APRIL 28, 2014 © 2014 Dow Jones & Company, Inc. Energy...
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APRIL 28, 2014 © 2014 Dow Jones & Company, Inc. Energy Investors Look for Second Act to Shale Gas Bonanza By Shasha Dai Even if the shale gas rush is over, many investors think there are lucrative opportunities still to be had because of the yawning need for capital in the energy sector. But more of them are shifting their focus away from gas. OilRigSunset_WEBThe announcement of Pine Brook closing its second growth equity fund above target at $2.43 billion came just a few days before The Wall Street Journal reported that Energy Future Holdings Corp. was flirting with filing for bankruptcy protection. Pine Brook's success was representative of the capital pouring into private equity firms specializing in energy at a time when many firms out raising capital have come away disappointed from meetings with potential limited partners. Energy has gone through a multiyear boom, private equity has been an important source of capital, and the returns have been eye- catching. But the news about Energy Future Holdings holds a warning about where investors can go wrong in making directional bets on energy prices. The company, formerly known as TXU Corp., was bought by Kohlberg Kravis Roberts & Co., TPG Capital and Goldman Sachs Capital Partners for about $45 billion in equity and debt in 2007 but then foundered as natural gas prices tumbled. Major1_WEBNow, general partners are contemplating the best places to invest amid an uncertain outlook for natural gas and oil prices and a recognition that much of the easy money has been made in popular investment areas like shale gas. "We were lucky to be around the shale play in 2008 and 2009. That's when the early or easy money was made," said Michael McMahon, a managing director in Pine Brook's energy investment team. "That is no longer possible." Many investors think there are lucrative opportunities still to be had because of the yawning need for capital in the energy sector. But more of them are shifting their focus to oil and away from gas, as well as to foreign markets and to more conservative investments containing proven reserves. Despite the long cold winter in the U.S. pushing gas futures prices above $6 per million British thermal units in February - the highest level in six years - prices in April were back down to about $4.5 per million BTUs, far below the double-digit figures recorded in 2008. "Gas got better, but relative to the returns you get on oil projects, it's not even close," John England, U.S. oil and gas leader at consulting firm Deloitte LLP, said in a recent report. Major2_WEBThe private equity industry has in part become a victim of its own success because the high gas inventory prior to this past harsh U.S. winter was partly the result of greater production from shale formations, an area in which private equity firms had been a major investor over the last few years. However, not everybody in private equity is running from natural gas. Washington, D.C., firm EIG Global Energy Partners, for instance, is "midterm bullish" on gas prices, said co- founder and Chief Executive Blair Thomas. Believing that gas prices may rise to $5 to $6 per million BTUs in the next few years, Mr. Thomas said he thinks now is a good time to buy dry gas properties. By contrast, firms are almost unanimous in their belief there will be rising demand for oil globally for the foreseeable future. "Oil is in vogue; gas is not," said Jordan Marye, a managing director at Denham Capital. The Land Grab Is Over This shift in interest means firms are taking different investment approaches. For one, back in the late 2000s, private equity shops and the management teams they backed were focused largely on "land acquisition" plays in such major shale basins as Marcellus, Bakken, Permian and Eagle Ford, said Alex Krueger, president and co-head of buyouts at First Reserve Corp. Now, however, "most basins relevant for the next 10 years have played out from a land perspective," he said. The land grab at U.S. shale formations over the past few years has largely been completed, with the pace of buying new acreage slowing down last year over 2012 levels, according to advisory firm Deloitte LLP. Accordingly, firms are "rebalancing" toward exploitation of existing properties, said Denham's Mr. Marye. "That's a good thing, because energy is a capital-, people- and operation-intensive industry, and firms need to focus on a much smaller number of projects." Another change in firms' approach is that when they do purchase energy assets, they tend to focus on proven producing properties, rather than unproven, undrilled areas. Denham, for instance, is targeting oil and gas producing properties in which finding costs are relatively low, that have proven but untapped reserves - or "lots of running room" in Mr. Marye's words - and are near pipeline and gathering systems. A third change is that firms are now not only looking to develop what they call unconventional reserves, such as shale formations in the U.S. and oil sands in Canada, but they are also interested in conventional reserves, or areas where oil and gas have been produced for decades, with what is deemed decreasing production potential. Over the last few years, many THE PUBLISHER'S SALE OF THIS REPRINT DOES NOT CONSTITUTE OR IMPLY ANY ENDORSEMENT OR SPONSORSHIP OF ANY PRODUCT, SERVICE, COMPANY OR ORGANIZATION CUSTOM REPRINTS (609) 520-4331 P.O. BOX 300 PRINCETON, NJ 08543-0300. DO NOT EDIT OR ALTER REPRINTS, REPRODUCTIONS NOT PERMITTED
Transcript of APRIL 28, 2014 © 2014 Dow Jones & Company, Inc. Energy...
