The Energy Transition and the Implications for M&A

Responding to greater deal fluidity in a period of uncertainty and rapid change

Donald Rumsfeld, the former Secretary of Defence during the George W. Bush administration once famously said: “We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns. The ones we don't know we don't know.”

His description aptly describes what businesses must be thinking as they transition from our current energy system to a more low carbon one. The pace of change and the degree of uncertainty we are witnessing across the energy value chain is bewildering. As we navigate towards a low carbon world, technological disruption is generating enormous upheaval, challenging the strategy of companies, their business models and how they fundamentally operate. Against this backdrop, the nature of deal making is changing from more static to dynamic plays, as businesses have to respond and adapt rapidly to events. Additionally, as portfolios change and become more diverse, companies will need to undertake more frequent asset reviews to manage their business through this change. Those players that can manage their business as a portfolio of assets, dynamically adapting to change, will be best placed to ‘future proof’ operations against disruption. 

Energy transition – lots of change

First things first. What exactly do we mean by ‘energy transition’? The term describes the ongoing shift from the current energy system (based predominantly on fossil fuels) to a low carbon, smarter, and electrified energy system. This transition is moving towards more decentralised or distributed models where energy is produced and consumed at the point of use. Technology and innovation (such as digital, energy storage and ‘smart’ energy management) are improving efficiency and underpinning this transition to create a model that is sustainable and reduces the impact of energy production on the planet.[1]

In recent years there has been a veritable wave of announcements, initiatives and policies by governments, countries and business in response to the energy transition as shown below:

[1] Please refer to our Low Carbon Economy Index which tracks the pace of this transition in each of the G20 countries.

Government / Regulatory

  • G7 supporting cutting greenhouse gases by 40% - 70% by 2050 from 2010 levels. And phasing out fossil fuels use by end of century
  • Paris Agreement aims to limit global warming to well below 2C and achieve net zero emissions this century
  • Norway Sovereign Wealth Fund withdrawing investments from mining or energy groups deriving more than 30% of sales or activities from coal business
  • EU’s “winter package”  - CO2 emissions reduction of at 40% by 2030; 30% energy efficiency target; new rules to enable consumer-centred clean energy transition

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Countries

  • Kingdom of Saudi Arabia Vision 2030 Plan to reduce dependence on hydrocarbons to a point where they could “live without oil by 2020”
  • UAE announced it intended to invest US$163bn in projects to generate 50% of nation's power needs from renewables by 2050
  • France & UK announced ban on sale of new diesel and petrol cars by 2040. France plans to end oil & gas production by 2040
  • UK announced plans to phase out coal-fired plants by 2025
  • Germany’s Energiewende seen rapid increase in deployment of renewables, and planned phase out of nuclear by 2022

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Business

  • Shell & Statoil created new low carbon business units in 2016
  • DONG divested legacy upstream oil and gas assets to focus on renewable energy
  • As part of OGCI, CEOs of 10 large oil companies to create fund to address CO2 emissions over next 10 years focusing on CCS and energy efficiency
  • Google announced it was planning to buy enough renewable energy in 2017 to meet power needs of its data centres and offices around world
  • Shell enters UK electricity market – applying for licence to supply power to industrial customers

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Other

  • Volvo announced all new cars manufactured by 2019 and onwards will be either fully electric or hybrid
  • Wood Mackenzie says O&G industry not investing enough in green technology
  • Shell CEO warns peak oil demand may arrive in next decade and supports better disclosure of financial implications of climate change risk
  • UK’s Smart Systems and Flexibility Plan aims to remove barriers to smart technology, enable markets for flexibility and support smart homes & businesses

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So how can corporates and investors navigate this uncertainty?

Faced with a myriad of announcements, the pace of change and disruption shaping the sector, how should companies and investors in the energy supply chain respond? How should they be managing their portfolios? Which assets should they buy, divest, refinance or reduce their exposure to? Unfortunately, access to data and insights do not render the task any easier. A case in point is the anticipated penetration of electric vehicles in the global car fleet. It is fair to conclude that their share will grow, but by how much and by when? As illustrated in Exhibit 1, the forecasts from eminent institutions vary wildly from a modest 6% to a dramatic 55% penetration rate by 2040. Given this broad range of forecasts, it makes investment decisions so much more complex. Depending on which forecast is considered more credible may influence the extent to which a business invests in energy storage, charging points for electric vehicles or even continued production of cars using traditional internal combustion engine technology.

Electric Vehicle Penetration of Global Passenger Car Fleet by 2040 Selected Forecasts

Exhibit 1

Nevertheless, there are many examples of energy companies positioning and restructuring themselves for this transition. In the UK, Centrica restructured its business and is building capability through acquisitions in distributed energy. Its focus has included taking strategic minority stakes in a number of technology start-ups. For example, it acquired a stake in AlertMe that provides home energy management services (it subsequently bought the remaining shares), as well as more recently having a share in Green Running’s advanced home energy monitor called Verv. More broadly, Centrica is also reducing its exposure to centralised power generation assets. It is worth noting the scale of investments across distributed energy. The big six UK utilities have collectively made some £1.6bn of investments in distributed energy businesses in the UK and internationally between 2013 and 2016. Engie alone is a significant player representing about a third of that total investment. In Europe both E.ON and RWE took their less profitable power generation assets and ring fenced them into separate operating units while retaining the retail customer, renewables and distribution businesses.

