The first half of 2020 has seen a considerable drop in M&A activity with the total value of deals falling 53% below that of last year and the total volume down 32% — the lowest total value and volume since H1 2010 and H1 2013 respectively. This in itself is not surprising, with COVID-19 putting a significant break on business and enterprise worldwide. However, by comparison, the total deal value in the energy sector specifically has increased by 7% and the volume of deals has suffered a much weaker drop than the market as a whole, suffering a drop of only 11%. The question is, what has caused the anomaly between the energy and global market, and why has it appeared now? The question becomes even more baffling when one considers the dramatic drop in energy consumption caused by the global pandemic. With people travelling less and global transport slowing, particularly during the main lockdown phase, the overall amount of human activity and consumption dropped significantly from March through the summer. We saw this manifest in contributing to the historical drop in the price of crude oil to a historic low of -$37.63 per barrel for West Texas Intermediate, which traditionally would accompany a drop in both the value and activity in the energy markets.
The significance of now
The energy market has long been dominated by oil, coal and gas, with the electricity generated from fossil fuels still accounting for over 60% of production in 2020. However, with an increased pressure from investors, environmental groups and the general public, demanding that energy companies make significant changes to their business models, we are seeing a shift in how large energy corporations approach their M&A decision-making process. With an emphasis being placed not only on the value created for companies here and now, but the value of protecting their legacy in the shifting energy landscape of the 21st century. The ability of an acquisition to position the company favourably, in anticipation of a global drive towards renewable energy sources, has become more critical than ever.
With mounting public pressure, accelerated scientific progress (reducing the cost of renewably-sourced electricity) and government policy, a trifactor has formed encouraging, if not forcing, the big hitters in the energy industry to act. For example, of the €1.8tn stimulus package agreed by the European Union in July 2020 in response to the COVID-19 crisis, almost 1/3 (€500bn) is to be set aside for climate-related initiatives, including the promotion of clean energy production. Furthermore, the last 12 years have engendered a significant shift in public opinion on the concerns surrounding global warming, with a study run by researchers at Yale and George Mason University reporting a record high 72% of respondents describing global warming as “important” and, for the first time since the research began in 2008, more than 60% of respondents saying that global warming is caused mostly by humans. An opinion that has gained further momentum in the developed world due to recent natural disasters such as the widespread Australian bushfires of September 2019 – March 2020. You could argue that this pressure towards renewables is nothing new and you would be right, at least as a prevailing topic of conversation among environmentalists and politicians alike so what physical cause, emerging in H1 2020, is giving rise to this discrepancy?
The source of the anomaly
In much the same way as one or two key players may prop up even the most downbeat, covid-ridden sports-team’s performance — so too it seems, can an urgent drive for renewable investment prop up the global energy market activity. Last week, BP announced a $1.1bn deal with Equinor, agreeing to buy a 50% stake in two US wind-power projects. The deal comes with an announcement from chief executive Bernard Looney, laying out the company’s ambitions to become a net-zero emission company by 2050 — in accordance with most OECD countries’ targets. To achieve this, BP has announced its target of increasing its annual investment in low-carbon business 10-fold to $5bn per year.
Furthermore, in July this year, Abu Dhabi Power Corporation acquired TAQA (Abu Dhabi National Energy Company) in a $20.3bn deal, the largest deal in the sector this year, with an accompanying statement describing the acquisition as a critical step in delivering on the UAE’s energy strategy for 2050 in reducing carbon emissions. In addition, this year has also seen the $2.7bn acquisition of Innogy by European energy giant E.ON, bolstering their renewable energy portfolio with the second largest acquisition by value this year, closely followed by the acquisition of North Eastern Electric Power Corporation Limited (NEEPCO) by NTPC ltd. (formerly known as National Thermal Power Corporation Limited). NEEPCO was renowned for operating India’s largest hydro power plant and is the only energy company in the North East region of the country supplying hydro, thermal and solar power, giving a clear indication that the transaction was motivated by NEEPCO’s renewable energy assets. It must be no coincidence that the three highest value deals in the energy sector of 2020 thus far have been the acquisition of renewable-based companies by their traditionally fossil-fuel heavy elder siblings. This then, an urgent drive towards holding renewable energy assets, could be the star player keeping the energy market activity going, in an otherwise downtrodden M&A landscape.
Private equity firm Kimmeridge has described the oil and gas sector as facing an “existential threat” as pressure mounts for divestment across fossil fuels and replacement with clean alternatives. The rate of change is a self-perpetuating one; as investors abandon the sector, the cost of capital is pushed up as it becomes increasingly difficult for companies to attract new funding. In turn, this makes it harder to turn a profit which further increases the difficulty of attracting new investment! Therefore it is critical that the energy giants, that accounted for around 16% of the S&P500 index in 2008 but now only contribute around 3%, transform in order to maintain relevance and appear attractive to investors throughout the middle part of the 21st century. To do this, they face two options: 1) Invest in their own internal R&D divisions, developing their own new renewable energy solutions; 2) Make tactical acquisition decisions, taking on the increasing selection of renewable energy companies. The latter of which, has been demonstrated in the energy markets of the first half of 2020 and is likely to continue as companies align their targets with the demands of public pressure, government policy and scientific progress. Has 2020 therefore triggered the turning point at which sustainable investing aligns with Milton Friedman’s iconic shareholder primacy doctrine? Will 2020 see sustainable investments providing direct value for shareholders and not merely acting as a source of favourable press image? Recent activity suggest it just might!