pretty well-conceived and has an elegance to it in terms of allowing people to know what to expect for outcomes so it’s not a shock to the system.
JU: Is it a similar story in the oil and gas industry?
CV: Definitely, the commodity cycle can be vicious and the capital needs are very intensive.
We have just worked on a number of restructurings but we are going to see a lot more in the O&G space both in upstream and also the services sector. A lot of companies have taken on debt that is going to be maturing and it will be hard for them to refinance it.
Consolidation is something that needs to happen, but the challenge is that even if a company continues to operate they may not be an attractive consolidation target with their historical debt load which you can’t ignore. Companies might not be able to pursue consolidations and that increases the chances that there will be more restructurings.
JU: Do you have any thoughts on what will occur in your sectors in 2020?
CV: As I mentioned before I think you will see more consolidation. I also think you’ll likely see some fairly large transactions, asset divestitures as well as M&A deals along with more restructurings.
I don’t know if that builds steam throughout the year or if you’re going to see deals popping up from time to time, but I would expect there to be more activity in 2020 than 2019.
KI: I think energy storage is something that will see more and more activity. It’s attracting more capital and it’s in demand. NY State is sourcing offers for 300MW of energy storage and Hawaii, Puerto Rico and other island utilities are looking to be generating carbon-free electricity by 2050, that will depend on energy storage.
More investment will drive the technology and improve the cost per unit, and I think as we deploy more offshore wind that and solar development will really progress with storage technology.