Each year around this time we take the opportunity to review the transactions and other significant industry developments over the past year and offer our views on what they may mean for the coming year.
Mergers and acquisitions activity in the energy industry during 2016 was below the levels of 2015 and 2014 in most categories, but still substantial. While the Goldilocks environment of 2014 and 2015 did not last through 2016, transaction volume was still a healthy $141 billion, which was just about the average of the past seven years. Concerns about rising interest rates, election uncertainty and a general fall-off in utility stock valuations created headwinds that could not be overcome by rising oil prices and a generally stable economy. Other factors may have been a growing mismatch between valuation expectations of buyers and sellers and generally fewer acquisition opportunities. With the extraordinary valuations achieved in several transactions announced during 2015, sellers had high expectations while at least some buyers may have concluded that valuations had reached untenable levels and pulled back a bit.
More than half the 2016 activity involved pipelines, midstream companies and MLPs, with $76 billion of announced transactions, down from over $130 billion the year before. Transactions among regulated electric utilities also declined to $19.8 billion from $33.8 billion. Among LDCs, volume declined dramatically to $4.8 billion from more than $18 billion in 2015, when transactions involving AGL Resources and Piedmont Natural Gas Company set a new high-water mark. Even at the reduced level, LDC transaction volume in 2016 was the second highest of any of the past seven years. One category where 2016 volume increased dramatically over 2015 was in transactions involving electric generation assets where volume was $33.5 billion, one of the highest years on record, and well above the $8.1 billion recorded in 2015. This dramatic increase was due in large part to the NextEra/Energy Future Holdings transaction that contributed over $18 billion to the total. Transactions involving renewable generation assets also decreased to $6.6 billion from $8.5 billion in 2015. Key transactions and trends that we see in each of these subsectors are discussed in more detail below.
As has been the case for over twenty-five years, there are many factors that favor continued consolidation among energy companies in the United States. Scale and diversity are as important as ever. The US energy industry is going through a period of significant change, with many companies facing unprecedented capital expenditures and competitive pressures. Much of our national energy infrastructure is in the process of being rebuilt. Energy policy and consumer preference are driving a shift away from fossil fuels toward renewable resources, although there may be some swing of the pendulum back toward fossil fuels under the Trump Administration. In many instances new renewable generation requires substantial investments in new high-voltage transmission lines to get the power to load centers. At the distribution level for regulated utilities, both electric and gas companies are in the process of replacing and upgrading much of their local infrastructure to improve both safety and reliability. Finally, what appears to have become a stable supply of relatively cheap natural gas has had a dramatic effect on the economics of both thermal and renewable generation resources. Larger companies are generally better positioned to withstand the panoply of risks they face, whether they be from weather, commodity cost volatility, regulatory factors or local economic cycles. A favorable economic environment and the continuation of historically low interest rates provided a tail wind for transactions during the past three years. Finally, the higher growth rates and lower levels of volatility in earnings of LDCs compared to regulated electric operations, together with the increased scarcity of pure play regulated gas companies, has resulted in an extraordinary level of interest in these companies.
Looking forward, we expect consolidation to continue, most likely episodically and with levels of activity that vary dramatically among industry sectors. Among regulated companies, it is difficult to see how the level of activity over the past couple of years can continue. There are indications that increasing interest rates and higher levels of regulatory scrutiny may create at least modest headwinds for additional deals. We expect the strong demand for gas distribution companies to continue, but there are only a limited number of such companies, and an even smaller number that are interested in pursuing a transaction. Consequently, we see the level of activity among regulated companies in 2017 as likely to decrease from the levels of the past three years. Renewable assets continue to generate strong interest among strategic buyers and private equity funds, and consequently we expect that renewables M&A will remain active in 2017. Indications are that activity will continue in the generation sector at levels similar to previous years, particularly as regards gas-fired generation. There are several sale processes underway or being considered and the demand for good quality assets appears strong. In the oil and gas sector, M&A activity in 2017 will likely continue to be driven by the intense financial stress that many oil and gas companies are under. There were several distress-driven transactions during 2016; we may see more in 2017.
Of course the other major uncertainty all companies are facing is the legislative and regulatory reform that will come about under the Trump Administration. Expectations are that the Trump Administration will make significant efforts to change regulations pertaining to the environment and related energy regulatory matters while also working towards wholesale tax reform. We have included discussion of the potential implications of reforms that might be pursued by the Trump Administration in many of the sections below (see Renewables, Environmental Regulation and FERC). We also have included a separate section discussing the possibility for tax reform during 2017 and what that reform might look like based on President Trump’s campaign proposals and the House Republicans’ “A Better Way” white paper.
The discussion below covers the following areas:
- Regulated Utilities
- Independent Power Producers and Generation Assets
- Master Limited Partnerships and YieldCos
- Project Finance
- Bankruptcy Developments in the Energy Sector
- Environmental Regulation
- Distributed Generation
- Energy Efficiency
- Potential Tax Reform Under the Trump Administration
- Mexican Power Markets
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