Gas: buy or build?

Industry Overview

The oil and gas industry is facing high market volatility due to geopolitical instability. Companies struggle to lock in new demand in a sector where oversupply is a big issue. The plunge in crude prices is leading big energy groups to cut their spending in order to make their business more sustainable. New alternative sources of energy, tougher environmental regulations and the unstable global economy, worsened by the slower growth of China, have contributed to a decrease in the oil demand. On the other hand, expectations of a low gas price in the short-term future have driven utility companies to invest more on gas businesses as a valid alternative to oil. Therefore, producers are expected to adjust their plans in order to hedge against future uncertainty. Refiners seek diversification in a market where the competition is fierce. The increasing consolidation activity allows to smooth increasing operating costs and boost revenues as well as to diversify portfolios.

Duke Energy

Duke Energy is the largest electric power holding company in the United States. It is headquartered in Charlotte and services more than 7.3 million U.S. customers.

Duke Energy’s businesses include power generation and gas distribution in US, Canada and Latin America. More specifically, in the US it has 57,500 megawatts of generating capacity from a diverse mix of coal, nuclear, natural gas, oil and renewable resources.

In Brazil the majority of its installed capacity of 2,307 megawatts comes from eight hydroelectric power plants.

Piedmont Natural Gas

Piedmont Natural Gas is a natural gas provider which serves more than 1 million residential and business customers in North Carolina, South Carolina and Tennessee. Headquartered in Charlotte, the company operates in US trough two units, respectively the regulated utility division and the non-utility division.

The regulated utility division accounts for more than 80 per cent of the adjusted earnings of the company. It also owns more than 22,300 miles of distribution pipelines and 2,910 miles of transmission pipelines.

Both Duke Energy and Piedmont Natural Gas are public companies traded on the New York stock Exchange.

Terms and structure

On Monday, October 26th Duke Energy announced that it planned to buy Piedmont Natural Gas for $4.9 billion in cash while covering $1.8 billion company debt. It is agreed that shareholders will receive an amount of $60 per share, a 40 percent premium to the closing price on Friday 23rd, once the deal is closed by the end of 2016. As a result, the company will expands its operations in 7 states and 8.8 million electric and gas customers in total. Taking into account the fact that the switch for duke energy from coal to gas would represent a key factor for future growth opportunities, they offered a price twice the fair value of Piedmont stock as estimated by Morningstar. The deal rationale is that regulated gas companies are offering stable returns while gas demand, instead of electricity, is expected to grow in the next foreseeable future. As for markets reaction, Piedmont’s stock rose by 37% after the announcement whereas Duke fell by 2% remarking investors’ concern over the premium paid. Goldman Sachs represented Piedmont while Barclays served as a financial advisor for Duke.

Transaction drivers

The main driver of the deal is for Duke Energy to expand its business in the natural gas sector by boosting its natural gas infrastructure and reducing its exposure to coal. First of all, as stated by Duke Management, the acquisition of Piedmont Natural Gas will enable the company to triple the number of its existing gas customers (500’000) adding nearly one million customers to Duke Business in operating countries.

Secondly, as a consequence of the acquisitions of Piedmont Natural Gas, Duke Energy will have almost all its earnings originating from regulated assets. Regulated gas companies are able to offer more stable reliable returns, especially if compared to other commodity-based companies, which themselves reported a strong volatility in their earnings, deeply affected by the big fall in commodity prices.

The trend of Energy Utility companies expanding their sphere of influence to regulated businesses such as natural gas distribution has been notable over the past year. In particular, taking place late in August, a deal very similar to the acquisition of Piedmont involved Southern Company acquiring AGL Resources, a natural gas infrastructure company sharing the same geographical areas of operations. Earnings from regulated assets represent a key strategy for Energy Utility companies, allowing them to reduce their risk and strengthening their balance sheet as well as their credit ratings.

To contact the authors:

Marcello Reccia               

Stefano Rovelli                

Francesco Brambati        

Maxim Grama                 

Luca Papa