German energy and infrastructure deals are defying the M&A trend

Energy and infrastructure (E&I) as an asset class has long been viewed by investors as a safe haven, typically offering reasonable returns, even in times of high inflation.

In Germany, with a significant backlog of investment for infrastructure projects such as roads, railways, and bridges and continuing government commitment to projects that will advance the country’s energy transition, appetite for E&I development is trending upwards. The German government’s desire to increase energy security in the country by asserting greater control over key infrastructure has led to it buying up natural gas pipelines through a nationalised subsidiary, while developing a multi-billion Euro plan for converting pipelines for hydrogen transmission.
The German government’s desire to increase energy security in the country by asserting greater control over key infrastructure has led to it buying up natural gas pipelines through a nationalised subsidiary,[1] while developing a multi-billion Euro plan for converting pipelines for hydrogen transmission.[2]

There are currently four electricity transmission network operators in Germany (50Hertz, Amprion, TenneT and TransnetBW) which are all critical for the country’s electrical power supply. In 2018, the German government acquired 20% in 50Hertz[3] and in 2023 a minority stake in TransnetBW[4]. Germany was also in talks with the Netherlands about buying back the domestic electrical grid currently owned by Dutch government-owned operator TenneT[5], and previously bought in 2010 from German electrical utility firm E.ON. However, just recently, it was announced that the deal for the sale of 100% of the shares would not go through and that Germany might only be interested in buying a minority stake.[6]

Maintaining control over Germany’s electrical grid and upgrading its existing capacity is seen as crucial to the success of the energy transition. This will also enable transmission of energy from new renewable generating capacity that is due to come online while meeting additional demand for electricity from electric vehicles, heat pumps and other low-carbon initiatives. However, the country faces the challenge of transmitting the substantial amount of energy generated by both on- and off-shore wind parks, mainly in Northern Germany, to the southern areas of Germany where many production businesses are based and large parts of the population live.

In addition to developing wind farms and hydrogen plants and pipelines, the government is continuing to invest in solar parks and battery storage units to power the journey towards Net Zero, alongside other energy infrastructure such as LNG terminals. According to the German Association of Energy and Water Industries (BDEW), the estimated cost for the energy transition in the country from now until 2035 is EUR 1.2 trillion[7], which represents an enormous opportunity for building, maintaining and servicing the assets and significant M&A opportunities as the renewable energy sector matures.

Alongside government investment in energy and infrastructure projects, private sector involvement is also growing, with an uptick in M&A activity as existing owners seize the opportunity to make the most of a buoyant seller’s market for E&I assets.

Against the backdrop of an overall decline in M&A activity, driven by geopolitical tensions, high interest rates and the impact of inflation - all of which make financing for deals costlier and harder to secure - the infrastructure sector appears to be defying the general trend. We have seen an uptick in deals in the past few months, and anticipate that activity will continue in the months ahead.

Typical risks on infrastructure deals

The primary concerns that arise in relations to infrastructure deals are regulatory issues, and the often lengthy period between the signing of transactions and closure of the deal.

 In the first instance, if the warranties under the relevant sale and purchase agreement are also given as of closing, new circumstances might arise during this period which could result in a breach of those warranties, generating a loss for the buyer.

 As due diligence on the buyside usually only covers the period before signing, W&I insurers have historically been reluctant to cover such closing warranties. However, if the seller is prepared to issue a bring down statement as of closing (i.e., confirming that the seller is not aware of any warranty breaches), W&I insurers might feel comfortable about covering warranties as of closing, despite the time gap.

 Since infrastructure deals also involve a huge number of regulatory risks, this is always an area of focus for the buyers, their advisors and the underwriters. Very often, there is a complex underlying environment for agreements, in relation to relevant permits, land use and legacy issues, and the status of infrastructure projects - whether operational or at the planning stage. In the case of German infrastructure deals, these risks might be mitigated due to the fact that the highest regulator itself – the German government – has initiated and is driving the energy transition. It is therefore reasonable to assume that the regulator would rather see relevant projects go ahead instead of making things more complicated on the regulatory side.

 Infrastructure deals also involve risks in relation to the condition of assets. Based on a general risk assessment including claims experience over the last couple of years, the condition of assets is an area almost always excluded by W&I insurers for infrastructure deals.

Appetite for W&I coverage

Historically, state acquisition of E&I assets has not been viewed as a significant opportunity for the W&I market. Changes of government, and movement of people in key ministerial or state leadership roles can make it difficult to establish an enduring knowledge base around transactional risks and therefore a reliable pipeline of buyers at state or national level.

 In the commercial M&A sector, the current soft market conditions inevitably results in prospective insureds and their brokers pushing to get the most favourable coverage options possible, which is putting the W&I product to the test.

However, the experienced nature of W&I buyers for infrastructure deals means that they typically appreciate the value of the product and are increasingly looking to secure coverage for deals. In addition to these sophisticated insurance buyers, there are a number of other factors that contribute towards making W&I coverage for E&I deals slightly less challenging to underwrite than for some other areas of the M&A market.

With typically little or no involvement of employee contracts in the transfer of assets from seller to buyer, there are fewer tax and employment law risks associated with transactions. Similarly, with a limited number or even no subsidiaries involved, there is unlikely to be any cross-border element in such M&A deals.For large assets like pipeline or grid systems, underwriters have to take a pragmatic approach to the required due diligence when structuring W&I coverage for deals.

A rigorous but sensible sampling approach to due diligence for the entire asset gives comfort to buyers that they can be covered for 100% of the risk, but without the time, expense and vast resources required to do due diligence on every kilometre of a transmission network.However, it is important that the chosen samples present a fair view of the overall assets at hand. A well-chosen percentage of such assets should be reviewed by buyside due diligence. Also, the chosen samples should include bits and pieces of different asset categories which may include factors such as location, age, size or type. Furthermore, despite a pure sample approach, the insurer may gain comfort in light of general standard procedures, maintenance plans or company guidelines that are in place on a group level and apply to the whole business.

As Germany increases the pace towards its energy transition, we anticipate that a lively M&A market around energy and infrastructure assets will continue to generate interest in acquiring W&I cover for these substantial deals.

1 https://www.worldpipelines.com/business-news/27032024/germany-tightens-grip-on-energy-infrastructure-with-sefe-gas-grid-deal/

2 https://www.hydrogeninsight.com/policy/germany-could-spend-billions-of-euros-to-convert-pipeline-for-russian-gas-imports-to-carry-hydrogen-report/2-1-1601844?zephr_sso_ott=XT12Tb

3 https://www.kfw.de/About-KfW/Newsroom/Latest-News/News-Details_481216.html

4 https://www.kfw.de/About-KfW/Newsroom/Latest-News/News-Details_786432.html

5 https://www.reuters.com/markets/deals/netherlands-germany-near-deal-tennet-grid-sources-say-2024-03-10/

6 https://www.reuters.com/business/energy/tennet-gives-up-sale-german-grid-operations-german-government-2024-06-20/

7 https://www.heise.de/en/news/Energiewirtschaft-Energiewende-kostet-bis-2035-1-2-Billionen-Euro-9703870.html