Q&A: Energy & infrastructure M&A

April 2023  |  FEATURE | SPECIAL REPORT: INFRASTRUCTURE & PROJECT FINANCE

Financier Worldwide Magazine

April 2023 Issue

FW discusses energy & infrastructure M&A with Jillian Ashley, Jennifer Wnek, Andrea Lucan, Kent Rowey and Simon Clark at Allen & Overy.

FW: Reflecting on the last 12 months or so, what would you highlight among the major trends shaping M&A activity in the energy and infrastructure sectors?

Ashley: We have seen robust M&A and investment activity in the energy and infrastructure space over the past 12 months, even as other sectors have seen slowdowns. This is due to a number of factors aligning. First, both energy companies and financial investors are flush with cash, and eager to deploy those dollars in ways that meet their environmental, social and governance (ESG) goals and contribute to energy transition. Second, in the US, the Infrastructure Investment and Jobs Act (IIJA) and Inflation Reduction Act (IRA) have brought new economics to the table. Third, unlike other sectors, energy and infrastructure M&A transactions are often not reliant on leveraged financing – many buyers, including energy companies and private equity funds, have sufficient cash to fully equity fund, at least initially, and the underlying assets themselves are leveraged on a project basis – so M&A in the space is far less impacted by increased interest rates in the leveraged debt market than in other sectors. In terms of trends in targets and transaction structures, in an increasingly competitive auction environment for operating assets, we have seen sponsors seeking to team up with developers for access to a pipeline of greenfield projects. We expect these trends to continue and activity to remain robust over the coming year.

FW: How would you characterise the impact on M&A of the recently passed Infrastructure Investment and Jobs Act and Inflation Reduction Act in the US?

Wnek: Both the IIJA and IRA have produced an uptick in investment and thus M&A activities in the US. We are seeing this most visibly in connection with the IRA due to the expansion of both the value and availability of tax credits attributable to energy transition projects. There are myriad impacts in the M&A sphere but two notable examples are increased investment in new technologies that were formerly cost prohibitive and investments in projects of various technologies benefitting from alternative methods available to monetise tax credits. Regarding the former, we are seeing increased M&A activity in the hydrogen space as a direct result of the IRA’s establishment of tax credits expected to reduce the cost of green hydrogen by half, as well with respect to electric vehicles and electric vehicle infrastructure given the allowance of tax credits for commercial vehicles and relaxation of certain restrictions on tax credits in connection with charging infrastructure locations and energy storage facilities. Regarding the latter, with the advent of the ability to now transfer tax credits through the IRA’s transferability provisions, the IRA has directly expanded access to projects that may have previously failed to fit the bill required to secure the tax equity slice of the capital stack and provided other projects with optionality in monetising tax benefits. Stakeholders are still working through the mechanics, both legal and technical, as we await clarifying guidance, but these laws, nonetheless have both immediately and visibly incentivised the M&A space.

FW: To what extent do you expect traditional energy companies to seek M&A targets offering access to new and greener technology and assets?

Lucan: Traditional energy companies have always kept an eye on emerging technologies, but we have seen a significant uptick in their level of interest in greener assets lately. ESG requirements are driving some of this interest, but a lot of what we would consider ‘traditional energy’ companies do not think of themselves in those terms. They are energy companies first and foremost, and they are expanding their portfolios to providing energy from every type of generation source. Traditional energy companies are also making synergistic investments, finding that their existing expertise, for example in offshore drilling, is easily transferrable to offshore wind. Overall, the most successful deals are synergistic deals – the deals where the buyers and sellers find complementary areas of expertise.

“We have found that investors are looking at projects earlier and earlier in their development cycle so they can capture the full potential of an asset.”

FW: How do you view the role of private capital in the energy and infrastructure sectors?

Rowey: The role of private capital in financing infrastructure is hugely important. It is easy to overlook the fact that private capital has played a critical role in the sector for decades. Energy infrastructure has been financed, built, operated and maintained by investor-owned utilities for over a century. Transportation infrastructure has been financed by the private sector through tax exempt municipal bonds since the sixties. It has only been in the last decade, with the advent of public-private partnerships (P3s) in the US, that a debate has emerged over the role of private capital in infrastructure. Opposition to P3s has been mostly misguided, with political machinations interfering with the widespread deployment of private capital to help rebuild the crumbling infrastructure in the US. A fair and realistic conversation about large-scale deployment of private capital is necessary and overdue.

FW: What general advice would you offer to companies and other investors on negotiating, structuring, financing and closing energy and infrastructure deals in today’s market? What key areas need to be considered?

Clark: The most skilful dealmakers we see have a laser-like focus on the material risks and value drivers in a transaction, and the ability to distinguish those from the plethora of secondary issues that arise, which are more efficiently left to more junior team members and lawyers. At the diligence phase, working with a law firm that can help the client really understand those risks – in energy & infrastructure assets particularly where it concerns the asset’s revenue stream – is obviously key. When it comes to execution, forging early alignment with the counterparty regarding approach on valuation, risk allocation, structure and timing is a hallmark of a successful deal. Having this mutual understanding across the principal level on both sides makes every other process run much more smoothly. I would also stress flexibility and keeping an open mind. Almost all deals have a few unexpected twists and turns along the way, but you need a flexible mindset and advisers who can creatively solve problems to help navigate that – or, where that is impossible or inadvisable, to have the courage to tell you so.

