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Deals in the US Market: Lower energy demand leading to consolidation [free access]

October 14, 2016

Utilities in the US are facing low energy demand, which is affecting their sales and earnings. The scenario is not likely to change significantly in the coming decades. The Energy Information Administration’s (EIA) 2016 Annual Energy Outlook (AEO) expects electricity consumption to increase at a compound annual growth rate (CAGR) of 0.9-1 per cent between 2015 and 2040. While growth in electricity demand is highly dependent upon population and economic growth, it has been significantly slower than the growth in gross domestic product (GDP) in recent years and continues to be slower in EIA’s projections. The key reasons contributing to lower demand for electricity over the next couple of decades include a rise in on-site generation facilities [mainly through rooftop photovoltaic (PV) systems] and increased investments in energy-efficient equipment. Utilities are therefore exploring new avenues to drive growth and maintain profits, either through multibillion-dollar mergers and acquisitions (M&A) deals or through forays into new business lines.


According to a Bloomberg analysis, deals worth over USD35 billion have been registered among the electric power utilities in North America during the fist half of 2016, compared with USD5 billion during the first half of 2015. These deals include M&A, consolidation, asset transfers, and joint venture and partnership agreements. Among them, the largest one is the recent offer made by Nextera Energy to buy Oncor Electric Delivery Company, a transmission subsidiary of Energy Future Holdings (EFH), for USD18.3 billion, after EFH failed to meet its debt obligations as electricity prices weakened. This is perhaps the largest deal in the US electric utility industry since 2011.


All these deals can be broadly divided into two categories. The first includes deals that are primarily the result of the cyclical trends created by low energy prices and the financial struggles of unregulated players, independent power producers (IPPs) and independent transmission developers. The second includes deals that are primarily due to organisational changes, like M&As, adoption of new business models, and consolidation of large-scale energy utilities. The following sections talk about these transactions in detail.


The cyclical trends

About two decades ago, there was essentially one business model that was followed in the electricity sector, i.e., the vertically integrated electric utility. Gradually, a shift towards splitting the utility business model into competitive retail energy providers, independent wholesale power producers, and transmission and distribution utilities started emerging. With this, the market also started witnessing the emergence of independent transmission developers.


After a wave of boom-bust for the unregulated side of the utility business, and the decline in the natural gas and electricity prices, the risks associated with any non-regulated investment have significantly increased for electric utilities in the US. This has caused huge losses for some of the publicly traded utilities such as Dynegy, NRG Energy and EFH, whereas regulated utilities have generally held steady. Thus, a trend towards reducing risks for investors through various M&A deals, mostly among non-regulated entities, has started emerging. The merger of Exelon Corporation and Pepco Holdings, which was announced in 2015 and finalised in March 2016, to combine their investment portfolios to reduce risks for the investors is a recent example of this trend. The merger brought together Exelon’s three electric and gas utilities—Baltimore Gas & Electric (BGE), Commonwealth Edison (ComEd) and Philadelphia Electric Company (PECO)—and Pepco Holdings’ three electric and gas utilities—Atlantic City Electric, Delmarva Power and Pepco—to create the leading mid-Atlantic electric and gas utility company.


In another deal after that in July 2016, Exelon’s other subsidiary Constellation announced that it would acquire ConEdison Solutions’ retail electricity and gas business. This is expected to allow Constellation to grow its footprint and assure additional sales.


Another example is the merger of Iberdrola USA with UIL Holdings Corporation, which is a regulated utility in Connecticut and Massachusetts, to create one of the largest energy utilities and the second largest wind operator company in the US. The combined company will be listed on the New York Stock Exchange (NYSE). Iberdrola SA will own an 81.5 per cent share and UIL will own the remaining.


Apart from the merger of electric utilities, power and gas utilities are also merging to expand their investment portfolios as well as their geographic presence. For instance, Dominion Resources, Incorporated, and Questar Corporation have planned to merge to create one of the country’s largest integrated energy companies, serving about 2.5 million electric utility customers and 2.3 million gas utility customers in seven states.


During this period of low electricity demand, independent transmission developers, which are competing with traditional and integrated utilities (having diverse business portfolios), are finding it difficult to maintain their revenues and expand their business. This is providing attractive options to foreign investors looking for opportunities to enter the US energy market.


The plan of Canadian Utility Group Fortis Corporation to acquire US-based ITC Corporation, one of the largest independent pure-play electric transmission companies in the US, is a recent example of this trend. This deal is part of Fortis’ long-term approach to expand its footprint through strategic acquisitions. Fortis has been building its asset base in the US over the last few years after the acquisition of New York-based CH Energy Group Incorporation for USD1.5 billion in 2013 and Arizona-based utility company UNS Energy Corporation for USD2.5 billion in 2014. Following the acquisition, Fortis will become one of the top 15 North American public utilities ranked by enterprise value, with an estimated enterprise value of USD30 billion, and will be listed on the NYSE. To finance the acquisition, Fortis has planned to sell 19.9 per cent of its stake in ITC to GIC Pte Limited, formerly known as Government of Singapore Investment Corporation Pte Limited, for USD1.23 billion.


