Older power plants bring value based on fuel type (diversity is important), location (infrastructure is all in place), and readiness (new plants can take two to four years to develop). But they also bring environmental issues and liabilities that must be considered carefully before an acquisition goes forward.
Environmental issues that may affect the value of a potential acquisition include:
- Air emissions performance, including current compliance status and the impact of anticipated future regulatory requirements
- Water availability and use for cooling
- Site contamination associated with past or current operations
- Hazardous materials such as asbestos, PCBs, and lead-based paint
- Provisions to transfer liability for existing site contamination to the new owner
It is the responsibility of the buyer to learn about and understand the relevant issues prior to purchase, during the due diligence phase. Once a purchase agreement has been executed, the buyer must develop a plan to complete the transaction and integrate the new plants.
Due diligence - Think fast!
The due diligence phase is characterized by detailed - but often hurried- review of seller-generated information about the facilities and site visits to visually inspect conditions at the sites, followed by internal analyses of the issues and liabilities to assess their impacts on a bid price. Buyer-imposed schedules for access to the Data Room and site visits, coupled with a looming bid deadline, result in the need to quickly filter and understand large amounts of information. The bid team must screen issues for relevance and importance and select the few significant items that are relevant to preparation of the bid. This step is essential - the 'material' issues must be sorted out so that the limited bidding time can be used most effectively.
Costs associated with site contamination and remediation, air pollution controls, consent orders, permit changes, presence of hazardous materials, or other liabilities, along with value from emission allowances, emission reduction credits (ERCs), advantageous environmental permits, etc. must be quantified and incorporated into the overall financial analysis for the bid. In addition, the bid team and its advisors must work hard to identify ways to address issues and enhance value. This is a critical element of the due diligence process - where creative solutions and ideas can make a difference in whether the bid is won or lost.
The analysis of liabilities and issues should include possible solutions to identify environmental problems and ways to enhance the value of the asset overall: Is repowering an option? Can the buyer add new capacity at site? Are brownfields cleanup incentives available? Can the buyer install emission controls and generate saleable allowances/ERCs? An experienced environmental consultant who knows the merchant power industry and its market drivers can be invaluable in helping to formulate strategic plans for the assets.
These efforts will help the bidding company to optimize its analysis and arrive at an offer that best reflects the company's business strategy.
Transition - Resolving Issues as a Buyer-Seller Team
Once a winning bidder has been selected by the seller, the two companies enter into a new relationship - one where they work together toward the common goal of completing the transaction. As the buyer explores the details of environmental issues identified during the due diligence phase, both the buyer and seller focus on working through issues and financial closing requirements on schedule. A checklist should be developed as early as possible to focus the team's efforts and make sure the target is well defined.
Transition generally lasts a few months to a year or more, and transition phase issues can include almost anything. During this phase, the buyer takes a much broader perspective and the seller is obligated to involve the buyer in any significant actions or decisions affecting the assets. The major areas of focus are typically:
Permit transfers - regulatory process, structure of company, financial assurance requirements
Ongoing/unresolved matters - remediation agreements, consent orders, pending permits, hydroelectric plant relicensing proceedings
Requirements for financial closing - make sure that all matters are addressed
Development issues - opportunities to add capacity or repower
Personnel issues - evaluate the experience and capabilities of environmental staff included in the sale
Planning for the integration phase
Position for value - How can the environmental aspects of the assets be leveraged to enhance value, profit, competitive advantage? Are there innovative solutions available to costly remediation problems?
In addition, there may be time-sensitive issues of importance to the transition team, such as the timing of a closing relative to the 'ozone season' in the northeast, or the EPA SO2 allowance auction. At stake could be the cost of ozone season allowances needed for compliance, or the appropriate distribution of proceeds from the SO2 auction. It is critical to manage issues both large and small, during the transition phase.
Integration - Creating Maximum Value
The integration phase begins the day after financial closing and involves the day-to-day activities necessary to make the acquisition a success. Successful integration incorporates the new facilities and personnel into the buyer's organization and culture and implements strategic plans to extract maximum value from the acquired assets. Key activities are:
Integrating people and procedures
Blending cultures is not easy, particularly because most sellers have been utilities and most buyers have been merchant generating companies. A well-prepared transition plan, along with the relationships and good faith established during the due diligence and transition activities, will enable the buyer to effect the smooth integration of new staff into its organization.
Conducting a compliance audit
It is a good idea to conduct a complete environmental, health and safety compliance audit soon after closing. This will establish a baseline and gather information that can be used for planning and the establishment of priorities for addressing the various environmental issues that will need attention.
Everything should have a fresh look, including permit conditions, monitoring activities, reporting procedures, and recordkeeping activities. This is the time to update calculation methods, reporting formats, and troublesome permit restrictions.
Implement going-forward strategies
Without sustained attention to the issues identified during due diligence and transition, some of the anticipated value could be lost or delayed, and the potential expected from the asset acquisition could be minimized. Some going-forward strategy issues associated with recent acquisitions have included:
- Air emissions compliance - can one plant be fitted with controls to generate allowances and/or offsets for other operating plants or new development?
- Allowance management/marketing optimization and permit optimization.
- Are there ways to generate cash or improve operating flexibility?
- Site remediation activities - Find ways to make this happen efficiently, cost-effectively, and with minimal disruption to ongoing operations or construction of new capacity.
- Development opportunities - This can be where much of the acquisition value is found. The buyer should establish plans to maintain compliant operations so its reputation with regulators and the public will support new development activities. The environmental manager should work with the business development team to permit clean, efficient new capacity. And the company should monitor and influence rulemaking and policy development to support company objectives.
The most successful integration is achieved when there has been adequate preparation in the weeks and months leading up to financial closing. For example, in a couple of recent acquisitions, buyers have implemented strategic plans, such as the addition of pollution control equipment that generates ERCs and/or allowances for sale, and incorporation of site remediation activities into plans for construction of new capacity at a site. These strategies were identified during the due diligence phase, refined during the transition phase, and implemented upon closing.
Environmental issues associated with power plant asset transactions can be significant, but opportunities exist to identify good acquisition candidates and to maximize the value of acquired assets. Proper management of the three phases of the asset transaction process - due diligence, transition, and integration - will add value to the deal and ensure a successful outcome.
Teaming for Success
A significant issue in many power plant acquisitions is the cost of compliance with known or anticipated future air emission requirements. Plants meeting current requirements could face future liabilities of tens of millions of dollars for control equipment. These costs would typically fall on the new owner and it is essential that a bidder's valuation of the assets reflects this issue.
In a recent project, ENSR helped a client evaluate risks associated with future nitrogen oxides (NOx) reduction programs in several states, as well as likely mercury emission targets. ENSR's compliance strategists worked with the client to identify the expected future emission limits, control options and costs, compliance strategies, and ways to optimize investments across the portfolio of plants. Their contributions helped the client to prepare a bid that reflected both liabilities and opportunities associated with future air regulations.