Decarbonizing M&A: How Legislation Is Changing the Landscape

You might have noticed that decarbonization is taking up a lot of space on legislative and policy agendas at every level of U.S. government, from the Inflation Reduction Act to the Department of Energy’s Industrial Decarbonization Roadmap to building decarbonization laws enacted at the state level.

And that’s not mentioning the international movements, including the Paris Agreement and investor initiative Climate Action 100+, both pushing firms to reach net zero emissions by 2050 or sooner.

Organizations seeking sustainability—either because of internal factors or external pressures—are looking for ways to implement decarbonization in every step of their operations. Unsurprisingly, that’s having a big impact on M&A activity in the decarbonization space, for private equity firms and strategics alike.

Legal Incentives Pave the Way for M&A

While pressure from internal and external stakeholders, sustainability concerns and reputational interests all play a part in the shift, legislation is likely the biggest factor in driving decarbonization-focused M&A.

“Long-term decarbonization drives M&A as it encourages companies to acquire clean energy assets and technologies vital to comply with the growing number of global environmental laws and regulations,” explains Sebastian Montoya, the co-founder of M&A Community, a forum dedicated to connecting dealmakers and focusing on the latest M&A trends.

Legislation has pushed decarbonization and green energy with both the stick (tougher laws and regulations) and the carrot (tax incentives). “The federal investment tax credit and production tax credit have been the cornerstone federal policies for the past 15 years for driving renewable energy investment at a national scale,” explains Michael Korengold, CEO of impact investment firm Enhanced Capital Partners. “The 2022 Inflation Reduction Act is now…enabling quicker adoption of new technologies such as standalone battery storage and clean hydrogen, especially with new and extended tax credits and designating capital to energy transition infrastructure.”

And this legislative emphasis on decarbonization is driving dealmaking. In the energy sector, Jennifer Park, chief editor of loan acquisition firm Amerinote Xchange, says strategic acquirers are looking to acquire businesses that can provide the green energy they need to comply with laws and regulations as well as qualify for incentives.

But there are also less measurable positive outcomes of these acquisitions, with Park noting that such investments can help strategics “gain a better reputation among customers, employees and stakeholders, and position them as leaders in the transition to a low-carbon economy.”

New laws may well be on the way, such as a carbon tariff bill reportedly in the works, which will likely accelerate the demand for deals that help businesses decarbonize.

The Big Picture

Decarbonization is becoming a major driver of M&A globally, as well as in the U.S., as the pressure to meet ambitious goals continues to attract capital and investors looking for growth prospects.

Strategic acquirers are looking towards acquisitions as a way to move the needle on their own decarbonization efforts, with some high-value international deals emerging as a result. They include that of  U.S.-based Avangrid, the third-largest energy firm in the world, which issued $4 billion of stock in 2021 in a private placement to Qatar Investment Authority (QIA) and Spanish energy firm Iberdrola. QIA supports a robust, sustainable energy strategy and has also acquired a 50% stake in Italy’s Enel Green Power, positioning the country to continue to make moves in the decarbonization space.

The high-growth potential of the decarbonization sector has also drawn interest from major infrastructure investment funds around the world. JP Morgan Investment Management’s own Infrastructure Investments Fund recently acquired a 60% stake in Italian energy company Falck Renewables, with plans to execute more acquisitions in 2023.

Meanwhile, private equity firms are increasingly prioritizing ESG in their deal sourcing and investment activities. In fact, recent research from Malk Partners finds that 100% of the PE funds they surveyed already incorporate ESG into their investment process, citing LP demand, risk management and value creation among their reasons for doing so.

“We have observed energy transition-focused PE firms as well as larger international clean energy developers acquiring smaller players with regional development and construction expertise or specific tech knowledge,” Korengold says. “The need to decarbonize our grid and industry helps bring new players into the space who are likely to partner with existing market leaders in order to scale.”

The middle-market is getting its piece of the pie, too, with decarbonization-focused M&A deals landing in the news in recent months.

Middle-market private equity firm Ara Partners, which is focused on decarbonization investing, recently invested in  CF Pathways, a company providing environmental risk management and other net-zero solutions, and Wattstor, a provider of automated carbon reduction and electricity cost-saving technology, for example.

And Korengold’s own firm, Enhanced Capital, teamed up with Crossroads Impact Corp, a holding company focused on community development investments, to fund a capital investment in Solar Landscape, a solar power provider, last December. “Our experience pairing tax credits and private capital gives us an effective playbook to support a clean energy economy and projects supporting wind energy, microgrids, EV infrastructure, carbon capture and battery storage while generating risk-adjusted returns,” Korengold said in a statement at the time.

This is likely just the beginning of a long-term trend of decarbonization-driven deals in the middle-market space. Earlier this year, McKinsey estimated that up to $275 trillion in investment will be needed to transition to net-zero greenhouse gas emissions by 2050, noting that private investors could contribute up to 55% of that figure, while institutional investors, including private equity firms, may provide as much as $1.5 trillion of that amount. With major global firms leading the way, middle-market companies and their PE sponsors are likely to follow suit.

“We anticipate seeing more new entrants and M&A activity in the space, as we pursue the local, state and national decarbonization targets,” Korengold says. “Much work remains to be done, but we see a lot of positive momentum across the industry to help us get there.”

Hilary Collins is ACG’s Associate Editor.

Kiara Taylor has worked as a financial analyst for more than a decade, filling a number of roles including as a equity research analyst, emerging markets strategist, and risk management specialist.