Extract from 'The Energy Mergers & Acquisitions Review'
Overviewi Oil and gas
The oil and gas industry is composed of four separate but related sectors:
- upstream (companies engaged in the business of extracting hydrocarbons);
- midstream (companies engaged in the business of transporting hydrocarbons);
- services (companies engaged in the business of assisting upstream and midstream companies with the extraction and transportation of hydrocarbons); and
- downstream (companies engaged in the business of refining petroleum after extraction).
The oil and gas industry continued to see strong M&A activity through Q2 2019, but experienced a marked slowdown in Q3 2019 as the overall macroeconomic environment deteriorated and investor sentiment worsened due to:
- supply and demand concerns;
- geopolitical issues;
- the negative reaction to environmental, social and governance (ESG) issues at oil and gas companies;
- significant concerns around the amount and serviceability of indebtedness at many oil and gas companies; and
- expectations of reductions in upstream drilling budgets.
All of the above would in turn lead to reduced operational and financial growth generally for companies in the oil and gas industry.
The equity and debt capital markets have been closed for most oil and gas companies, with the exception of those companies with the best credit profile. Investors are looking for low levels of indebtedness, visibility to free cash flow generation and a return of capital through share repurchases or dividends, which many oil and gas companies cannot provide. Private equity companies have stepped in as an alternative source of financing through the use of innovative deal structures, including drillcos, wellbore securitisations and non-op joint ventures.ii Power and utilities
The power and utilities sector continued to see strong M&A activity through Q3 2019, but deal size has trended lower when compared to 2017 and 2018 levels. Total deal value declined to just over U$5 billion in Q3 2019 for US power and utilities M&A, marking the quarter with the lowest value since the first half of 2017. Asset deals have been the primary driver for M&A activity for power and utilities since 2018, which, when combined with lower deal value, signals a continued slowdown in consolidation in the sector generally since the most recent utility M&A wave in 2015 and 2016.
While strategic deals dominated US power and utilities M&A both in terms of deal size and volume, private equity and other financial investors remained active across the sector. In June 2019, for example, J P Morgan's Infrastructure Investments Fund announced the U$4.3 billion acquisition of El Paso Electric Company, the largest deal announced in the US power and utilities sector so far in 2019, although it would be eclipsed if the U$67 billion merger discussions between PPL and Avangrid reported in Q4 2019 were to materialise into a deal. The role of private equity and other financial investors in power and utilities M&A is expected to continue in the coming years, in large part due to capital deployment needs of infrastructure-focused funds, which have grown significantly in number and size. Private funds raised U$85 billion in capital for infrastructure investments globally in 2018, of which U$44 billion is attributable to North American-focused funds, and over 200 funds were seeking to raise in excess of U$190 billion of additional capital at the start of 2019.
Renewable energy also continues to play an increasingly important role in the US power and utilities sector, driven by declining prices coupled with the improved performance of the underlying technology, as well as regulatory policies and investor commitments. Renewables have been driving a considerable amount of the M&A activity. In Q3 2019 alone, renewable deals represented more than 50 per cent of total deal volume and 19 per cent of total deal value in North America. Policy shifts at all levels of the government and among investors in the US have – and will continue to have – meaningful impacts on renewable energy M&A activity, including the looming phase-down of US federal tax incentives and the advancement by state and local governments of renewable energy policies in the US as the federal government refrains from adopting formal climate change initiatives. In particular, 29 states and Washington, DC have adopted renewable portfolio standards, and California, Hawaii, Maine, Nevada, New Mexico, New York, Washington and Washington, DC have all passed legislation committing to carbon-free electricity by certain dates. Investors in the US are also increasingly focused on acquiring or investing in renewable energy to meet their corporate zero-carbon or other ESG objectives. Socially responsible investments globally grew by 34 per cent to U$30.7 trillion over the past two years, and nearly half of S&P 500 companies addressed ESG topics in Q4 earnings calls in 2018. Private equity firms are following this trend by creating dedicated impact investing product lines and platforms, including those specifically focused on renewables investing. Despite all of this M&A activity, the power and utilities sector continues to face an uncertain market in 2019, from state subsidies for certain generation resources and related changes to rules promulgated by the Federal Energy Regulatory Commission (FERC) and capacity market auctions in certain organised markets such as PJM and ISO New England, to price volatility in restructured power markets such as the Electric Reliability Council of Texas.
