Renewable Energy Business Integration in O&G Companies
By Carlo Stiore, Global PMI Partners
This article addresses how traditional Oil & Gas (O&G) companies manage the acquisition and the subsequent post-merger integration of Renewable Energy (RE) businesses. We will explain how post-merger integration consulting can play a crucial role in supporting M&A integration in these acquisitions.
We will provide insights on the following items:
- How do O&G companies react to energy transition
- What is the impact of RE business on O&G companies
- What are the implications of an acquisition of a RE business by an O&G company
- What is the role of Post Merger Integration (PMI) in case of an acquisition of a RE business by an O&G company
- How O&G companies react to the energy transition
Climate change and need to take action on CO2 emissions have been at the centre of public opinion discussion since the Paris Agreement in 2015.
Many countries have pledged to limit global warming to well below 2 degrees Celsius, preferably to 1.5 degrees Celsius compared to pre-industrial levels, by implementing actions to reduce their greenhouse gas emissions.
The pressure on O&G companies to change their strategy and move from fossil to renewable energy increased rapidly. It reached its highest level to date during the 2020 COVID 19 crisis, when crude prices hit their lowest level since many years (the futures price was even negative). The energy transition moved to the top of the agenda of the O&G sector and a RE business focus became core to achieve decarbonisation targets.
O&G companies have responded differently to the energy transition issue:
- Early movers have radically shifted from fossil to renewable-only business. An example is DONG, a Danish company that changed name to Ørsted, offloaded its fossil business in 2017 and became the world’s largest developer of offshore wind parks. Another example is Italy’s ERG, in the past a refiner with service stations, now focusing mainly on wind business.
- Some underestimated the energy transition importance and continued business as usual. This behaviour typically applied to some US O&G companies. These are now changing their mind following the COVID crisis and President Biden’s US administration policy on climate change.
- Most of the O&G companies however created a renewable energy division and started to invest in RE business, mainly via acquisitions and partnerships. Some focused capital projects in those sectors of RE where they had more familiarity, e.g. biofuels or offshore wind.
- The impact of renewable energy on O&G companies
Investing in RE significantly impacts the organisation and business processes of a traditional O&G company:
- RE business does not have the same profitability of the fossil fuel business. The return on capital that an investor can expect is usually in the single digits and well below what (at least in the past) fossil business could deliver. This implies that allocating more capital to RE is unavoidably lowering the return to the shareholders. Another consequence is that O&G companies are competing in the RE market with companies and investors (such as Private Equities (PE) or funds that invest in infrastructures) that use a much lower cost of capital in assessing the investment opportunities. As a result, to be a winner in the acquisition race is a daunting challenge for O&G companies.
- Apart from some exceptions, the vast majority of the RE business is new to O&G companies: they don’t have the expertise and, in many cases, will retain the owner and/or management of the acquired companies to support the business after the acquisition.
- Once a RE business is acquired, the traditional fossil fuel integration template does not apply, because the processes are largely different and the systems (i.e. the ERPs) are not built to manage products different from hydrocarbons. Additionally, in most cases the acquisitions target small or medium companies that cannot be easily integrated in a globally scaled corporation where business processes are standardised and offshored.
- The implications of a renewable energy acquisition by an O&G company
As a quick and seamless integration of a RE business is not likely, organizations and processes need to mature and adapt. This will likely happen in the medium to long term, after the energy transition process is completed. In the meantime, several companies prefer to keep the acquired companies in a stand-alone mode: key management is retained as far as possible, a few resources are seconded to the RE company from the O&G organisation, and processes and systems are kept intact.
This implies a slow-move integration, executed with incremental steps and potentially a lack of optimizations – at least in the short term. This is recognised, as the alternative likely would kill the acquired business.
Most international O&G companies have historically developed business structures using standardised organisational processes across the various countries. This standardisation is reflected in the ways the companies are doing the business that is very much similar across the globe. They use the same ERP system and the same methodology to assess and measure the performance of the various businesses.
An acquisition of a RE business is something that can have dramatic impact. It is true that some of the RE businesses have similarities with fossil business: e.g. biofuels are produced in refineries, offshore wind technology can leverage crude offshore platforms knowledge. However, there are cases where there is no apparent link with the fossil world: a solar roof top developer or a battery manufacturer have just as many commonalities with fossil business as a winery company.
