This alert is the first in a series focusing on mergers and acquisitions in the energy and commodities sector. Over the series, we will examine various issues that arise at key stages of the acquisition and divestment process.
When undertaking the acquisition of any asset, as opposed to shares in a company, one of the first stages of the process is the conducting of the due diligence exercise: what are you buying, what state is it in, and will you encounter any problems following the acquisition? The answers to all of these questions will help determine the price that you offer, the warranties and indemnities that you request, and the permissions and permits required.
In the table below, we consider the top 10 headline issues to consider when conducting the acquisition of an asset in the energy and commodities sector. These issues will apply no matter what the asset – be it a power plant, LNG terminal, oil refinery, tanker or any other asset. While many of these issues also apply to non-energy and commodities assets, those set out below tend to be more prevalent for energy and commodities assets, given the nature of such assets. There, of course, will be a number of other matters to consider, but we have sought to focus on issues that may arise on energy and / or commodity asset acquisitions specifically.
The issues below are considered from a buyer's perspective. While there will necessarily be overlap between the buyer's and the seller's considerations, the issues the seller will focus on will tend to differ.
|Issue||What to Consider|
|1.||Question of Materiality||When undertaking any due
diligence exercise, there likely will be a large number of
contracts, personnel records, and fiscal accounts involved. Both
from a practical and financial perspective, it may not be possible
to review all of those contracts, records, and accounts in the
To that end, a de minimis threshold should be set: for example, only reviewing contracts that have a value over a given sum, or have a tenure of more than a certain number of years. This will help streamline (and speed up) the due diligence process.
|2.||Financing Arrangements||Large assets may not have a sole owner, but rather may have multiple owners or be the subject of charges, mortgages or other security interests or encumbrances. Confirming the ownership structure and any associated arrangements (via the review of any existing financing or security documentation) will assist the prospective buyer in determining whose consent is required for the purchase (and/or whether any security or encumbrance needs to be released, together with the necessary steps for completing such a release), and help with the structuring of the sale.|
|3.||Contractual Arrangements and Reporting obligations||The primary source of
revenue for an energy asset is its output. Therefore, extensive due
diligence should be undertaken with respect to the contracts
revolving around that output.
The due diligence should focus on issues such as: (i) exclusivity arrangements; (ii) restrictions on assignment, novation and change of control provisions; (iii) the term and provisions of the various bespoke sale and purchase arrangements that deviate from the target's standard terms; and (iv) leases and licences that are due to expire within a year of the proposed acquisition date.
Depending on the nature of the asset's output, certain reporting obligations may arise. For example, reporting obligations arise in respect of power and gas trades undertaken in the EU, pursuant to the Regulation on Wholesale Energy Market Integrity and Transparency. If such reporting obligations do arise, it is necessary to ensure that the entity that is reporting is properly registered with the relevant EU member state regulator, and is set up to make timely and accurate reports. While not a lengthy or onerous process, it is essential that this is in place, in order to avoid regulatory penalties or sanctions.
|4.||Service Provision||It is important to
ascertain if there are any service agreements in place with respect
to the asset in question. For example, does a third company or
group company provide technical assistance, technical services,
engineering services, consulting and research services, etc.?
The asset in question may cease to function, or output may decrease, if such services are not provided. Therefore, following the purchase, a prospective buyer may need to consider interim or transitional arrangements with the third parties already providing those services, until it can arrange for such services to be provided by its own group companies or by third parties that it arranges.
|5.||Hedging Arrangements||Over the past few years,
certain underperforming assets have implemented hedging
arrangements and/or route to market services. Therefore, when
acquiring an underperforming asset, consider its viability for the
imposition of hedging arrangements and/or route to market services
(if these are not in place already).
For example, in the context of a generation asset, ascertain if the asset is registered with Elexon (the party responsible for the smooth functioning of the wholesale electricity market in the UK), in order to determine whether or not it would be possible to trade power production on the wholesale electricity market.
|6.||Consents and Approvals||The provision of hedging
arrangements may require an application for authorisation from the
relevant financial regulatory authority for the entity undertaking
those arrangements. Similarly, the individuals performing hedging /
route to market services may need to be approved by a regulator.
Such authorisations and approvals cannot be transferred from the
seller to the buyer; rather, the buyer will have to seek such
approvals from the regulator for the entity, and the relevant
Depending on the buyer's market share, approval from the relevant competition authority also may be required.
Obtaining such approvals and consents is often a lengthy process. Therefore, the process and timing for completing the documentation to obtain consents and approvals, as well as the actual delay in obtaining each such consent or approval, will need to be factored into the proposed timing for the transaction.
|7.||Environmental Considerations||Certain energy and
commodity assets may give rise to increased liability from an
environmental perspective, given the potentially hazardous nature
of their output. Therefore, targeted environmental due diligence is
essential in order to determine the permits, licences,
authorisations and consents that are already in place; whether any
of the above have been breached; and whether any further permits,
licences, authorisations and/or consents are required in order to
perform the proposed onsite activities.
As well as considering potential environmental liabilities, a prospective buyer also may wish to consider the availability of (depending on the jurisdiction in which the asset is located) tradable carbon credits and renewable subsidy payments, including emission reduction and trading credits that may be available due to the nature of the output from the asset.
|8.||Insurance||Due diligence relating
to insurance should take a multifaceted approach: consider
insurance relating to the asset itself, insurance for key
individuals, and insurance for the business.
Issues to consider include the risks covered, the extent of the coverage, the annual premium, and whether or not this has been paid in previous years. In addition, it will be necessary to ascertain if the insurance policy is transferable from the seller to the buyer, or if the buyer would be required to take out a new policy.
Finally, it will be necessary to consider whether the policies will apply to claims arising pre and post- acquisition. In the event that the policy does not cover claims arising prior to the acquisition, the buyer would be advised to ensure that the indemnities in the sale agreement cover such liabilities.
|9.||Anti-Bribery and Corruption||If the asset is located
in a jurisdiction labelled as "high risk" by Transparency
International, then investigations should be conducted into the
seller's compliance with anti-bribery and corruption laws (both
domestic and international). Such considerations will be
particularly (but not exclusively) relevant when considering
acquisitions in the agricultural commodity space: many of the
farms, and associated infrastructure units, are located in
jurisdictions in which public perception of bribery and corruption
is deemed to be very high.
It will be necessary to consider whether or not the seller, or the seller's group, has any links with government officials, or those in public office, and if such links exist, whether they were relied upon when obtaining requisite authorisations, approvals and consents. Review accounts, to ensure that all payments made by the target have been properly accounted for, and recorded.
Similarly, if obtaining export licences and accessing public services and utilities require interaction with government officials, consider how this will be done without breaching any anti-bribery and corruption rules.
|10.||Employee Benefits||The location of the
asset may mean that there are esoteric employee benefits that will
need to be considered as part of the due diligence exercise.
For example, in France, there are strict requirements on sellers of certain companies to inform, and consult with, a works council on issues relating to the management and running of the company being sold. Such consultations are often a pre-closing requirement. Any delays in conducting such consultations, or protracted consultations, could affect the timing of a disposal, and should be factored into the acquisition timetable.
Were the asset located in South Africa, it would be necessary to assess the target's compliance with local health programmes, and any liabilities (contingent or otherwise) arising under those programmes.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.