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Risk in Context

Four Critical Risks for Investors Eyeing US Midstream Energy Assets

Posted by Robert Robideaux April 21, 2015

As valuations become more attractive, private equity investors, armed with an estimated US$1.22 trillion in “dry powder,” have their sights set on the energy industry. They’re particularly focused on midstream assets, including oil and gas gathering, transportation pipes, and storage facilities with stable revenue profiles.

As private equity investors look for midstream energy targets, they would do well to consider four specific risks around mergers and acquisitions (M&A):

  1. Environmental Risk
    Environmental risk is well documented, especially in midstream transportation and storage. Identifying, quantifying, and managing environmental risk is a priority during M&A due diligence and portfolio operations. An energy M&A transaction should include environmental liability insurance, which can provide coverage for numerous risks, from pre-existing pollution conditions to counterparty credit risks.
  2. Tax Liability Risk
    During a transaction, buyers are often exposed to tax situations that can present significant contingent risk to the ongoing business. Tax indemnity insurance can cover the cost of the tax treatment if it’s successfully challenged by a taxation authority. In most cases, the cost of defending the tax position can also be covered. All tax issues should be discussed with your internal and/or external tax counsel.
  3. Counterparty Credit Risk
    To make their assets attractive to potential buyers, sellers may provide guarantees through fee-based demand-payment contracts. These provide revenue certainty for investors, since they’re paid whether or not hydrocarbons are produced at the well. For investors, this replaces commodity or volumetric risk with credit risk. Put simply, can the seller honor its payment commitments? It’s a risk to carefully assess — and potentially transfer — before buying these assets.
  4. Post-Acquisition Operational Risks
    Operational risks can impact revenue, bankability, and debt covenants. These can be cumbersome when assuming projects already under construction, particularly with risk of loss/delay in liquidated damages in an engineering, procurement, and construction contract. Another area of concern: how the new portfolio aligns with covenants of the debt package, specifically revenue protection and related insurance requirements.

Related to:  Energy

Robert Robideaux