Buyout firms have ramped up energy and power investments over the last two years, particularly in oil and natural gas markets that are benefiting from advances in drilling technology and relatively high commodity prices.
The sector is a frontier of sorts for buyout shops, given how many new platforms they’re creating. From Oct. 1, 2009 through Sept. 30, 2011, U.S.-based sponsors closed at least 95 control-stake deals in the sector with a disclosed deal value of $8.2 billion. About 61 percent of those deals could be characterized as new, or platform acquisitions; by contrast, only around 13 percent of all control-stake acquisitions in 2010 could be called platforms.
Oil and gas was the most popular sector over the last two years, with 39 deals with a disclosed deal value of $4 billion. The power sector came next, with 17 deals and a disclosed deal value of $2.9 billion. Alternative energy sources was third, with 14 deals and $816 million in disclosed deal values
Investors giddy on the prospects for high returns sought energy and power funds more than any other industry-focused strategy this year, committing close to $8 billion through the third quarter, roughly $2 billion more than turnaround funds, which were the second-most popular strategy, according to data Buyouts compiled. Some large generalists firms—seeing fresh deal opportunities and, surely, the prospect for fee income—are raising dedicated energy funds to meet demand.
Several trends are driving private equity investment in the sector, which the Energy Information Administration expects to account for 9.5 percent of total gross domestic product in the U.S. in 2011. Underlining much of the action is improved technology, which is enabling more productive, efficient drilling of natural gas and oil, said Jim Dillavou, head of Deloitte & Touche’s energy transaction services practice. “In many instances, there’s not a lot of questions about the reserves out there,” he said. “It’s a matter of putting up a decent amount of capital and executing to get those resources.”
The sector poses significant risks, however. Sponsors need to factor in the potential for a drop in commodity prices, political instability in host countries and environmental disasters that could threaten individual investments and damage the already spotty reputation of private equity firms. Relatively speaking, though, the energy and power industry has proved resilient despite the economic downturn thanks to oil prices remaining relatively high over the last few years, said Jonathan Ginns, a managing partner at
“Even though oil prices might be around $90 a barrel today, we would run a model saying we could make X percent return at $60 a barrel,” Ginns said. “We’re particularly attracted to situations where we don’t have to take significant conviction in commodity prices.”
Natural Gas: The New Gold Rush
New ways of extracting natural gas from shale rock is inspiring a veritable gold rush in the United States, changing the landscape in the energy industry and opening opportunities for buyout firms to invest directly in shale properties and in companies that help build and maintain pipelines and other infrastructure needed to support the booming industry. A banker at Jefferies Group has estimated it would take more than $1 trillion to develop domestic shale fields, according to a 2009 New York Times article.
“Hydraulic fracking has been around for a while, as has horizontal drilling, but the industry has learned how to do it better and more efficiently for the development of these shale formations,” said Jonathan Smidt, a senior partner in KKR’s energy group.
KKR, which closed at least four platform acquisitions and one add-on over the last two years, recently bought Barnett Shale properties in Texas from Carrizo Oil & Gas Inc. and from ConocoPhillips Co. Both properties were older, more developed shale properties, and both Carrizo and ConocoPhillips wanted to raise capital and free up management time to invest in newer, higher growth shale properties, Smidt said
“We generally tend to come in further along in the property’s lifecycle, where there’s more information about the play and we can get a little more comfortable about the prospects,” Smidt said.
“E&P companies are spending so much money to drill thousands of wells, they either don’t have cash flows to build out their pipeline network or would prefer to spend it on acerage and drilling,” said Mark McComiskey, a managing director at
First Reserve, which closed at least three platform acquisitions over the last two years, has been interested in buying natural gas-fired plants, though so far it has been unsuccessful due to rising valuations, McComiskey said. The thesis there is that coal-fired power has fallen out of favor due to lower cost gas prices making power from natural gas power plants cheaper, while rising coal costs and increased environmental regulations have increased the cost of power from coal-fired power plants.
“If you’re going to build a power plant it’s now often a cheaper source of power to build a gas plant,” he said.
The focus on shale has also resulted in opportunities to buy less sought after conventional energy assets at attractive valuations.
TPG, for example, recently partnered with
“We and TPG bought at a time where we believed refining was undervalued and would return to historical norms,” Ginns, of ACON, said of the Marathon deal.
Meanwhile, major energy companies are drilling for oil and gas in deeper and more exotic locations, creating opportunities for strategic partnerships and investments in companies that help provide and maintain the equipment and infrastructure that supports the effort.
In May 2010, First Reserve committed $500 million in Barra Energia Petroleo e Gas, a Brazilian company that has a 30 percent stake in a block of oil and gas reserves off the coast of Brazil through agreements with Chevron Corp. and Royal Dutch Shell plc.
Alternative energy sources like wind and power may be collecting the headlines these days. But LBO shops seem to think there’s plenty of life left in good old oil and gas.