Temporary energy short circuit can’t halt shift to sustainable power

Energy will be integral to the future of emerging Europe economies, just has it has been in the past, but the shift from traditional reliance on fossil fuels to be replaced by renewables is poised to accelerate. The move away from oil, gas and coal has been driven by a mix of political pressure, regulation and commercial drivers in the search to find clean and affordable energy.

The sector was going through a turbulent period before the war in Ukraine, as it was buffeted by a combination of demand and supply challenges and regulatory changes. Disruptions to oil and gas supplies by Russia and sanctions against Moscow sent prices soaring, but also prompted the EU and governments to increase energy security by reducing dependence on Russian imports, improving the connectivity of networks and accelerating the deployment of renewables.

Like many sectors, deal activity in the energy and utilities eased off in 2022, with deal numbers down from 91 to 69, while values rose by 55% to EUR 4.03bn. Renewables saw transactions fall from 59 to 49, but there was a surge in values, up 59% to EUR 1.77bn. For pure wind projects, there were 19 deals, down from 20, while values rose 26% to EUR 780m, and for solar projects both deal numbers and values fell. However, the value of mixed projects leapt to EUR 531m on the back of seven deals, up from two previously. Notable deals included the EUR 194m purchase of three onshore windfarms by Poland’s PGE, the EUR 190m purchase of solar and wind plants in Poland by Ingka Group of Netherlands, and the EUR 83m purchase of a Romanian solar project by Greenvolt of Portugal.

Boost or bust?

Although the rise in prices should be good news for investors in renewables, David Kohl and Marco Selenic at CMS Austria caution that this has to be balanced against rising costs. They said: “Peaking electricity prices currently lead to a welcome windfall for renewable energy producers and one would expect a boost for greenfield renewable projects. Looking deeper than the surface, however, sheds a different light on this and the current situation might even transpire to be detrimental for the move to green energy in the short run.”

They warned that several developments had the potential to put projects on hold or even threatened them with going “bust”. Rising construction costs for energy projects, which have increased significantly because of inflation, disruption to supply chains and rising equipment costs, have left project developers struggling to pass these on to contractors under turnkey development agreements. In addition, there is the risk that high energy prices could trigger government intervention such as price caps or windfall taxes on profits.

Kohl and Selenic predicted that in the long run, elevated energy prices were expected to fall back to sustainable levels, leading to “a rather uncomfortable situation” for the developers of renewable projects. They added: “As the costs in renewable energy projects are essentially front-loaded in their entirety (with subsequent operating and maintenance costs being relatively low), the developer has to bear the currently high construction costs on the one side, while on the other, revenue streams in merchant projects (the energy sold directly on wholesale markets rather than using tariffs) are expected to face downward pressures as energy prices return to long-term sustainable levels. This naturally increases project risk. Going hand-in-hand with this are rising interest rates, which increase the financing costs for renewable projects.

“All this obviously eats into renewable investors’ profits, leading to the question whether many renewable projects will be mothballed under the current economic conditions,” suggested Kohl and Selenic. Their answer was yes, some projects could be put on hold, but they were optimistic that disruption would only be temporary, saying: “In general, we see the appetite of investors and lenders for renewable projects in the region remaining high.”

They added: “Those investors who are willing to navigate the ‘subsidy jungle’ and try to find the right mix between market exposure and fixed offtake price arrangements will conclude that in the long run, renewable projects are not only good for the environment, but also good for their own portfolio.”

Perfect storm

Developments in EU regulation have been happening rapidly... to the point where some countries in the region—particularly those most reliant on fossil fuels—have voiced concerns that the EU is going too far, too fast. Weaning them off coal and gas requires a massive shift and new ways of financing and running renewable projects, such as the use of power purchase agreements (PPAs) which are becoming more common across the region. Countries that have seen an increased appetite for renewables include Poland, Romania, Hungary, Bulgaria and the Czech Republic.

Despite concerns about the rising costs of renewables in the near term, they have grown dramatically over the past decade in the drive to hit decarbonisation targets, first helped by financial stimulus packages to encourage early adoption and then by technological breakthroughs, particularly in solar, which have increased efficiency.

Another driver has been the increasingly widespread adoption of ESG measures, as investors have sought to meet their environmental and social obligations — and even some conventional oil and gas companies have joined the rush for renewables.

From an environmental perspective, one of the downsides of the current market conditions is that support for gas and coal could resurface in the push to achieve energy security, through investing in gas interconnectors or oil and gas production projects that might previously have been consigned to the back burner. Nuclear remains an alternative to coal and gas when it comes to energy supply on a massive scale, but the war has revived safety fears around the industry.

M&A in the pipeline

Blazej Zagorski of CMS Warsaw said: “We’ve seen increased activity in the energy sector in recent years, with energy transition being a key underlying factor. Developments over the last 12 months have shown also that energy  cannot be treated as a typical commodity but  has a strategic importance as regards reliable energy sources and networks.

“What we do currently see are regulatory changes aimed at counteracting recent developments such as rapidly increasing energy prices. In the short term,  increase of regulatory burden and general instability  may result in a slowdown on the market, both in terms of investments and transactions.

However, energy transition and the drive towards securing energy sources should play an important role in a further development of the market in the medium term. In turn, that should also stimulate keen activity in M&As on the market.”