If the deal is finalised, it will be the second time the ownership of ITC changes hands. Earlier, in 2003, DTE Energy sold ITC holdings to an investor group including Kohlberg Kravis Roberts & Company (KKR) and Trimaran Capital Partners LLC for approximately USD610 million in cash.


Other deals that have taken place during the past year include the acquisition of the Cross Sound Cable transmission system, owned by Brookfield Infrastructure Partners, by AIA Energy North America LLC, a fund managed by Argo Infrastructure Partners. The Cross Sound Cable system connects the transmission grids of New England and Long Island, New York.


Investment based on changing energy mix 

Vertically integrated utilities serve a significant part of the US transmission network. With the rising focus of the US government on promoting clean energy sources, these utilities are also bound to meet renewable energy targets. Utilities find mergers or acquisitions a quicker way to achieve the set targets, thus resulting in the merger of their transmission networks as well.


For instance, Great Plains, a vertically integrated electric utility, has planned to acquire another vertically integrated electric utility, Westar Energy. Great Plains serves about 851,200 customers in 47 counties in Missouri and Kansas with a combined diverse generation platform of more than 6,400 MW of capacity. Westar Energy is the largest electric utility in Kansas serving 702,000 customers with 7,200 MW of electric generation capacity fueled by wind, coal, uranium, natural gas and landfill gas, and 6,300 miles (10,143 km) of power transmission network.


Westar Energy's attractive growth prospects, particularly in renewable energy in the Plains states, have made it a likely acquisition target for several years, and Great Plains Energy finally struck a deal by offering USD60 per share to Westar Energy. The deal requires approval only from regulators in Kansas. This deal is also part of Great Plains’ business strategy to expand its footprints in Kansas and Missouri. In 2008, Great Plains Energy had acquired Aquila, an electric utility serving customers in adjacent areas of Missouri.


Emergence of new business models 

With the changing market structure and demand, new business models are also emerging in the electricity transmission segment. For instance, in 2015, GridLiance GP, LLC, and Blackstone Energy Partners, an affiliate of the Blackstone Group L.P., formed a transmission company under the name of GridLiance. This is the country’s first competitive transmission company focused on collaborating with under-served US municipal, cooperative and joint action agency utilities to jointly plan, develop, own and operate transmission infrastructure.


Through its model, GridLiance plans to bring together public power utilities to create a strong, unified regional entity with enough scale and resources to better represent their interests in the Regional Transmission Operator (RTO) planning and project award process. This will help present them as a viable competitive alternative to incumbent investor-owned utilities (IOUs), presently building the majority of the power projects in the US. In March 2015, GridLiance signed 30-year development agreements with the Missouri Joint Municipal Electric Utility Commission (MJMEUC) and the Oklahoma Municipal Power Authority (OMPA), which provide it with the right to plan, construct and operate the agencies’ transmission infrastructure in the service areas of SPP and Midcontinent Independent System Operator (MISO).


GridLiance is following organic as well as non-organic methods to expand its presence. In September 2015, it made its first acquisition of assets by acquiring 420 miles (676 km) of 69 kV and 115 kV transmission lines and related substation infrastructure from Tri-County Electric Cooperative (Oklahoma) and Nixa. It has also announced its plans to participate in the bidding for Southwest Power Pool’s (SPP) first competitive transmission project.


In June 2016, Kansas Power Pool (KPP) and GridLiance GP LLC signed a co-development agreement to mutually plan, build and run the transmission infrastructure in KPP's 31 member cities. Very recently, the Valley Electric Association (VEA) board of directors also approved an agreement to sell its 164-mile (264-km), 230 kV transmission network to GridLiance for about USD200 million.


Asset acquisition deals

Over the last year, several asset acquisition deals have also been conducted in the power transmission segment. These include the exchange of assets between Wisconsin Power and Light Company (WPLC) and American Transmission Company (ATC) under which WPLC acquired transmission assets worth USD3.71 million from ATC, while the latter acquired certain transmission facilities from WPCL for USD4.59 million.



During this period of low demand for electricity, consolidation in the transmission segment not only provides safer investment opportunities but also benefits customers, as utilities are able to offer competitive prices and better grid connectivity. The introduction of new business models is also leading to improved competition and grid reliability. As consumers become more energy efficient and on-site generation increases, M&A deals remain a sure bet for utilities to maintain returns and profits.