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Still pretty tough

After the tumult of 2001, when the Enron scandal collided with the California energy crisis and the fallout from the 11 September terrorist attacks, bankers active in the energy sector experienced a period of relative calm last year

A STRING OF major deals in 2002 ensured the banks had enough business to keep the wolf from the door. Deregulating European power markets and a post-mega-merger asset shuffle in the oil and gas sector has ensured a level of activity to sustain most investment banks' interest.

But seasoned bankers could be forgiven for taking a longing look back at the halcyon days of 2000, when robust mergers and acquisitions (M&A) activity last earned them top-whack advisory fees. While deal volume appears to be holding up - just - pressure on fees is hitting banks where it hurts most. Competition for a lot of these deals is so intense that corporates are able to drive down the fees a bit. They can afford to be a bit more selective, says Chris Haynes, a consultant at Alexander Mann Global Markets.

There are some very low fees now, acknowledges one energy banker. But it does vary from transaction to transaction. There's a general bunching of the M&A sector, but this is more a sign of the depressed economic climate. Of course, the initial public offering market's dried up, so, effectively, its up to M&A to keep things ticking over. 

Some banks, such as Citigroup's Salomon Smith Barney (SSB) investment banking unit, have leveraged existing financing relationships with large energy clients to help win them major advisory deals. SSB lined up M&A transactions in the early part of this year for Russia's Yukos and Malaysia's Petronas, which has been busy hunting for assets in Africa.

Healthier than some

Some point out that the broader energy sector is at least in a healthier condition than other sectors, not least the basket case that telecoms has proved to be for the past couple of years. The big-oil mega-mergers of recent years at least ensured volume would be high in absolute dollar terms. On the oil and gas side, there's been a lot of portfolio realignment following the mega-mergers and that's been underpinned by relatively strong oil prices, says Jonathan Franklin, partner and head of M&A at Ernst&Young.

Plus, in the power sector there's been activity that is related in one form or another to financial distress - whether from issues to do with corporate governance or real distress caused by over-leveraging in the context of falling power prices and expensive acquisitions. 

Forced disposals form a big part of the M&A market, particularly on the power side. There are a number of forced disposals from a regulatory perspective, which is increasing the absolute volume of M&A activity, says Mark Bentley, global head of Energy&Utilities at HSBC Investment Bank. But I don't necessarily think energy is doing better than other sectors. What you're seeing is a number of relatively large transactions, but, compared with absolute levels in 1999 and 2000, activity has fallen radically - particularly in terms of the transactions that you never get to hear about. 

Deal volume in year-to-date 2003 has declined since 2002. M&A activity generally is well down on 2000 levels, but in the energy area deals such as the Iberdrola defence (against the Euro26bn, including assumed debt of Euro11bn, hostile bid launched by Gas Natural) and the upstream sector in Russia are keeping teams busy, says Jeremy Wilson, head of natural resources at JP Morgan.

The advisory banks face other challenges. Clients are building very competent in-house M&A capabilities, says Wilson. What they are turning to investment banks for in many cases is strategic and transactional judgements from key individuals who have been following the industry for the past 15-20 years. The transactional knowledge that someone like Rod Peacock [head of JP Morgan's global energy team] brings to the table can be invaluable. 

A bout of merger activity in the oil and gas sector in the first half of 2002, led by Royal Dutch/Shell - one of the few supermajors to have avoided the spate of mega-mergers - taking over UK independent Enterprise Oil for Euro6.2bn ($7bn) and the US Pennzoil-Quaker for $1.8bn, raised hopes of a more sustained revival.

But the second half saw relatively little activity. BP's early 2003 acquisition of a 50% stake in Russia's Tyumen Oil (TNK), paying some $6.7bn in cash and shares, is one notable exception, as is Malaysia's Petronas' acquisition of Italian gas group Edison's Egyptian assets for $1.8bn. The $5.3bn Devon Energy-Ocean Energy merger, completed in the first quarter, could presage further consolidation among US medium-sized oil companies.

Spending on the rise

Figures from PricewaterhouseCoopers show that in the first half of last year, international electricity and gas utilities' spending on acquisitions rose by 50% to Euro55bn. The $18.14bn merger of the UK's electricity and gas transmission monopolies, National Grid and Lattice, announced in April last year, proved the standout deal.