OUTLOOK

Even if recent M&A activity in the energy sector has slowed in the face of problematic market conditions, Horea Popescu, Romania CMS, said he expected it to recover. “I know there is some doom and gloom around energy, but I dare to differ regarding the renewable sector. I believe it is a part of the energy industry where the fundamentals are significantly different. Firstly, the demand for additional energy sources is increasing, and secondly, there is strong commitment from the EU and individual countries to get rid of polluting industries. In Romania, half of our M&A activity involves renewable projects—and this has never happened before. We had the first wave a decade ago, but this time I believe that the economic fundamentals look much better and I can see the transactional and development activity continuing for at least the next couple of years.”

Further reading:

31/01/2022

Time for transition: Energy M&A 2022

While world leaders have been gathering for COP meetings for decades, what made COP26 perhaps particularly notable is that the private sector also gathered in force, and with a commitment and determination to be a key driver in the decarbonisation of the world’s economies.  In previous years, there have been murmurings from various corporates that to make social or environmentally driven investment decisions may not align with their fiduciary duty to act in the interests of shareholders. As shareholder activism has driven the debate into boardrooms from above, this attitude is rapidly reversing direction. While returns are generally seen as lower in the clean sector compared to, say, the oil & gas sector, being invested in the green transition is increasingly seen as a key route to preserving and protecting shareholder value. At the same time, voluntary and mandatory climate related disclosures are aligning the drivers for investors across the board so that capital is increasingly driven by the metrics they produce.  This is being reflected in, among other things, the plummeting cost of capital for green investments. At the same time high carbon intensive investments, such as coal based projects and businesses, are struggling to secure funding, with many facing in­solv­ency. In­vest­ments in the energy transition, a key part of the green transition, will principally take the form of M&A. The outcome of COP26 and the momentum it has generated means that European dealmakers in the energy sector will be even busier in 2022. Europe leads the world in the energy transition and the race to net zero is driving near-record levels of dealmaking – notably in wind and solar photovoltaic generation. At the same time, the energy transition is both expanding and fragmenting the energy sector. For many, it has traditionally been focused on energy generation. The transition is bringing to the fore less visible technologies. Everything from traditional hydropower to grid-scale batteries, electrification of transport and hydrogen. It is also bringing into the mix sectors that have not traditionally been focused on energy, such as industrial decarbonisation, shipping and mining for the natural resources needed for the energy transition. In parallel with this, there is a huge and growing story around energy transmission and distribution. Electricity networks will need to expand massively to facilitate electrification and new technologies. They are also becoming smarter with the use of digital technology to optimise the way power is distributed, traded and consumed. Further, new types of networks may provide investment opportunities for those looking for stable long term assets, such as hydrogen and carbon networks. Against this background, traditional fossil fuel-based players are decarbonising their operations. For the oil and gas majors, this means acquiring or significantly enhancing their capabilities in renewables, including wind, solar and hydrogen, while simultaneously divesting selected carbon-intensive assets in response to mounting ESG pressures. This may be one of the reasons why 50% of respondents in our study point to distress-driven deals as a top sell-side driver. Change is endemic in the energy sector, but the current transition makes the years since liberalisation of energy markets in the late 1980s seem almost steady-state in comparison. Despite the momentum and push for capital to be invested in the energy transition, there remain obstacles, not least the limited pipeline of good quality investment opportunities, continuing concerns over lockdowns and COVID-19 variants, financing difficulties arising from potentially unstable long term revenue streams and diminishing rates of return. Notwithstanding these challenges, our study finds that energy sector M&A will increasingly be an engine driving capital into propositions that match social and political ambitions for the green transition. Key findings  Energy remains a premium asset class for most institutional investors, with its performance during the pandemic and impetus from COP26 further enhancing its at­tract­ive­ness75% of energy companies are considering an acquisition and/or divestment in 2022Alongside premium assets, in some subsectors there are undervalued targets driving buy-side activity, with sellers shedding distressed assets as the sector shifts in response to the energy transition45% think COVID-19 will be a major M&A obstacle in 2022, but this remains a fluid situation that can change rapidly

Publication

24/11/2021

CMS Expert Guide to hydrogen energy law and regulation

 Hydrogen guide – introductionThe important role that low-carbon hydrogen will play in decarbonising our energy usage is becoming increasingly widely recognised. Its versatility and broad range of applications render it uniquely placed to reduce emis

Expert Guide Energy & Climate Change

13/12/2021

Carbon markets and COP26

After six years of negotiation, COP26 resolved one of the outstanding issues of the Paris Rulebook when it reached a consensus on a global carbon market mechanism. Article 6 of the Paris Agreement set...

Publication

30/11/2021

The impact of COP26 on the energy sector

What does the Glasgow Climate Pact mean for businesses? What about the many other initiatives announced at COP26? And what’s next, as governments contemplate a crucial decade for climate change?  

Publication

18/04/2024

CMS Expert Guide to renewable energy

The Renewables Sector is now many decades old and considered a mature investment sector by many. Yet the issues it faces continue to evolve and grow at pace with the evolution and growth of the sector itself. Some of the issues emanate from broad geo

Expert Guide Energy & Climate Change

14/06/2021

Energy Transition: The evolving role of oil & gas companies in a net-zero...

After an extraordinary year of health and economic challenges, the global oil and gas sector has an essential role to play in the economic recovery. The same could however be said of any economic recovery and expansion over the past 100 years – during this time oil and gas companies have provided most of the primary energy that has fuelled huge economic growth. But this time does look different. The oil and gas sector will power economic recovery not just through oil and gas exploration and production, but also (and perhaps counter-in­tu­it­ively to some) through facilitating the transition to a lower-carbon economy and eventually a net zero future. This report presents a wide-ranging review of the role of oil and gas companies in that future.

Publication

Drive to go green boosts investment in clean energy

Renewable energy in Central Eastern Europe | Emerging Europe report 2020/21