Foreign Direct Investment in the Energy Sector: Three important trends
The Covid-19 pandemic has powerfully boosted the expansion of foreign investment control regimes globally. These regimes now cover a wide range of sectors, going beyond the traditionally sensitive sectors (e.g. national security and defence) and even capturing acquisitions of non-controlling shareholdings.
This expansionary trend has been particularly pronounced in the energy sector. This sector – and in particular, the security of energy supply – had already been high on the political agenda of most governments, given that energy is a key input for economic development. Security of supply is an important concern due to the rising demand for energy worldwide, as well as the heavy reliance of some countries on energy from imported sources. As a result, there are growing concerns that the acquisition by foreign entities of strategic energy infrastructure could disrupt countries’ security of energy supply.
We have observed a number of important trends which are set out below.
Almost any energy-related transactions may be caught
In recent years, the type of energy transactions subject to foreign investment screening has broadened considerably. Some screening mechanisms cover not only the entire supply chain (e.g. exploration, production, transportation, storage, wholesale and retail distribution) but also all key infrastructures or technologies, or activities which are crucial to these infrastructures. This can include all technologies and software used in this sector, the processing of related personal data and real estate assets needed for energy-related activities.
The EU FDI Screening Regulation lists critical infrastructure (including energy), critical technologies (including energy storage as well as quantum and nuclear technologies), and the supply of critical inputs (again, including energy) among the factors which Member States and the European Commission are to take into account when assessing whether an investment may affect security or public order. Similar wording is reflected in some of the foreign investment regimes of EU Member States.
In France, for instance, activities relating to infrastructures, goods or services which are essential to guarantee the integrity, security or continuity of energy supply, are subject to screening, without any materiality threshold. In addition, any R&D activities in relation to energy storage fall under the purview of the Treasury. Similarly, the current broad language of the Italian Golden Powers Regulation, can be construed as enabling the Italian government to review almost any deal involving companies active in – or having assets linked to – the energy sector. As for Germany, a cross-sector investment review is mandatory for deals touching upon the supply of electricity, gas, fuel, oil, and district heating, or certain technologies used to operate such infrastructures, if certain quantitative thresholds are met. Further, with the most recent reform, which came into force 1 May 2021, alongside a range of other activities, Germany has also added the manufacturing of smart meters and certain components to the list of sensitive activities.
This broad scope is not limited to the EU. In the UK, the energy sector is one of the 17 sectors that will be subject to mandatory notification under the new National Security and Investment Act 2021. Although the precise definitions are yet to be finalised, it is anticipated that this will encompass a broad range of activities in the energy space. This notably includes licensed transmission, distribution and interconnector operators; material electricity generators and aggregators; key petroleum terminals, pipeline and infrastructure; and significant fuel suppliers. Given the broad jurisdictional scope of the new regime, it is expected that many transactions in the energy sector will be subject to mandatory notification.
In the U.S., CFIUS has jurisdiction over energy deals involving facilities for generating, storing, transmitting, or distributing electricity in the U.S., as well as for oil and gas refineries, pipelines, and storage facilities, and oil and gas terminals at key maritime ports. CFIUS also has the right to review any deal resulting in a foreign person owning or otherwise controlling real estate in the U.S. which is located near sensitive government facilities and activities; this jurisdiction often covers sites used for renewable energy projects.
Depending on the identity of the investor and the sensitivity of the infrastructures, prohibitions are (more) likely to occur
While prohibitions of foreign investments are usually rare (click here for our post on recent Foreign investment prohibitions in Europe), several precedents from the last few years concern the energy sector.
In 2012, the U.S. President, on the advice of CFIUS, ordered the unwinding of the acquisition of wind farms located in close proximity to certain sensitive U.S. Navy training areas by Ralls Corporation, a U.S. company owned by two Chinese investors. The decision was later overturned by a court for administrative reasons, but the case is still an indicator of CFIUS’s concern with such transactions.
Similarly, in 2016, the city of Antwerp blocked China’s State Grid bid to acquire a 14% stake in the Belgian electricity and gas distributor Eandis (now Fluvius).
In the same vein, in 2016, Australia opposed competing bids from China's State Grid and Hong Kong-listed Cheung Kong Infrastructure Holdings for the acquisition of the country’s biggest energy grid, Ausgrid, after they failed to overcome security concerns. In 2018, it also prohibited the acquisition of Australian gas pipeline company, APA Group, by Cheung Kong Infrastructure Holdings.
Finally, in 2018, Canada blocked the acquisition of Aecon by China Communications Construction Co on national security grounds.
These precedents, which all concern Chinese investors, underscore the rising wariness of Chinese firms buying up strategic infrastructure assets in Western countries.
The absence of a foreign investment screening mechanism does not preclude transactions from review
In light of the energy sector’s strategic importance, practice shows that even where governments do not have specific foreign investment control powers, they tend to implement new screening regimes without delay, in order to intervene in any energy-sector transactions they deem problematic.
For instance, in 2014, when General Electric sought to acquire Alstom’s nuclear energy operations, the French government extended the list of sectors subject to foreign investment screening in less than a month, to have a say on the transaction.
More recently, the Slovakian government adopted an energy-specific foreign investment regime in just a week. This was triggered by concerns over the ownership of Slovenské elektárne, an electricity provider, when Russian State-owned bank Sberbank called on major shareholders to offer their shares as security against an outstanding loan.
Even if unable to review an investment through their foreign investment regime (or absent such a regime), governments can still, if necessary, oppose the acquisition of strategic infrastructures by investing in the target themselves or threatening to do so. For example, in 2018, in response to an attempt by China’s State Grid to buy a 20%-stake in the German transmission grid operator 50Hertz, the German state instructed its state-owned development bank (Kreditanstalt für Wiederaufbau, KfW) through an assignment transaction to acquire this stake. Ultimately, the State used a back-to-back arrangement with co-shareholder Elia, Belgium’s transmission system operator, which acquired the participation through a pre-emption right and immediately passed it on to KfW.
As governments grow wary of undesired influence over their critical infrastructure and the potential impact on security of supply, the energy sector is increasingly falling within the purview of screening mechanisms. This trend, on top of long-established merger control mechanisms, is creating additional hurdles and uncertainty for transactions. Parties to energy-related transactions, now more than ever, need to ensure that foreign investment filing requirements and associated risks are factored into their timetable and assessment.
And foreign investment risk is not limited to Chinese investors. While the highlighted cases surely relate to such investors (mostly State-owned), we are aware of a range of transactions – including by Western investors – which have received a higher degree of scrutiny.
Energy is mostly about highly regulated physical infrastructures and as a result, it is not always clear what a country’s concerns are focussed on – investors have no means to shut down the infrastructures and typically only make the investment in order to benefit from stable returns through regulated grid charges.
However, with the shift to carbon neutrality and more environmental awareness, certain energy infrastructures – in particular electricity generation, electricity grids and electricity retail supply – are becoming even more critical for the entire industry than they are today. For instance, it is projected that the German chemical industry will consume as much electricity as Germany produces today by 2045, being the year when Germany aims to achieve carbon neutrality. This means there will be very significant investment needs over the coming years and a high degree of dependency of the entire economy on a well-functioning electricity sector (but equally on inflows of foreign capital to finance such investments).