The energy trading business has seen its fair share of participant realignment over the years, as various financial institutions, utilities, and other companies have come in and out of the business, sometimes in spectacular fashion. With the impending implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“the Act”), we may be on the cusp of another great upheaval in the industry, as various participants choose to avoid some of the more burdensome provisions of the Act by exiting the business or limiting their participation, while others choose to leverage their investment in systems and regulatory knowledge through expanded operations.
As these participants come and go, they often face the issue of how to sell out of, or buy into, an existing portfolio of energy commodity trades. In some ways, these transactions are like any other acquisition or divestiture of a line of business. However, there are some unique aspects of these transactions that, if improperly navigated, can visit great misery on the buyers and/or sellers. This article describes a typical energy portfolio acquisition transaction and suggests ways to identify and avoid those potential pitfalls.
A Typical Transaction
While it is somewhat dangerous to use the adjective “typical” when describing any energy trading acquisition, there are some common elements. These transactions are almost always run, at least initially, through a large bidding process where the seller determines exactly what is being sold and how it is being packaged. Generally, the seller will be selling either the entire business (employees, systems, and contracts) or just a portfolio of contracts. Each potential bidder is allowed, at this stage, some limited due diligence to come up with a proposed bid. Once the seller evaluates all bids, it will typically choose a limited number of buyers for further negotiations. At this point, the selected bidders will have the ability to conduct additional due diligence and will likely be invited to submit detailed comments on the transaction structure and related documentation. At some point, the seller will enter into exclusive negotiations with one buyer, and the final transaction documents will be negotiated and executed.
The transaction documents will usually involve some period, after signing, for the parties to obtain all necessary government approvals and third-party consents. For transactions that include Federal Energy Regulatory Commission (FERC) regulated gas storage and transportation contracts, for example, the parties will seek a waiver of certain FERC requirements related to the transfer of such contracts. While these approvals are pending, the parties will begin the process of asking trading contract counterparties to agree to novate their trading positions to the buyer, with the actual novation contingent on closing the purchase and sale of the portfolio (a novation differs from an assignment in that it replaces the seller with the buyer as if the buyer had signed the original contract). Once all consents and approvals are obtained, the parties will establish a closing date, agree to a purchase price adjustment to reflect the change in value of the portfolio since signing, and close the transaction.