Stormy weather ahead for energy transition M&A

Introduction

Strategic M&A deals are always fraught with risk, and there will be too many oil and gas companies chasing too few transition-focused targets.

There was a very amusing newspaper cartoon printed during the global financial crisis ten years ago. It showed a businessman with an umbrella sheltering from a small cloud which was gently raining on him. The cloud had the words ‘credit crunch’ written on the side. Out of sight of the man, above the cloud, was a much bigger cloud waiting to move in. The much bigger cloud was entitled ‘climate change’.

Fast forward to 2021, and the same cartoon would be making the same point as it did in 2010, with the only change being to rename the smaller ‘credit crunch’ cloud ‘Covid-19’. The ‘climate change’ cloud, if anything, would be a lot bigger and darker than it was in 2010.

So when the coronavirus cloud lifts, climate change will still be there as the number one issue confronting companies, investors and markets, but with more urgency than ever. 12 months ago, companies started to announce net-zero strategies for 2030, or 2040 or 2050. In other words, a commitment to make their businesses into ones which are no longer net emitters of carbon, all while presumably maintaining healthy returns for investors and shareholders—not a challenge to be understated for companies operating in a global economy founded on cheap and reliable power supplies and the easy transport of goods and people around the world with little regard to the embedded long-term environmental costs.

Further, commentators are no longer just measuring the carbon emitted by a company—they are looking at the carbon emissions in the company’s supply chain as well as the carbon emissions of the company’s products in the hands of its customers. This can be witnessed in the emergence of scope three carbon emissions being included in the carbon footprint of oil and gas companies, which adds in the carbon emitted when the oil or gas is combusted in vehicles or buildings.

Steps to net-zero

While Danish renewable energy company Orsted is a good example of a company that has made a transformational change by exiting oil and gas and becoming a world-leading developer of renewable energy, many energy companies have begun with relatively small steps towards net zero.

While some actions—such as a few small venture capital investments into cleantech, a passive holding in a climate change fund or new criteria for assessing proposed investments—seemed progressive a few short years ago, they would not seem credible at the AGMs of the 2020s, when shareholders have their annual chance to call out the board. Small steps will be labelled greenwashing, and boards will be pressured to become more ambitious. We will shortly reach the point when ESG issues are ranked as important as, if not ahead of, shareholder returns.

As soon as the coronavirus recedes, the importance of climate change action will reassert itself. There will be a sense that the pandemic was a global problem tackled head-on by global action, and that similar efforts should be made to combat climate change in the 2020s. Companies will have to think bigger in 2021, and start speaking to and acting on more ambitious steps in the direction of net-zero. What worked in the last ten years is not going to work again. Companies will have to be brave and take bigger, more strategic steps, including M&A, if they hope to make the move towards net zero in a timeframe that will be acceptable to investors and, increasingly, regulators.

Strategic M&A

But strategic M&A, meaning strategic acquisitions to transform a business rather than bolt-ons to expand it, as anyone who works on these deals knows, is fraught with risk. A fair chunk of ordinary M&A deals are later seen as failures, and the risk is exponential for transformational deals. For example, the failed $350bn AOL/Time Warner merger of 2000 will live long in the memory of dealmakers; “old economy” Time Warner trying to catapult itself into the new internet age became a case study on how not to do M&A. See also Marconi’s reshaping of itself from a defence contractor to a telecoms business, destroying a UK bellwether stock and all shareholder value in the process.

So here is the rub. Companies are going to have to move quickly to address carbon emissions. Standing still is not an option, nor is purely organic change. For most energy companies, transformational M&A is the only way forward. And, as if M&A on that scale is not enough of a risk, the number of renewable energy targets that might make a strategic difference to a large company is not very big. If there are not enough targets to go round it is going make for some interesting dealmaking.

Still, doing nothing is not an option. Companies will be forced to step up and demonstrate substantive change at pace once the world moves beyond coronavirus. Where energy companies look to M&A deals to deliver this change, they should look to learn lessons from the internet boom and the credit crunch crisis to ensure that the they do the right deals at the right prices to the long-term benefit of their investors and the environment. It is not going to be straightforward. Strap yourself in for renewable energy M&A 2021!

Stephen Rigby is a partner at Norton Rose Fulbright