In oil and gas, we are witnessing an array of approaches. Total has invested in solar PV, other renewable enterprises and battery producers (while still making more traditional acquisitions as illustrated by its US$7.5bn decision to buy oil and gas assets from Maersk). Dong (recently rebranded as Ørsted) has taken the more radical position, exiting its legacy oil and gas business to focus on wind turbines and clean energy. And more recently, Shell caused a stir in the market when it announced it was applying for a licence to sell power to industrial customers in the UK electricity sector.

Capital allocation and capital flows impacting M&A

As market participants tailor their investment approach for the energy transition, we shall see significant changes in capital allocation and capital flowing in new directions. For example, a vertically integrated oil and gas company in the past would typically allocate capital across its upstream business (exploration and production), its midstream business (pipelines and perhaps LNG) and downstream operations (refineries, storage, distribution and retail).

Needless to say, each of these businesses will have very distinct capital expenditure profiles. As that same company assesses the prospect of a low carbon world, it will need to reconfigure its asset portfolio and by implication its balance sheet to address the future state. A utility player will go through a similar process of evaluating how its asset portfolio should evolve. Given these forces driving capital flows, M&A becomes much more likely. Moreover, opportunities will emerge for Private Equity, pension and infrastructure funds to become involved in funding this capital re- allocation.

Understanding the pathways to the energy transition will shape M&A plays

That said, it is nonetheless very challenging for businesses to tailor their investments to manage this energy transition. Clearly, there will be short term opportunities to make specific and profitable M&A plays, and to divest and acquire specific businesses for example. But it is harder to predict the longer term market evolution and the timing. Perhaps one way forward is to consider different scenarios and assess the implications for your M&A approach and develop a strategy that thrives in all of these possible outcomes. An illustrative example of this possible approach is demonstrated below:

 

Background to Pathways

As part of our outlook assessment we focused on two themes - Technology and Centralised / Decentralised energy models.

For innovation there were two ends of the spectrum. ‘Steady Innovation’ referred to innovation and technology that delivered incremental benefits such as improved energy efficiency on the demand side and production optimisation on the supply side. ‘Disruptive Innovation’ was the other end of the spectrum which led to huge leaps forward in benefits which would address energy storage for example and drive electric vehicle adoption rates.

The other axis was the shift between 'Centralised' and 'Decentralised' energy models. ‘Centralised’ models reflected production being produced centrally, with traditional incumbents such as ‘Big Oil’ and utilities driving the pace of the energy transition. The other end of the spectrum was ‘Decentralised’, where energy supply is more distributed but also reflects a shift in influence from core players (such as ‘Big Oil’ and utilities) to consumers.

Using these themes as our axes we selected two scenarios that were the most distinct and compelling - the 'Managed Transition of the Old Guard’ was in the ‘Centralised’ and ‘Steady Innovation’ quadrant. The flip side of this managed transition is the ‘Power to the People’ scenario which was in the ‘Decentralised’ and ‘Disruptive Innovation’ quadrant.

A new way of looking at portfolios

Companies and investors now have to grapple with the challenges of a more volatile market place where the frequency and impact of external events can quickly undermine business models. In this rapidly changing environment, we expect deal making to become more dynamic and complex. In the past deal making may have responded to long term and more static strategies. For example, to enable companies to build up a geographic presence in certain parts of the world, to acquire scale or to bolt on specific capabilities. However, now in a market where volatility and disruption are the pervasive drivers, strategies have to be more flexible and evolve quickly. As a consequence deal making will reflect these changes. In a technology led world, businesses will need to acquire and divest regularly diverse assets to help position themselves and “hedge” for future growth pathways. These investments will encompass traditional sources of energy but increasingly newer ones, as well as extending across the low carbon value chain (such as access to reserves of lithium or some new material to supply the growing demand for energy storage). Business will need to partner much more frequently with other companies that provide them with the capabilities and technology to deliver long term sustainability.

In order to execute this level of deal making, businesses will need to adapt their mind set and processes to be significantly more agile. They will have to review and evaluate portfolios frequently with a willingness to ‘flex’ these business interests (buy and sell) at short notice in response to market events. In oil and gas parlance, the days of drilling a well in a field, maximising production and then decommissioning the well, are numbered. Businesses need to manage multiple sources of new energy and hedge across the value chain. Note for example how utility players are acquiring companies that facilitate the energy transition such as battery producers, smart meter and energy management providers.

So as businesses navigate through this era of disruption it is difficult to know whether the strategy and business model you have today will survive the ‘unknown unknowns’ of tomorrow. Therefore it is critical to have a resilient deal making capability in place to flex the business according to the ebbs and flows of change. Having the right deal strategy, execution and portfolio management in place today, might just decide if you are still in business tomorrow.

Contact us

Drew Stevenson
UK Head of Oil & Gas Deals, PwC United Kingdom
Tel: +44 (0) 7710 002801
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Adrian Del Maestro
Director of Research, Strategy&, PwC United Kingdom
Tel: +44 7900 163558
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Robert Turner
Partner, PwC United Kingdom
Tel: +44 (0) 7590 351990
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Andrew McCrosson
Partner, PwC United Kingdom
Tel: +44 (0) 7714 711161
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