This is the fourth in a series of six blogs that summarize discussions by top executives, investment bankers, and ex-Federal Energy Regulatory Commission (FERC) Commissioners about developments in the U.S. utility and power sectors. The discussions took place at the virtual 34th Annual Power and Gas M&A Symposium on February 24, 2021.
Brian Boufarah, a Partner at Deloitte, moderated this session that included three participants: (1)
Phillip Adams, Manager of Acquisitions at Southern Company, (2) Drummi Bhatt, Senior Director of Market Intelligence and Corporate Strategy at Mitsubishi Power America, and (3) Roger Wood, Managing Director at Moelis & Company.
The Roundtable focused on:
The session focused on the state of generation M&A activity and the key themes. The speakers touched on innovative-type opportunities and the types of organizations that are ready to deploy capital there on scale given the risks.
A few highlights:
- Competitive pricing dynamics and compressed returns are a theme.
- Opportunistic M&A activity will continue as industry participants look to rebalance and re-rationalize portfolios and deploy capital into attractive growth and yield investments.
- There is a trend of investments in “climate tech” — renewable and zero-carbon technologies.
- On the generation mix side, investors have started looking for strategic capital deployment.
- Special purpose acquisition companies (SPACs) are now getting involved much earlier in the development process. Legacy investors are seeing that investing in the development phase or early-stage process is the only way to get returns that are attractive.
- It is logical for large global companies to be driving a lot of the research. Venture capital (VC) also makes sense to put money to work to help provide the key to the net-zero future. Traditional utility clients are typically not in the business of taking this risk.
- The global energy transformation is gathering pace, and technology evolutions should jointly accelerate the transition and create a new power reality, contributing to a very clean, reliable, and cost-effective energy future.
Questions to the Panelists:
Can you provide your perspective on where the state of generation M&A activity is right now. What are the key themes?
Roger Wood, Moelis & Company: The theme I would highlight is the compression of returns. We hear increasingly that we are only looking at mid-single digit returns for contracted operating assets. Is that really where the market is? There are some market participants that are leading proponents of investment in the so-called energy transition talking about a bubble in renewable energy valuations and deals that have been done at crazy valuations, so a rich pricing environment. I think that could apply to financial markets more broadly. The 10-year treasury yield has increased a bit, but it is still less than 1.5%. The High-Yield Index is currently less than 3.5%. So, in that context, the returns people are looking at are not too bad. There was an interesting deal announced last week involving a PV solar company and the press release highlighted that they were getting a 6% equity IRR, so interesting dynamics. Competitive pricing dynamics and compressed returns are an interesting theme.
Drummi Bhatt, Mitsubishi Power Americas: The global energy transformation is gathering pace, driven by the twin forces of rapid decarbonization and technological innovations. At the same time, customer business models are evolving with value moving due to low energy prices. In 2021, I expect pandemic-related uncertainty to continue to impact the deal market. However, opportunistic M&A activity will continue as industry participants look to rebalance and re-rationalize portfolios and deploy capital into attractive growth and yield investments, similar to what we saw in the second part of 2020. I do see a trend of investments in “climate tech” — renewable and zero-carbon technologies. This could lead to the consolidation in joint ventures to exploit strengths of various technologies and regional networks.
On the generation mix side, investors have started looking for strategic capital deployment. This market has really developed over the last year, and it is possible to venture into new higher-risk technologies on a private venture capital basis, or put money to work on existing technologies that might need some adjustments to be cleaner. Mitsubishi is doing both as we go through this transition. We believe the greatest opportunity lies in storage solutions as the renewable build continues. We are committed to provide all duration storage technologies in a number of ways, such as lithium-ion installations for short-duration and long-duration hydrogen-capable gas turbines as a complement to traditional renewable generation. I believe that these can be very profitable investments, regardless of the length of a fund's holding period.
Phillip Adams, Southern Company: A year ago, the theme was about so many more new investors and how they were driving returns down, and that theme has only been exacerbated over the last year. Despite everything that happened last year, the market only got more attractive to new investors. In addition, investors are going farther up the chain now. In the past, the money coming in was “notice to proceed” (NTP), or more likely “commercial operation date” (COD)-type projects, or projects that had been operating a while. Now capital can be invested even farther up the chain. Special purpose acquisition companies (SPACs) are now getting involved much earlier in the development process. Legacy investors are seeing that investing in the development phase or early-stage process is the only way to get returns that are attractive. At Southern, we still have opportunities in the wind and energy storage space that meet our investment criteria, but more investors compress returns. Some certainty in renewable growth will drive more opportunities, and those opportunities may allow some attractive returns to pick back up this year and going forward.