Apart from PanCanadian Energy's $8.9bn acquisition of Alberta Energy, which was completed in April, and a series of smaller oil company mergers, Dealogic data show that European gas-power transactions dominated deal flow, forming at least half of the top-10 M&A deals of 2002.

Following on from the Lattice/National Grid deal, there is an emerging trend of bringing gas and electricity groups together. There is also a lot of discussion around infrastructure unbundling and subsequent consolidation post the Lattice/National Grid merger, says Wilson.

RWE's $7.4bn takeover of Innogy, the UK utility, announced the German company's arrival in Europe's third-largest energy market. It followed quickly in the footsteps of E.On's foray across the English Channel through its merger with Powergen and its purchase of the UK assets of the ailing US group, TXU, last year.

Utility groups such as E.On and RWE have also been among the most active visitors to the debt markets in the past year. The former took the award for last year's biggest syndicated loan in the energy sector, raising $15.27bn from a team of top-tier international banks - a clear sign of its intention to hit the acquisition trail. The cash will come in handy as E.On presses ahead with its Euro10bn acquisition of the German gas distributor, Ruhrgas, having seen off legal challenges to the deal last year. This could be further good news for Rothschild, which advised the company on the TXU acquisition last year and on its sale of a Euro1.1bn stake in France's Bouygues Telecom.

But not all gas-power mergers are likely to come off. Goldman Sachs looks to have lost out on one of the potential deals of 2003, after Gas Natural, the Spanish gas distributor, was forced to withdraw its hostile bid for the larger electricity group, Iberdrola, in early May. Spain's energy regulator barred the deal, on which Goldman Sachs advised Gas Natural. The Gas Natural/Iberdrola deal was an example of how aggressive people are willing to be in developing their utility strategies, says one banker.

Tight credit

The Spanish regulator's veto of the deal is unlikely to derail putative gas-electricity mergers in the pipeline in Portugal, France and Germany. But, overall, tighter credit in the energy sector could take the shine off the more ambitious plans of European gas and power players. RWE has ruled out large-scale energy acquisitions in the US and says further purchases will be funded through asset disposals rather than debt.

But bankers say utilities debt is becoming more risk sensitive, making it potentially more difficult for the big borrowers, such as E.On and RWE, to stay on the acquisition trail. According to Dealogic data, the two German firms accounted for three of the top-five syndicated loans, at a total of almost $25bn, in 2002.

Towards the end of 2002, most of the pressure on the major utilities was put on them through having to focus on their credit ratings, says a banker. With the fallout from Enron, ratings agencies became quite zealous in the protection of their reputations, so a lot of companies have taken the view that preserving their debt status is paramount to their long-term survival. They are going into a stabilisation phase, rather than a growth phase. 

The biggest issue for many power utilities has been tightening credit. This has led to a focus on credit-related issues and a reduction in debt - and inevitably with that comes a reduction in M&A activity, says the banker.

But the credit squeeze has also brought opportunities for advisory banks. It has prompted some companies to announce divestiture programmes. France's Suez and Electricité de France (EdF), and Italy's Edison, are getting rid of some subsidiaries guilty of less-than-sterling performances.

The focus on going back to core business is all good management-speak, but just a few years ago some of these same utilities were trying to be things they weren't. Now it's back to basics, the banker adds.

RWE and EdF are good examples of companies that have expanded enormously over the last four years and are now taking stock and perhaps divesting some of the businesses that were not key components of the original acquisitions. says Franklin.

Spotting the first green shoots of M&A recovery in the energy sector looks a tough call. Russian oil and gas could see increasing activity, with Yukos in the throes of buying rival Sibneft for a reported $13bn.

Bankers expect the top-five Russian oil companies to attempt to acquire lower-tier oil producers. Some of these deals may not be analogous to the BP-TNK deal, but there may be cross-border flows with Russian companies internationalising and Western companies willing to go in and give it another go, says Franklin.

The central European downstream is another prospect, says Wilson. Privatisation in central Europe is also active, with firms such as Ina, Unipetrol, Petrom and Depa, and the Gdansk refinery for sale, he says.

Some bankers are sanguine about prospects of a revival of energy sector M&A activity to the levels seen in 2000. It could take another two or three years, if we indeed ever get back to those levels, says Bentley.

