The first quarter of this year was a monster for merger and acquisition activity in the power sector, with 22 deals larger than $50 million announced for a total of $41.4 billion in value. The United States power mix is in a state of flux, and nothing draws in the smart money like volatility.

“We saw a continuation of a theme we’ve been talking about for a while – this investment around the infrastructure to support the changing electricity supply in the United States,” said PwC's Jeremy Fago, who leads the firm's power and utilities deals segment.

The first quarter of of 2016 marked a ”pretty big pickup” in M&A activity, said Fago, with 64 deals overall — more than any other quarter in the last year. Compared to the first quarter of 2015, total deal value increased by 508%, and the average deal size increased by 93%, from $972 million to $1.9 billion.

Gas commodity prices are certainly a factor, sitting at historically-low levels and practically goading electric utilities to dip in a toe. But while natural gas might impact the viability of some deals, or the rate of acquisition activity, Fago said it's actually a smaller part of a change that is in the works regardless.

And the shift away from coal towards renewables is on, no matter how the courts land on the Clean Power Plan. The Obama Administration's rule is certainly pressing the case and speeding M&A activity, Fago said. Despite that, renewable energy companies made up just 3% of deal activity in the first quarter.

The biggest driver isn't one particular sector or a low commodity price, but a broad trend of change throughout the utility industry.

“All of the infrastructure supporting that generation is where people see a lot of opportunity for investment and capital deployment,” Fago said.

All things being equal, the United States has a friendly regulatory regime allowing for steady returns and safe investment, he said. “The U.S. is ripe for opportunity, given the massive changes we're seeing in the country,” Fago said. “Changes are happening and the opportunities are on the back end, to  deploy capital to really meet the infrastructure changeovers that are necessary in this country.”

Why did renewables make up just 3%?

First, renewables. The heir-apparent story of the day and essential to meeting broad carbon reductions, renewable power deals made up just 3% of the deals by value – down from 8% in the previous quarter. Two factors are driving this decline, said Fago: broad declines in YieldCo stocks, which had been market darlings just a year ago, and the extension of tax credits for wind and solar projects.

“Every time we see the tax credits come up to that cliff where they expire, we see an exponential pickup in deal activity,” Fago said. “As developers look to get their projects online, the need for capital to get those done in time to capture the tax benefits becomes more accelerated. We always see deal activity pick up around the expiration of incentives.”

With both solar and wind tax credits now settled, deal activity declined. But Fago said that wasn't the biggest impact. In the second quarter of last year, about 90% of renewable deal value was driven by YieldCos – public companies formed to own operating assets and produce a predictable cash flow and dividends. Because of the way they are valued, growth is vital to their valuation. Some eight out of 10 deals in Q2'15 were YieldCo deals, Fago said.

“YieldCos were all over the M&A space, purchasing assets to feed the vehicles,” Fago said. “As capital markets traded down on the YieldCo stocks, that's become problematic … they're not in a position to acquire like they were before.”

So what depressed the YieldCos?

When YieldCos first entered entered the market, the big questiions were "how quickly YieldCos could grow, the number being formed and how big they would ultimately get,” Fago said. “When you're talking about growing dividends 10%, 20% year-over-year, the question is, 'How many assets are available for that, and at what point do you start taking on more risk?'”

“I think the market got a little bit concerned about the ability for the broad sector to grow as significantly as expectations were being set," he said. "That was probably the biggest driver of their sell-off.”

The subsequent rise in the cost of capital for those companies opened up the space for more potential buyers.

A quick look at YieldCos like Abengoa Yield PLC, 8Point3 Energy Partners LP and NRG Yield shows broad declines in the last four quarters. Abengoa's share price fell from almost $40 last May to under $20 today. 8Point3 (formed by First Solar and SunPower, the name represents how long it takes sunlight to reach the Earth, in minutes) now sits around $16/share, down from $20. NRG's investment vehicle tumbled from $25 to about $15/share.

So with YieldCos no longer a rising star, what happens to renewable deals? 

Fago said he expects deal volume to rise, “but the interesting question is, who are the buyers?” Infrastructure funds, private equity and hybrid utilities will all be looking to the renewable space as the sheer volume of assets inevitably rises.

“The Clean Power Plan, in my mind, was almost somewhat of a national renewable policy – just, indirectly,” Fago said. “Because of the compliance options … that has the potential to open up a lot of renewable development across the country, and there is still a lot of area for consolidation, whether that be at the developer level or bringing operating portfolios together.”

It's not all about cheap gas

Electric utilities are looking to gas investments for a variety of reasons, and while cheap natural gas is one factor — investments in production or pipeline capacity would help ensure cheaper supply — Fago said it is only one part of the commodity's impact.

Overall, the potential for customer diversification, reversing declining loads, and broad sector growth are all pushing consolidation. 

"I think the bigger driver of some of the electric utilities looking at gas assets is diversification of customer base, particularly on the LDC side," he said. "On the electric side we continue to see stagnant to zero, to in some cases negative load growth, given demand side pressures."

And in addition to the diversification, Fago said companies are chasing "the growth opportunity on those portfolios after acquisition."

"We have all of this gas and it's completely shifted the flow of natural gas," Fago said. "I think you're going to continue to see electric utilities looking at gas assets … for growth potential and diversification of customer base, but also kind of a vertical integration, because their portfolios are shifting."

Interest in gas plays will continue to rise, but it's not the commodity price. Instead, Fago said the it will be the longer-term opportunities to deploy capital within the gas fields, because of the further investment that will be needed to support the evolving electric grid.

"The supply stack in this country is shifting from baseload coal and sometimes nuclear, to gas and renewables. That's going to be the key driver, not necessarily the commodity price itself," he said.

Change in the U.S. power sector drawing foreign interest

PwC noted a rise in "inbound deals" this quarter, particularly from Canada. There were five total inbound deals, but they accounted for 71% of the deal value. The quarter before, there were only three inbound deals.

In February, for example, Canadian company Fortis Inc. announced today an $11.3 billion deal to acquire Michigan based ITC Holdings, in a strategic move to enter the U.S. transmission market. The deal combines $6.9 billion in cash plus Fortis Shares for ITC shareholders, while assuming $4.4 billion in debt. The combined companies would have an estimated enterprise value of $30 billion. 

Fortis said that ITC's economies of scale and geographical situation positioned it to take advantage of the "significant transmission investment opportunity."

Look for more deals like that one, Fago said, as the changes in the United States create investment opportunities for foreign capital.

"You've got generation opportunities, transition opportunities, and then obviously the pipeline opportunities supporting the generation changeover. And then you've got a pretty nice regulatory construct, broadly speaking when you look at regulated business," Fago said. "I think because of predictable, stable, good yielding opportunities, you're smarting to see a lot of international interest from funds with certain investment requirements, looking for somewhat stable cash flows and growth."