COVID-19 and What You Need to Know About the Impact on the Renewable and Traditional Energy Sectors
On September 9, 2020, two Vinson & Elkins partners, Bryan E. Loocke and Peter C. Marshall conducted an insightful one-hour PLI webinar, “COVID-19 and What You Need to Know About the Impact on the Renewable and Traditional Energy Sectors.” Bryan is based in V&E’s Houston office and is a partner in the Energy Transactions practice, and Peter, from the firm’s Dallas office, is a partner in the Mergers & Acquisitions and Capital Markets practice, and a member of the firm’s Renewables Task Force. More than 250 people attended the webinar, representing a wide swath of the country’s largest companies and financial investors in the arena.
The program addressed the impact of COVID-19 on investment and M&A activity in the energy sector and focused on certain key clauses within M&A and commercial contracts and their applicability to risks associated with the effects of COVID-19. The pair also discussed what they expect the investment and M&A landscape to look like in the renewable and traditional energy sectors over the next 12-18 months.
As Peter explained at the start, companies in a small number of sectors are either benefiting from COVID-19, such as technology and online media, or, at the other end of the spectrum, facing an existential crisis from the broader effects of COVID-19, such as travel and hospitality. Peter noted that they have actually seen a fair amount of investment and M&A activity at both ends of the spectrum, since there is considerable bargaining power in negotiations. A majority of companies in most industries, renewable energy included, fall in the middle of this spectrum, and the effects of COVID-19 have created some delays or other challenges to investment and M&A activity.
Bryan said that the impact on upstream and midstream oil and gas industries have certainly been felt. “COVID-19 didn’t kill it,” remarked Bryan, as he spoke about the upstream energy sector, “but it did tip a number of upstream companies over the edge.” He pointed out that during the 12 months before COVID-19 hit, bankruptcies had been accelerating due to cyclical performance and Saudi-led price cuts, and the pandemic was the straw that broke the camel’s back. “Capital market players are having difficulty in seeing money coming into the sector, financings have slowed down drastically, and it’s harder to get deals done,” said Bryan.
Peter stated that while there are still opportunities in both traditional and newer forms of energy, in renewables, sellers have often faced delays and other complications in managing a sales process. “Some strategic investors, in particular, are focusing on other priorities, whereas sellers and their financial investors are struggling with how to coordinate various aspects of a sale process, such as management presentations and on-site diligence.”
Bryan noted the traditional energy M&A market had slowed down, as the pandemic and the economy both put a strain on deals and obtaining financing. “Even if you have the liquidity to do a deal, you may still decide to kick the can down the road.”
There is still a lot of interest in M&A in the renewable sector, according to Peter, but the initial bid-ask spread may be wider than it had been in the past. The combination of a significant tightening of projected yields over the past several years along with operational and broader economic risks associated with COVID-19 have resulted in buyers having less room for error in diligence. “In the past, if there were certain unknown liabilities or project delays, you may still have been able to achieve base case returns, but now buyers have to be even more focused in diligence to avoid being on the hook for unknown liabilities or other variations from modeled assumptions,” explained Peter.
Bryan concurred that the same was true in more traditional energy transactions, and explained that there is less room for error within the entire energy ecosystem, and due diligence and modeling review is more important than ever – requiring a closer look at the commercial and legal underpinnings of target companies and assets.
Peter said that, while COVID-19 has created certain challenges, a number of other factors have buoyed the overall investment climate in renewable energy. Some of these factors include an increasing amount of fund capital dedicated to renewable energy, limited partner pressure for renewables investments to represent a portion of a traditional fund’s portfolio and tax credits and other governmental policies at the local, state and national level.
Both speakers discussed the importance, particularly in light of the pandemic, of being very intentional about how risk is allocated in contracts within the sector. They focused on comparing and contrasting the use of “material adverse effect” clauses in M&A agreements with the use of “force majeure” clauses in commercial contracts. While an analysis of these provisions can be very fact-specific, in general, the effects of the pandemic would not be considered in determining whether a material adverse effect has occurred; however, they would be taken into account in determining whether a force majeure had occurred. A detailed discussion followed as to the critical differences in applicability and how the thresholds, impacts and protections vary between the two types of clauses.
Peter stated that the takeaway is buyers of renewable energy assets will need to include very specific protections in an M&A agreement to avoid assuming the risk of effects relating to the pandemic and that they should not rely on typical clauses within an M&A agreement such as material adverse effect.
There were several lessons that listeners took away from the session. Fortunately, non-COVID-19 factors have acted as a mitigant to the negative effects of the pandemic on the renewable energy industry, though COVID-19 has acted as an accelerant to broader challenges facing the traditional energy industry. Bryan and Peter demonstrated that transactions throughout the energy sector require sophisticated guidance and that market participants must be very thoughtful regarding the allocation of risks of all sorts within their contracts. As for opportunities, they said to expect significant investment and M&A activity in both renewable and traditional energy over the next several years, albeit for very different reasons.
To view the PLI webcast, click here. This program is free to view for PLI members.
This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.