Small is beautiful
There is another problem O&G companies need to face when acquiring RE business: the sizes of the targets are usually “small” in relation to O&G companies that are large corporations. Very often these companies are still managed by the owners and therefore it is likely they have a simple, not sophisticated organisation. A jump to the global standard platform that O&G companies manage for their fossil business should be managed very carefully.
Headoffice cost allocation
Last but not least, there is the issue of the central costs. O&G companies – like all multinational corporations – have proven schemes to share corporate and central cost with local operations. For consistency and to keep the scheme bullet proof on the tax point of view, costs must be allocated to all local operating companies, based on some criteria such as headcount number. As you can expect, such costs are not trivial and even in case of the profitable fossil business are not easy to be digested by their Profit & Loss accounts. A RE business usually has a lower profitability than fossil and, as a consequence, the central cost burden may be a source of concern for the performance of the business.
- The role of PMI in the acquisition of a RE company by an O&G company
Given the comments above, the Post Merger Integration of a RE asset or business in a O&G company is likely to be a complex process that needs to be carefully designed and managed. There are two key elements to consider when approaching PMI in these kinds of acquisitions:
- Strategy: it is fundamental to clarify how the acquisition fits into the company’s strategy. There are various options that often reflect the maturity level of the investment:
- it can be an early-stage diversification, when there is still no clear long-term target and the main objective is entering a specific market/business to gain knowledge and then plan for future growth
- it can be part of a growth strategy, aiming to buy a seat at the table in the markets/businesses that have been identified as targets for future expansion
- it can be part of a structured plan to enable growth and release synergies with the existing business (fossil or renewable).
- Synergies: once the acquisition strategy is defined, it should be clear why the target has been acquired and what the synergies are that can be extracted. Unless the target is a distressed asset, it is likely that a price aligned with the market has been paid and, as a consequence, the acquisition will be cash positive only if synergies are released, i.e. if the revenues and the costs of the target can be, respectively, increased and reduced due to the integration with the buyer. If the acquisition strategy is in in the early stages, it can also happen that the aim is to have a NPV=0, i.e. at least not to lose money, and use the target to test the market/business and gain knowledge.
Once strategy and synergies are clarified, the PMI of a renewable asset or RE business into a O&G company can be planned. There are different levels of integration:
- Stand alone: the target is kept as is, with same organisation and processes. The intervention here will be limited to the secondment of key staff (e.g. CEO, CFO) and the implementation of a minimum control & compliance framework to ensure the buyer is able to pursue its goals minimising the disruption in the target activity. Finance and HR functions are those that are most impacted by the PMI.
- Integration with existing RE assets: this happens when several targets have been acquired in the past and the company is ready to integrate between themselves. This implies to have defined a common organisation and standard processes that need to be supported by an ERP system. In this case, it is expected to integrate key business processes such as procurement, manufacturing and selling, with RE assets already acquired. The interfaces with the fossil business are limited to contracts to purchase goods or (more often) services and to sell them the output, i.e. the electricity, which is a commodity that is usually traded by O&G companies.
- Full integration with RE assets and fossil business: this is typical of investments in a mature phase when the interface between RE and fossil is improved. Common processes exist and are fully aligned across the company irrespective of the nature of the business. Further synergies are released in areas such as procurement of goods and services, customer value proposition, etc. The integration process will need to focus not only on assets, systems and processes but also on people, probably the most critical aspect. Not only because there is the requirement to integrate cultures that likely are very much different (small vs large companies, fossil vs renewable, etc.), but also because the strategy must clearly address how energy transition will affect current skill pools and identify tools and processes to support the transition.
To recap, the energy transition is becoming particularly challenging for O&G companies that need to invest in a business (RE), which is new to them and, likely, will not deliver the same profitability of the old fossil business. Such transition will need to be managed carefully and when it comes to acquisitions a professional Post-merger Integration will ensure a successful deal implementation.
About the author
Carlo Stiore is an Associate at Global PMI Partners in Italy, focusing as PMI expert on transaction strategy, synergy management and business process integration. He has been leading M&A projects in Europe (Italy, Germany, UK) and the Americas. He spent most of his professional life in O&G companies and is a member of the Energy Practice, with competencies on Downstream business and Renewable Energy.
Global PMI Partners, an M&A integration consulting firm that helps mid-market companies around the world by delivering exceptional consistency, speed, and customized execution on the complex operational, technical and cultural issues that are so critical to M&A success.