Broader opportunities

Bankers are generally more upbeat about broader financing opportunities in the sector. There's certainly an appetite for deals and there always will be for high-quality transactions. That won't ever go away, says Andy Pheasant, head of natural resources, global debt origination at Dresdner Kleinwort Wasserstein.

Power utilities accounted for the bulk of the major syndicated loans in the energy sector last year, according to Dealogic. This has provided a lucrative line of business for the top-drawer lead arrangers, with JP Morgan participating in the seven top deals last year. But tightening credit conditions, which has already left its mark on M&A levels, means banks may have to look harder to find deals of the level of E.On's $15bn loan last year.

Table 1: Top energy sector M&A deals, 2002




*Rank value








date (2002)


Alberta Energy


Merrill Lynch,



RBC Capital Markets,

Public offer,




CIBC World Markets




stock swap


Innogy Holdings


CSFB, Deutsche Bank



Merrill Lynch

Public offer



Enterprise Oil


NM Rothschild&Sons,

Royal Dutch/Shell



Public offer




Morgan Stanley




CSFB, Lehman Brothers,



Morgan Stanley, UBM,





Merrill Lynch


Rothschild Italia



auction, consortium


TXU Europe


NM Rothschild&Sons,



Morgan Stanley,





Merrill Lynch


UBS Warburg


Glencore International





JP Morgan




(Australian/S African coal)




SSB, ABN Amro Bank



Deutsche Bank,

Privately negotiated,




BNP Paribas



Shell&Dea Oil (50%)


Morgan Stanley

Royal Dutch/Shell



Joint venture,






Veba Oil&Gas


Deutsche Bank



Harrison Lovegrove




(international operations)


& Co, Gaffney Cline&


Associates, Merrill Lynch,


RBC Capital Markets


Slavneft (74.95%)



Sibneft, TNK



Auction, divestment,






Target sector is oil, gas and power. Deals announced between 1 Jan and 31 Dec 2002. Excludes withdrawn and buybacks. *Includes debt. 2003


Source: Dealogic


Project financiers are seeing fewer greenfield energy projects coming to market. The power sector's taken a bit of a beating in the UK and US. We're finding ourselves around the rescheduling table much more than dealing with new transactions. In the past 12 months, banks seem to have been spending more time around renegotiation tables than discussing new power deals with clients, says Bali Kochar, director of energy finance at Italy's Banca Intesa.

Some power deals are, however, proceeding in Europe, such as Interpower (Edison- Italy) and Bilbao Bizkaia Energiá (ESB- Spain). The oil and gas sector has been a bit more buoyant, with transactions such as Egyptian LNG, Nigeria LNG (NLNG), and Oryx GTL underwritten in 2002, and more deals, such as Sohar Refinery Company and the Baku-Tbilisi-Ceyhan (BTC) pipelines, in process.

The strong interest in recent and present deals is forcing banks to compete aggressively on terms, says Kochar.

Fire sale

The fire sale of assets from US power developers, such as TXU and Enron, has resulted in a number of companies looking at buying into the existing range of assets and a consequent decrease in greenfield activity. A number of project-finance teams have experienced falling headcounts as business has dried up. Pressure on loan pricing has prompted a number of international banks to pitch for advisory mandate, rather than increase lending exposure.

However, most energy bankers do not expect a contraction in credit to the mainstream part of the sector. The fundamental nature of the market won't change, but you might see a contraction in the riskier fringes, says one banker.

Credit-quality analysis of project sponsors has risen significantly.

Lenders are demanding more equity up front, often resulting in lower debt:equity ratios than before. If you're a project sponsor, you need to put your money where your mouth is, says Navid Chamdia, assistant director in Ernst&Young's structured-finance group.

That caution is also reflected on the underwriting side, says a project financier at a major investment bank. Banks don't know what the status of the market is so they focus on how the market might react - anticipating the problem rather than seeing the problem today, he says.

Underwriting risk is more of an issue now for many international banks, which can often achieve higher returns in home markets than in lending to larger energy projects in regions such as the Middle East, where a political-risk premium often has to be paid.

Some of the larger Mideast Gulf-based energy syndication deals have experienced a decline in the number of banks li

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