APRIL 28, 2014 © 2014 Dow Jones & Company, Inc.
Energy Investors Look for Second Act to Shale Gas BonanzaBy Shasha DaiEven if the shale gas rush is
over, many investors think there arelucrative opportunities still to be hadbecause of the yawning need for capitalin the energy sector. But more of themare shifting their focus away from gas.
OilRigSunset_WEBTheannouncement of Pine Brook closing itssecond growth equity fund above targetat $2.43 billion came just a few daysbefore The Wall Street Journal reportedthat Energy Future Holdings Corp. wasflirting with filing for bankruptcyprotection.
P ine Brook ' s success wasrepresentative of the capital pouringinto private equity firms specializing inenergy at a time when many firms outraising capital have come awaydisappointed from meetings withpotential limited partners. Energy hasgone through a multiyear boom, privateequity has been an important source ofcapital, and the returns have been eye-catching.
But the news about EnergyFuture Holdings holds a warning aboutwhere investors can go wrong inmaking directional bets on energyprices. The company, formerly knownas TXU Corp., was bought by KohlbergKravis Roberts & Co., TPG Capital andGoldman Sachs Capital Partners forabout $45 billion in equity and debt in2007 but then foundered as natural gasprices tumbled.
Ma jo r 1 _WEBNow, gene ra lpartners are contemplating the bestplaces to invest amid an uncertainoutlook for natural gas and oil pricesand a recognition that much of the easymoney has been made in popularinvestment areas like shale gas.
"We were lucky to be around theshale play in 2008 and 2009. That's whenthe early or easy money was made,"said Michael McMahon, a managing
director in Pine Brook 's energyinvestment team. "That is no longerpossible."
Many investors think there arelucrative opportunities still to be hadbecause of the yawning need for capitalin the energy sector. But more of themare shifting their focus to oil and awayfrom gas, as well as to foreign marketsand to more conservative investmentscontaining proven reserves.
Despite the long cold winter inthe U.S. pushing gas futures pricesabove $6 per million British thermalunits in February - the highest level insix years - prices in April were backdown to about $4.5 per million BTUs, farbelow the double-digit figures recordedin 2008.
"Gas got better, but relative tothe returns you get on oil projects, it'snot even close," John England, U.S. oiland gas leader at consulting firmDeloitte LLP, said in a recent report.
Major2_WEBThe private equityindustry has in part become a victim ofits own success because the high gasinventory prior to this past harsh U.S.winter was partly the result of greaterproduction from shale formations, anarea in which private equity firms hadbeen a major investor over the last fewy e a r s .
However, not everybody inprivate equity is running from naturalgas. Washington, D.C., firm EIG GlobalEnergy Partners, for instance, is"midterm bullish" on gas prices, said co-founder and Chief Executive BlairThomas. Believing that gas prices mayrise to $5 to $6 per million BTUs in thenext few years, Mr. Thomas said hethinks now is a good time to buy drygas properties.
By contrast, firms are almostunanimous in their belief there will berising demand for oil globally for theforeseeable future. "Oil is in vogue; gasis not," said Jordan Marye, a managingdirector at Denham Capital.
The Land Grab Is Over
This shift in interest meansfirms are taking different investmentapproaches. For one, back in the late2000s, private equity shops and themanagement teams they backed werefocused largely on "land acquisition"plays in such major shale basins asMarcellus, Bakken, Permian and EagleFord, said Alex Krueger, president andco-head of buyouts at First ReserveCorp. Now, however, "most basinsrelevant for the next 10 years haveplayed out from a land perspective," hes a i d .
