Article

Run on energy and infrastructure deals set to drive further market evolution

Published Date
Dec 9, 2022
The energy crisis has turbocharged energy and infrastructure M&A. As activity intensifies, corporates will continue investing alongside financial sponsors – who in turn are partnering with developers to access new greenfield opportunities in the energy transition.

In the midst of a global energy crunch that has reinforced the need for security of supply, we expect a blockbuster run of energy and infrastructure deal-making in the year ahead.

In the six months to the end of November the value of energy and power deals outstripped those in every other sector, the first time this has happened since the beginning of 2019.

Energy producers are generating record revenues and oil futures remain high, albeit not quite at the levels they reached during the summer of 2022.

Energy majors’ growing cash reserves and desire to decarbonise their portfolios make them prime candidates to pursue renewables deals and invest in new technologies throughout 2023 and beyond. That is, however, provided their shareholders sanction bids rather than push for funds to be returned through buybacks.

Infra deals largely immune to syndicated debt crunch

We expect infrastructure investors to remain among the most active financial sponsors in the market, with their transactions largely immune to the sort of conflict-induced uncertainty that has interrupted the flow of syndicated debt, at least in Europe.

In the U.S., the Inflation Reduction Act and the Infrastructure Investment and Jobs Act have channelled significant funding into the energy and infrastructure sector in the forms of grants, loans and tax incentives. Much of that funding is targeted at projects that contribute to energy transition.

These incentives are spurring further private investment and we expect activity both in initial investments and secondary trades to remain robust.

Financing is typically easier to access for energy and infra acquisitions than other forms of sponsor investments. This is because the assets’ longer hold periods, often more than 20 years, lessen the impact of current shocks like the war in Ukraine.

It’s also true that many infra deals do not require leverage as they involve the trading of stakes in assets that already have debt in place.

The concept of debt portability is well-understood in the market, where refinancing deals are structured so the transaction does not invariably trigger a change of control that requires the debt package to be reset.

Sponsors pursue greenfield investments

Within the energy and infrastructure sector some interesting deal trends have emerged.

The first is that with so much capital to deploy and auctions increasingly competitive, sponsors are teaming up with developers to access greenfield investment opportunities.

These deals follow a typical private equity-style playbook, with the initial acquisition establishing an overarching framework agreement through which the sponsor commits equity financing in return for a first look at new projects. Once the framework is in place, each subsequent investment can be structured as a normal co-invest.

We also expect more strategic buyers and sponsors to acquire and develop assets together, with consortium deals helping corporates to deleverage their balance sheets, limit concentration risk and pursue a wider variety of opportunities.

Regulations to manage electricity price shock make valuations difficult

While there is money available and an appetite for deals, assets are proving tricky to value.

Soaring gas and electricity prices have led to a range of regulatory measures being introduced to ease the impact on businesses and consumers.

In Europe for example, windfall taxes on “excess profits” – which in countries such as the UK have been applied evenly to all electricity generators – make for a patchwork of regulation and present challenges in accurately predicting future project revenues and therefore assessing with confidence what targets are worth.

In some cases, this is leading to deals being put on hold as parties wait for the volatility to ease. In others, buyers and sellers are being more flexible in order to reach an agreement on price.

Where parties are unable to find a solution, we are seeing earn-out mechanisms negotiated that ratchet up and down in response to shifting market conditions.

In some recent European deals, parties have considered complex hedging structures involving contracts for difference alongside more straightforward terms that adjust the sale price by reference to the price of electricity post-closing.

Indeed, more of our deals in 2022 featured earn-outs compared to 2021, and they are set to remain a feature in 2023 for as long as the uncertainty persists.

Image of Richard Evans

Richard Evans

Partner

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This content was originally published by Allen & Overy before the A&O Shearman merger