FW: Could you highlight some of the risk-related issues that need to be addressed when undertaking an M&A transaction in the energy and infrastructure sector? How important is it to perform robust due diligence and deploy effective transactional risk management practices?

Ashley: Risk allocation is the key question in diligencing any energy or infrastructure project, or portfolio of projects. Key risks include development and construction risk – in the case of greenfield projects – operational risk, offtake and pricing risk, environmental risk and regulatory risk, among others. To what extent contractually does the target, versus its contractual counterparties, bear these risks? To what extent have they actually manifested? What protections and mitigants does the business have in place? All of these questions are important to understanding, and pricing, the business. All the more pressure is put on the diligence process in an environment where sellers are seeking a clean exit, and buyers are often solely reliant on representation and warranty insurance for any recourse, with the deductibles and exclusions inherent in that.

FW: What steps can companies and other investors take to capture the full value-creation potential of a deal? Fundamentally, what elements are key to M&A success in this sector?

Lucan: We have found that investors are looking at projects earlier and earlier in their development cycle so they can capture the full potential of an asset. Energy M&A has traditionally focused on the buying and selling of fully-developed, construction-ready projects; buyers expected a project largely free of development risk. Now, we are seeing investors buy early stage development projects, where projects have only site control or just an interconnection queue position, and even development platforms to ensure they have access to project pipelines.

FW: With energy companies continuing to generate huge returns and grow cash reserves, and private funds flush with capital earmarked for the energy and infrastructure sectors, do you expect to see an uptick in deals over the coming months? How do you expect energy and infrastructure M&A activity to unfold over the coming months?

Clark: The energy transition and the need to address the infrastructure deficit – in the US and globally – is a multi-decade, multi-trillion dollar proposition. It will surely have a few ups and downs, and fits and starts along the way, but the urgency and scale of the need, the amount of capital that has already been amassed, the policy tailwinds, and the number, size and capability of the players involved make it a hard thing to bet against. We have already seen evidence of the resilience of the energy & infrastructure sectors over the past year, with deal activity continuing to show a strong pace notwithstanding the rapid rise in interest rates. So, regardless of what happens over a couple of quarters or even a year or two here or there, we are long-term bullish.

Jillian Ashley is a partner in Allen & Overy’s projects, energy, natural resources and infrastructure group and head of the US China Group. She has significant experience representing asset managers, private funds, financial institutions and companies in their investments in assets in the energy and infrastructure sector. She regularly advises clients on the full life cycle of transactions in the sector, including project development, acquisitions, joint ventures, minority investments and a range of financing solutions. She can be contacted on +1 (212) 610 6477 or by email: jillian.ashley@allenovery.com.

Jennifer Wnek is a partner in the projects, energy, natural resources and infrastructure group, based in New York. Her practice is focused on advising clients in all aspects of the acquisition, disposition and financing of renewable energy and transition projects and businesses, including structuring complex partnerships to optimise the tax and other economic benefits of owning, financing and operating renewable projects. She also provides counsel regarding the drafting and negotiating of material project documents and supply chain agreements. She can be contacted on +1 (212) 610 6315 or by email: jennifer.wnek@allenovery.com.

Andrea Lucan is a partner in Allen & Overy’s global projects, energy, natural resources and infrastructure practice. She focuses her practice on project development and M&A, with a particular emphasis on representing companies engaged in the development, construction and operation of solar power, wind power, energy storage and alternative energy projects. Her experience extends to all elements of alternative energy development and financing, including M&A transactions, equity and debt financing, equipment purchase and sale agreements, and power purchase agreements. She can be contacted on +1 (424) 512 7161 or by email: andrea.lucan@allenovery.com.

Kent Rowey is a partner in Allen & Overy’s projects, energy, natural resources and infrastructure practice. His global experience is unique among infrastructure lawyers. He has been involved in major infrastructure financings in the Americas, Europe, the Middle East and Asia, including many first of their kind transactions. He has played a leading role in the development of private finance in the transportation infrastructure sector in North America. He can be contacted on +1 (917) 330 7724 or by email: kent.rowey@allenovery.com.

Simon Clark is a partner in Allen & Overy’s projects, energy, natural resources and infrastructure group. He specialises in advising private equity funds and other sponsors in their energy and infrastructure investments in the Americas. Prior to joining the firm, he was deputy general counsel at an international power generation company. In addition to his current focus on infrastructure transactions, Mr Clark has broad cross-border M&A, private equity and capital markets experience. He can be contacted on +1 (212) 756 1150 or by email: simon.clark@allenovery.com.

© Financier Worldwide

©2001-2024 Financier Worldwide Ltd. All rights reserved. Any statements expressed on this website are understood to be general opinions and should not be relied upon as legal, financial or any other form of professional advice. Opinions expressed do not necessarily represent the views of the authors’ current or previous employers, or clients. The publisher, authors and authors' firms are not responsible for any loss third parties may suffer in connection with information or materials presented on this website, or use of any such information or materials by any third parties.