The land grab at U.S. shaleformations over the past few years haslargely been completed, with the pace ofbuying new acreage slowing down lastyear over 2012 levels, according toadvisory firm Deloitte LLP.
A c c o r d i n g l y , f i r m s a r e"rebalancing" toward exploitation ofexisting properties, said Denham's Mr.Marye. "That's a good thing, becauseenergy is a capital-, people- andoperation-intensive industry, and firmsneed to focus on a much smallernumber of projects."
Ano ther change in f i rms 'approach is that when they do purchaseenergy assets, they tend to focus onproven producing properties, ratherthan unproven, undri l led areas.Denham, for instance, is targeting oiland gas producing properties in whichfinding costs are relatively low, thathave proven but untapped reserves - or"lots of running room" in Mr. Marye'swords - and are near pipeline andgathering systems.
A third change is that firms arenow not only looking to develop whatthey call unconventional reserves, suchas shale formations in the U.S. and oilsands in Canada, but they are alsointerested in conventional reserves, orareas where oil and gas have beenproduced for decades, with what isd e e m e d d e c r e a s i n g p r o d u c t i o npotential.
Over the last few years, many
THE PUBLISHER'S SALE OF THIS REPRINT DOES NOT CONSTITUTE OR IMPLY ANY ENDORSEMENT OR SPONSORSHIP OF ANY PRODUCT, SERVICE, COMPANY OR ORGANIZATIONCUSTOM REPRINTS (609) 520-4331 P.O. BOX 300 PRINCETON, NJ 08543-0300. DO NOT EDIT OR ALTER REPRINTS, REPRODUCTIONS NOT PERMITTED
conventional properties have been sold,largely by big energy corporations.
Major3_WEBThat is an area intowhich private equity firms and privateequity-backed companies come intoplay, scooping up older wells andapplying the same techniques they didwith shale wells, such as hydraulicfracturing and horizontal drilling,hoping that they will unlock oil and gasthat has historically been off-limits toconventional drilling techniques.
Northern Blizzard ResourcesInc., a Riverstone Holdings-backedcompany, was one example. In 2010, theCalgary, Alberta, business paid 975million Canadian dollars for NexenInc.'s heavy oil properties in WesternCanada, assets that are located in an"old and tired" basin, said DavidLeuschen, a Riverstone co-founder.Northern Blizzard then pumped freshcapital into the field, drilling a new wellevery one-and-a-half days, improvingoperations of existing wells andenhancing oil-recovery processes.
In general, Riverstone aims todouble or triple production reserves orcash flow of its portfolio companiesdur ing i t s ownersh ip , sa id Mr.Leuschen , w i thou t comment ingspecifically on Northern Blizzard.
Non-U.S. Markets BeckonOther countries may also provide
investment opportunities. Mexico, forinstance, is opening up its energyindustry for the first time since thecountry nationalized the industry in1938. Deloitte said in the recent reportthat the reform could "encourage jointventures and acquisitions on both sidesof the border" as Mexico's national oilcompany, Petroleos Mexicanos, maylook to update its expertise.
Mexico is one market Riverstoneis actively reviewing for both onshoreand offshore production operations,according to the firm's partners. Mr.Leuschen said the opportunity set inthat country is similar to that in the U.S. across various subsectors, includingd e e p - w a t e r e x p l o r a t i o n a n ddevelopment; exploi t ing dri l l ingopportunities on the Gulf of Mexicoshelf; building and acquiring pipelines,gathering systems and processingplants; exploring shale formationsacross the border from Texas; andbacking and building oil-field servicescompanies.
T h e G u l f o f M e x i c o , i nparticular, offers rich deep-waterdrilling and production potential, said
Mr. Leuschen. Riverstone first got intothe Gulf area in 2004, backing acompany cal led Mariner Energy,primarily to develop oil and gas in deepwater. A second investment, CobaltInternational Energy Inc., a deep-wateroil and gas producer in the Gulf, wentpublic in late 2009 and was among thebetter performing investments inRiverstone's earlier funds.
