“...the power market may turn full circle – to one where the US market is increasingly populated by foreign utility investment.”

If the barometer of a market’s health and confidence is the level of merger and acquisition activity then the global power market is on the road to post-Enron recovery, according to the latest PricewaterhouseCoopers survey of deal activity in the first half of 2004. In the first six months of the year deal values totalled $31.4 billion, up almost 6% on the second half of last year and up 134% on the first half of 2003. Driving the improved deal value has been the ongoing retrenchment of US companies, which originated in Europe and has now become a global phenomenon. It is notable that as a result of this retrenchment the deal value in Asia-Pacific for the first half of 2004 increased 50% on the first half of 2003. But these figures pale against the value, and volume, of deals being transacted in Europe, which remains the most fertile region for merger and acquisition activity. The other notable statistic from this analysis is the predominance of domestic deal activity, particularly in Europe.

Taking the global market as three broad regions; Europe, the Americas and Asia Pacific, this survey would tend to suggest that Europe is thriving, Asia Pacific is buoyant and the Americas, in particular the USA, is still recovering from the post-Enron fallout. Alternatively, the data equally suggests that the global power market is becoming less global and more regional with domestic deal values outstripping that of cross-border/international deal values. But whichever way we assess the raw data one inescapable conclusion stands out; the problems with the US power industry and the well documented, and ongoing, Enron saga caused both the stagnation in deal values in 2001/02 and the reversal in fortunes evident in 2003/04.

Two factors are driving the resurgence in deal values: market competition and rising wholesale electricity prices. In Europe, the directive for full wholesale competition by July 2004 has encouraged the larger players – the already vertically integrated utilities – to acquire smaller, distressed suppliers and generators in order to achieve further economies of scale and to bolster their competitive position. And with full competition to the retail/domestic level targeted for July 2007 further merger and acquisition activity should be expected. The caveat to this is the very impact on competition of this deal activity. European regulators have to date shied away from the issue and in doing so have allowed the creation of a small number of dominant utility groups with assets spread across generation, distribution and supply. But with prices being competitive at the onset of this process they could argue that the end consumer was not being disadvantaged, while the utilities could argue that through mergers and acquisitions they could offer better service levels. However, with wholesale prices of European gas and electricity rising significantly during the summer this argument is being slowly corrupted, and will arguably not hold through the second half of 2004 as suppliers ratchet up their supply tariffs.

The other interesting observation about the European market is the growing divergence between domestic and cross-border transactions. In the context of the ‘old’ 15–strong EU this makes sense. Through previous investment in non-domestic assets, Europe’s leading utility groups developed their optimum asset portfolios and now, with few notable non-domestic assets left, are focusing on sweeping up the smaller domestic suppliers to reinforce their domestic market share. But with the new accession countries having joined the EU in May it is likely that further cross-border acquisitions will be targeted by these dominant utilities, particularly if domestic regulators (and the European Commission) consider that these utilities’ acquisition-led growth strategies are now anti-competitive. Certainly there are some rich pickings in those member states that have recently joined the EU; many of them need to bring in outside investment to improve the local power network infrastructure.

Asia Pacific is, it would appear, loosely following the European liberalisation model with deal value growth linked into this market development. And as with Europe it is benefiting from the continued retrenchment in the US market. Where Asia Pacific differs from Europe, and which may impact on future deal values, is the absence of a homogenous market region comparable to that of the EU. It would be expected that, for this reason, most of the deal value would be domestic with the its level linked to the rate of competition. For this reason the countries of Australia, New Zealand, Singapore, Thailand, and the Philippines are expected to be some of the key target markets.

If the European and Asian markets are the main buyers of assets the primary seller continues to be the US. Coming up for three years since Enron, and the market is still in a slow recovery process, and its presence in the global market from its utilities is fast depleting. The problem for the US utility industry is whether it will be able to re-enter markets it has left. The perception of US commentators is that they can, and will, but this bullish tone tends to camouflage some market realities, such as cost. Since selling their European assets at knock down prices the rising wholesale price has significantly increased the asset value, bolstering the market entry barrier. Unless companies go bankrupt it is difficult to see US utilities re-entering Europe and Asia Pacific in the short to medium term.

But perhaps of more interest is the security of US domestic assets. With European utilities merger and acquisition activity slowly reaching maturity, as the number of new companies to buy reduces, where do these cash-rich entities invest next? The US market, which through the retrenchment of its utilities, is not in the rudest of health, may welcome a major acquisition field for non-domestic utilities. As such the power market may turn full circle from one where US utilities had a near global presence to one where it has very little and its domestic market is increasingly populated by foreign utility investment.