Legal and regulatory framework
As with M&A more broadly, the legal framework for energy M&A involves concurrent regulation under a variety of federal and state laws.
M&A in the energy industry (both oil and gas and power) are regulated at both the state and federal level. At the state level, approvals are typically required under applicable corporate laws where each entity to the transaction is organised and, in the case of certain portions of the power industry, approvals by local public utility commissions. At the federal level, strategic transactions receive the most scrutiny typically associated with the solicitation of votes from shareholders, the registration of shares being issued as consideration and the disclosures required for a fully informed vote by shareholders.
M&A in the energy industry are subject to antitrust laws. The US antitrust laws, primarily the Sherman Act and the Clayton Act, prohibit certain business conduct that harms consumers by reducing competition. Most relevantly, Section 7 of the Clayton Act prohibits M&A that are likely to substantially lessen competition. Section 7A of the Clayton Act, known as the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (HSR Act), requires pre-closing notification of transactions meeting the jurisdictional thresholds to the Antitrust Division of the Department of Justice (DOJ) and the Federal Trade Commission (FTC). The HSR Act requires the parties seeking to undertake reportable transactions to submit filings to the DOJ and FTC and observe a waiting period prior to closing.
As in other sectors, the FTC and the DOJ take a fact-based approach to their assessment of mergers in energy markets, exemplified by their hands-off approach in exploration and production (E&P) and a more interventionist approach to downstream transactions. Going forward, the agencies' approach may also be impacted by broader political trends.
The energy regulatory frameworks applicable to energy M&A activities varies between upstream oil and gas E&P, midstream oil and gas infrastructure, and power assets.
Energy M&A activity involving upstream oil and gas exploration and midstream infrastructure is governed by a patchwork of state and federal laws and regulations. At the state level, the requirements vary by state, and are most often administered by a state's public utility commission, the state agency with jurisdiction over environmental matters, or both. For transactions involving upstream oil and gas E&P, the energy regulatory requirements generally are, in relative terms, not onerous. Those requirements typically involve the need to obtain approval from, or in some jurisdictions merely providing notice to, the relevant state regulatory body for the change in control or ownership of mineral leases, rights of way and other property interests involved in the transaction. If the transaction involves oil and gas exploration or production on federal lands, or in federal waters, there may be similar regulatory requirements at the federal level. Those federal requirements vary based on the type of federal lands or waters at issue (e.g., national parks, national forests, and waters of the Outer Continental Shelf) and the regulatory agency with jurisdiction over activities in such lands or waters.
Similarly, the legal framework for energy M&A activity involving midstream oil and gas infrastructure primarily consists of various state requirements. The states' respective regulatory requirements for energy M&A transactions range from minimal – for example, post-closing notification of a transaction – to significant – for example, requiring prior authorisation to consummate a transaction. Further, even among those states that require prior authorisation of such transactions, the timelines and standards of review used in those regulatory proceedings vary by state. At the federal level, there is no generic energy regulatory requirement applicable to energy M&A transactions involving midstream infrastructure. However, if a transaction involves changes to the physical or operational characteristics of, or the services provided by, a natural gas or oil pipeline that is regulated by FERC, those changes may require prior approval from FERC. Additionally, a change in ownership may require the filing of a post-closing notice at FERC, to the extent the change affects certain corporate information on file with the agency. Transactions involving the export or import of natural gas or oil can also trigger regulatory regimes administered by the US Department of Energy (DOE), the Marine Administration (MARAD) and the US Coast Guard (USCG), which may necessitate those agencies' prior authorisation of the transaction.
In contrast to the regulatory regimes for upstream and midstream oil and gas M&A transactions, the merger control regime for power (conventional and renewable) and utilities includes a robust federal regulatory programme. Depending on the specific assets involved in a transaction, prior authorisation for the transaction may need to be obtained from one or more regulatory agencies, including FERC, DOE, the Nuclear Regulatory Commission (NRC) and the Federal Communications Commission (FCC). Further, as with upstream and midstream oil and natural gas transactions, there is a patchwork of state legal and regulatory requirements applicable to energy M&A transactions involving power and utilities. Those requirements typically involve approval by the public utility commission or commissions in the states relevant to the transaction. At both the federal and state level, the regulators generally have the authority to impose conditions on a proposed transaction to ensure that the transaction is consistent with the public interest. It is not uncommon for regulators to exercise that authority, and the basis for doing so is most often to protect electricity consumers against potential, adverse rate impacts that could result from the transaction.