Elsewhere, Riverstone seesopportunity to develop oil and gas in theNorth Sea, although the opportunitiesare fewer than those in North America,said co-founder Pierre Lapeyre. Inaddition, unconventional oil and gasproperties in the U.K. and on theEuropean continent represent prospectsfor private equity firms to applyunconventional drilling and productiontechniques similar to what they did withshale plays in the U.S., said Mr.Lapeyre.
No Crystal Ball on Oil PricesTrafficMerge_WEBIn theory,
though, firms' bets on strong oil pricescould also go wrong, as they did withnatural gas prices. A March article inBarron's, which like this magazine ispublished by Dow Jones & Co., citedanalysts predicting oil prices coulddecline to $75 per barrel over the nextfive years from the current $100 or so.New discoveries of oil in the U.S. andelsewhere and weaker demand globallybecause of increased alternative energyconsumption place downward pressureon prices, according to the Barron'sreport. If that prediction materializes,many of the firms' oil investments mayend up being unprofitable, at least inthe short term.
In reality, few firms are willingto predict oil prices. "Our crystal ball isas murky as anybody else's," saidRiverstone's Mr. Leuschen. He addedthat while Riverstone does hedgecommodity price risk, as many otherfirms do, it focuses more on multiplyingits companies' reserves or cash flow. Aslong as that objective is achieved, theeffect of falling oil prices would belimited, he said.
By comparison, the midstreamsector, or the gathering, transmissionand processing facilities that help bringoil and gas to end markets, is at leastone step removed from the directexposure to commodity prices and tendsto generate recurring revenue streams,a key attribute that helps secure debtfinancing. Pipelines and similar assetstypically sign multiyear contracts with
energy producers that help lock in cashflow and make it easier for pipelineoperators to raise debt.
The need for capital for buildingnew pipelines is increasing as energydevelopers and producers move to moreremote areas in search for oil and gas,farther away from existing pipelinesystems. The success of some earliermidstream investments also showedthat good returns can be had: Pipelineoperator Kinder Morgan Inc., whichwas acquired for $15 billion in 2006 by aconsortium including Riverstone,Carlyle Group, Goldman Sachs CapitalPartners and American InternationalGroup, for instance, returned aboutthree times the money its sponsorsoriginally invested in the buyout by2 0 1 2 .
One issue for private equityfirms looking to invest in pipelines andother midstream assets, industryparticipants say, is competition frompub l i c ly t raded mas ter l imi tedpartnerships, many of which are alsobacked by financial sponsors. "Thereare a lot more MLPs today than therewere two or three years ago, so there isgreater competition for assets," saidJim Penilla, director of Robert W. Baird& Co.'s energy investment bankingteam, who advised on initial publicofferings of several MLPs in the pasty e a r .
T h a t v i e w i s s h a r e d b yRiverstone's Mr. Lapeyre, who saidpublicly traded MLPs are "very fiercecompetitors" when it comes to buyingand building pipelines. "The flip side isthat public MLPs can be very attractivebuyers for private equity-backedmidstream companies," said Mr.Lapeyre.
Firms Deny There's a BubbleOveral l , because potent ia l
opportunities far exceed the combinedcapacity of all the private equity fundsraised, firms contend they aren't seeingan oversupply of capital. "Capital needin the industry has never been greater,"said Denham's Mr. Marye, adding thathe thinks the size of funds being raisedis "reasonable." Private equity capitalalready raised and to be raised "pales incomparison" with capital needed,including public equity, private equity,high-yield bonds and bank loans, saidMr. Marye.
ApplePicking_WEBAndreaKramer, a managing director atHamilton Lane, seconded that view."The sector is enormous and requires an
enormous amount of capital beinginvested," said Ms. Kramer. "I'm notsure if there is an overhang beingbu i l t . "
Accordingly, firms say thatvaluations in general are reasonable,despite certain subsectors such asupstream oil and gas being relativelypricey. Denham's Mr. Marye, for one,said he thinks valuations are "flat."
"This is a good market for dealmaking," he said. "Things are not toohot and not too cold. Certain segmentsmay be overheated or neglected, butoverall the market is a moderate place."
