A growing deal imbalance and disruptive technology are reshaping utilities’ M&A

Deals within the global power and utilities sector hit a Q1 high in the first quarter of 2016 and illustrated the emergence of two major trends. Will a growing deal imbalance and the increasing impact of disruptive technology continue to shape M&A through 2016 and beyond?
Power and utilities sector is a complex industry and a review of the past quarter’s deals, along with the capital outlook of the utilities executives, reveals a range of diverse factors and regional influences behind utilities’ M&A strategies. But two big trends are emerging as real game changers for the sector, which I believe will continue to drive investment strategies through 2016 and 2017:

Trend #1: Investors targeting renewable and regulated assets
The first trend sees a growing deal imbalance leading to increasing competition to acquire a tightly held pool of power and utilities assets. Amid continued low wholesale prices in a number of regions and impairments of assets in Europe, more companies and funds are keen to deploy capital and diversify operations. Regulated network assets, stable retailing operations, and long-term (preferably sovereign backed) power purchase agreements (PPA) renewables deals are in demand all over the world.  The market for gas generation in the United States, given the fuel mix in those markets, is also a target for both domestic and international investment. 
Across all regions, this deal imbalance is impacting the valuations of regulated transmission and distribution assets, which are trading at above-average premiums. Renewable energy assets are also attracting competitive valuations, particularly in Europe. Valuations of renewables in the Asia-Pacific region should start to pick up as funding opportunities and the regulatory environment improves.
Auction results in several markets are worth noting. In April, Mexico awarded 1,860 MW of wind and solar contracts with the average contract price as aggressive as $50.7/MWh.  In May, we saw a new record lowest bid set in Dubai when 800 MW of large scale solar received bids as low as US$30/MWh (without subsidies). This is half the winning bid of US$58.4/MWh by ACWA last year.

Trend #2: Utilities investing in disruptive technology and distributed energy assets
When reviewing transactional reports such as Power Transactions and Trends, it can be easy to focus on the big numbers. But smaller deals, when viewed together, can reveal some interesting insights and highlight the emergence of new trends.
Over the last quarter, we’ve seen an increasing shift towards investment in the distributed energy and energy technology space. More utilities are raising capital, making small-scale acquisitions and changing their strategies as they adapt to the impact of new competitors, particularly in developed markets. For example, in 2015, about one-third of the six million British energy customers that switched suppliers chose a new entrant. In Australia, utilities are bracing for the impact of recently announced plans of telecommunications giant Telstra to roll-out solar, battery storage and home energy services.
Our research shows us that utilities are taking steps to prepare for these changes and that M&A and investment are key pillars of their approach. About 40% of the power and utilities executives we spoke to for Capital Confidence Barometer said their company plans to pursue acquisitions outside their core sector to gain new technologies and skillsets. We have recently seen examples of how this is shaping transactional outcomes:

• Southern Company will acquire PowerSecure for US$431m to provide customers with distributed generation and energy efficiency solutions
• Engie SA has bought Colorado-based energy services provider, OpTerra Energy Group
• Direct Energy, a US electricity and gas provider acquired Panoramic Power, a provider of energy management solutions for US$60m.

The market is rewarding those utilities that invest in these areas. In Europe, power and utilities companies selling energy efficiency and management products and services are seeing revenue growth of between 3-4% per annum, according to a 2015 IEA report. In the Middle East, Schneider Electric’s investment in energy management technologies has helped the firm achieve 12% revenue growth over three years.

Counterbalancing trends as “peakless” network becomes a reality

Together these two trends paint an interesting picture of the utilities transactional environment today and into the future. In a small way, they balance each other.  A rise in the penetration of distributed energy will see regulated network valuations come under pressure. As we become better able to store and move energy at different times of the day, the “peakless network” becomes a long-term possibility. We believe that we’ll start to see signs of this counterbalance within about 18 months, contingent, of course, on the costs of the underlying technology and who emerges as the ultimate owner of distributed energy and the technology that underpins it.  In the meantime, we expect 2016 to be another strong year for power and utilities transactions as companies use strategic dealmaking to prepare for the new energy world.

For more insights, download Power transactions and trends and P&U Capital Confidence Barometer, follow me on Linkedin or contact any of our EY regional Transactions Power and Utilities Leaders.