What are your views on some of the innovative-type opportunities and if people are ready to deploy capital there on scale, or if it is more watch and be a quick follower once deployed.
Drummi Bhatt, Mitsubishi Power Americas: We are definitely going through disruptive changes in this industry. My team is involved in every developing technology that could have a significant impact on how the economics of the decarbonized and digitalized grid might play out in the future. Currently, we see renewables and green hydrogen at scale to be well positioned to work together for a path to zero-carbon emissions, which is what most utilities are desiring. Additionally, we believe that grid resiliency will become more important as we decarbonize, be it short- or long-duration energy storage, total plant solutions, artificial intelligence (AI), or weatherization of assets. These will all be very important contributors to resource adequacy. For example, I think AI enables insight of a potential impact based on historical data and is able to provide a recommended course of action, and it would do this well before the event occurs. Additionally, I think long-duration energy storage, specifically green hydrogen, will become a critical part of the grid system, enabling the shifting of energy to ensure resource adequacy. The global energy transformation is gathering pace, and we expect technology evolutions to jointly accelerate the transition and create a new power reality, contributing to a very clean, reliable, and cost-effective energy future.
When you talk about the storage element, are you really suggesting operating off the grid with solar and wind, and, when that goes down, flipping on the gas plant using hydrogen? So, we are still in a green environment, but running hydrogen as storage for the solar.
Drummi Bhatt, Mitsubishi Power Americas: Because of the intermittency, renewables alone cannot always fulfill 100% of the demand for clean energy, thus long-duration storage is very important. Green hydrogen is uniquely positioned to fulfill the need for long-duration dispatchable energy storage. It is made possible by using excess renewable energy to produce it today through curtailments in the future as energy storage, through which gas turbines could be run as early as 2045 on 100% green hydrogen. So yes, green hydrogen is being considered as an energy storage medium. It is effectively stored in that the hydrogen is created when there is excess capacity of renewable.
How active are companies investing, or are there just a few corporates that are large enough to underwrite some of this technology?
Roger Wood, Moelis & Company: I think it is logical for large global companies like Mitsubishi to be driving a lot of the research. Venture capital (VC), which is traditionally looking for the next disruptive technology, makes sense also to be putting a lot of money to work behind people they think will provide the key to the net-zero future. At the other end of the spectrum, a lot of our traditional utility clients say they may be users of this technology one day, but they are not in the business of taking this risk. Since the financial crisis, we have seen utilities go back to basics. A few of them are doing it in a small way through their own internal VC arms, but I would say the low-risk universe (also including a lot of infrastructure funds, pension funds) want to see it once it is commercialized. So, I think it is important to look at the different types of investors.
Phillip Adams, Southern Company: As it relates to green hydrogen, there is some research there, and we are keeping our eyes on the market. It is just not quite ready for a company like ours to make that investment. That said, energy storage is very attractive right now. The growth there has been astounding the last year or so, and we expect that to grow exponentially over the next couple of years.
How do you see the ESG money coming in? Is it getting spread across the different elements of the industry, those that are more risky and those that are less risky? Or is everybody investing in ESG because they are buying an operating power plant, or a solar or a wind plant?
Roger Wood, Moelis & Company: We can have a debate about what we mean by ESG and the labeling but, taking a fairly broad definition, as of year-end last year, there was something like $17 trillion of U.S.-domiciled ESG assets. If you look globally, it was probably more than $40 trillion. So, that is a huge amount of money. We do see most of that chasing the lower risk opportunities, in particular, operating assets versus the development assets. I think the VC part will look to the ESG funds to take them out when the technologies are close to being commercialized. But, so far, I view the VC universe and the ESG universe to be still relatively separate.
What's your view on green storage, and what are you seeing?
Drummi Bhatt, Mitsubishi Power Americas: To operationalize the decarbonization vision, I think several kinds of renewable and short- and long-duration energy storage technologies are needed to work seamlessly together, and these are the technologies we have been exploring for years. On the short-duration energy storage side, Mitsubishi sells the lithium-ion battery storage systems that excel at affordably storing renewable power for up to four hours, which is very useful for moving power from the afternoon to the early evening, or for other short-term uses. With our green hydrogen long-duration storage solutions, we are providing cost-effective renewable energy storage for longer durations (such as days, weeks, months, or even seasons), which is what is needed. Green hydrogen using renewable power to electrolyze water addresses a major challenge in what we call the Phase 2 of decarbonization, and it helps tackle long-term intermittency, which is currently managed using natural gas power generation. I believe that hydrogen is an integral part of this transition, which is why we have been investing in it for several years now. We will continue to invest in such technologies and innovation to successfully lead the energy transition.