Positive Energy Flowing Through America – an M&A Perspective

America’s power generation capabilities are in the midst of a monumental change that is altering the landscape and natural gas is not the only source creating positive momentum.   Renewable energy, and in particular wind, is competing on price with the assistance of the Production Tax Credit (PTC), and should be able to exist without this subsidy in the near future.  This improvement in price is causing utilities to take a portfolio approach to their investment in new power generation by diversifying resources.

Wind energy pricing has been falling as a result of changes in the sector creating a resource that is more competitive with other forms of power generation. According to the National Renewable Energy Laboratory (NREL), average pricing has decreased from $70/MWH in 2009 and is now approaching historic lows of $40/MWH in 2012. More recently, wind power generated in Maine and New Hampshire was sold to Massachusetts utilities at rates that were below coal and nuclear. The NREL states that a number of factors have helped drive the price of wind power down, including:

• Wind farms are becoming more efficient  increasing productivity and opening up new resources
• Turbine prices are decreasing which is pushing installed project costs lower
• The cost of the average wind project has dropped nearly $200/KW in 2012 versus 2011

The PTC still has a significant impact on the price of renewable energy. However, the lower costs of projects have made wind more competitive, which will eventually negate the need for federal subsidies.

Although renewable energy is growing, natural gas will continue to dominate the American power landscape for the foreseeable future due to an abundant domestic supply and current low prices. The result has been significant growth in power generation from natural gas.  The current price levels, while low today, have been increasing. According the U.S. Energy Information Association, natural gas prices were at their lowest in April 2012 at $2.79 per thousand cubic feet. Since then prices increased 55.6% to $4.34 per thousand cubic feet in July 2013, the most recent reporting date. Prices will continue to increase as the economy and demand improves. However, the greatest cause of price increases will most likely come when natural gas is exported at higher levels than today. As prices increase, natural gas’s attractiveness will diminish to some extent.

According the EIA’s Annual Energy Outlook 2013, in 2018, power produced from natural gas plants will range from $67.10/MWH to $130.30/MWH while onshore wind is expected to cost $86.60/MWH. While natural gas is inexpensive today, prices will go up making power from this source less attractive. There is no variation in the price to produce wind power since the resource is free and nearly all the costs have been incurred during the construction of the farm.   Therefore, utilities are taking a portfolio approach to investing in power resources to create a natural hedge against changing demand and prices. Alternative energy is viewed as a key element to this approach.   Acquirers and investors should follow their lead.

What does this mean for M&A in the power sector? Natural gas and the companies that serve this segment will remain attractive to acquirers and investors in the coming years.  Nevertheless, these groups would be wise not to overlook opportunities in the alternative energy sector.  Following the utilities portfolio approach and seeking diversification in the power generation end markets might lead to better returns.  While natural gas is clearly the most attractive segment today, small changes could easily alter the landscape and make alternative energy resources, such as wind, the new favorite child.

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