Energy PE fundraising at an ebb in 2019 as LPs rethink allocations

Some LPs are planning to reduce exposure to oil-and-gas funds due to climate change considerations, however, a bigger fundraising challenge in the near term is limited paybacks on existing investments.

While overall private equity fundraising was robust in 2019, the well of capital for oil-and-gas-focused offerings appeared to be running dry, and firms were looking for new ways to approach investing, including boosting exposure to renewables.

Global energy PE fundraising has been mostly in decline since 2014, when 86 vehicles collected $74 billion, according to PEI data. Activity weakened further last year. A mere 16 funds closed on a little more than $11 billion in the first three quarters, the data show, a small fraction of the $49 billion secured by 40 funds in all of 2018.

If the slow pace of activity continued in Q4 2019, as the evidence suggests it did, energy PE fundraising will finish the year at its lowest ebb in more than a decade.

A brutal fundraising market for energy PE firms is, of course, linked to a global industry facing multiple headwinds. While supply and demand conditions are generally strong at present, oil-and-gas prices remain volatile and subject to wide ranging geopolitical factors. In addition, industry players of all types and sizes are hobbled by capital shortages.

Even bigger challenges loom on the horizon – among them, growing international concern about fossil-fuel extraction and its impact on climate change.

LPs reducing exposure

For a measure of this concern, look no farther than the investors responsible for most of PE’s dry powder.

About 40 percent of institutions responding to Coller Capital’s Global Private Equity Barometer for winter 2019-20 say they plan to reduce their allocations to oil and gas over the next five years due to climate change considerations. Roughly the same percentage of respondents will ramp up activity in the areas of climate-friendly products/services and renewable energy.

Some of the world’s largest limited partners last year reinforced this message in a series of climate-related initiatives.

Canada Pension Plan Investment Board in November singled out climate change as a top priority for the year ahead. It promises a bottom-up evaluation of every major investment according to climate risks and opportunities along with continued deployments to renewable energy.

In addition, a group of pension plans and insurers forming the Net-Zero Asset Owner Alliance in September agreed to fight climate change by committing to carbon-neutral investment portfolios by 2050. Those making the pledge included Allianz, Caisse de dépôt et placement du Québec, Caisse des Dépôts, California Public Employees’ Retirement System and Zurich Insurance.

The effects of reduced LP exposure to fossil fuels is likely to be felt in energy PE fundraising over time. In the near-term, a more significant factor is limited payback on existing investments.

That is the view of Jeff Eaton, a partner with Stifel Financial Corp’s Eaton Partners, a fund advisory and placement business. In an interview with Buyouts, Eaton says LPs “put a lot of money” into oil and gas over the past four to five years, especially in the exploration and production – or upstream – space but have so far seen meager distributions paid back in return.

“There’s not a lot of positive news in upstream, particularly on the exit front, and very few managers are showing up with checks,” Eaton says. “LPs as a result see no real proof the strategy is succeeding and are increasingly unwilling to believe that things will improve.”

Eaton, who advises energy PE firms in fundraising mode, says this issue has contributed to a sharp decline in LP commitments. As a result, there were few oil-and-gas fund closings in 2019, he says, despite the fact there are four- to five-times more managers in operation relative to a decade ago. In addition, managers today are taking longer to wrap up funds and often raising less than they did previously.

Haves and have-nots

Fundraising barriers are highest for PE firms active in upstream energy, Eaton says. Only top-tier managers which have recently delivered on performance are proving able to secure fresh capital.

The situation is perhaps not as bleak, however, in other corners of the market.

For example, midstream funds, which make investments in oil and gas processing, storing, transporting and marketing, appear to be faring better. Evidence of this was provided in 2019 as several major shops with a full or partial focus on midstream – among them, ArcLight Capital Partners, Energy Capital Partners, Energy Spectrum Partners and Tailwater Capital – closed or were nearing closes on their latest vehicles.

LPs are attracted to midstream, Eaton says, because they previously committed little capital to the strategy and are only now “catching up.” Interest is also being fueled by a strong economic requirement for more infrastructure to get abundant oil and gas supply to new and existing sources of demand.

Brian Baker, a managing partner and CIO in Brookfield Asset Management’s infrastructure group, agrees, noting PE and infrastructure firms are “one of the only places to go” to find risk capital for developing much-needed midstream assets. This opportunity, he tells Buyouts, is helping drive the more positive environment for raising midstream funds.

Brookfield is expected to soon wrap up its fourth flagship infrastructure vehicle, earmarked in part for investments in midstream energy. The fund, which held an initial close last year, is reportedly seeking $17 billion.

Differentiated approach

Market experts, Eaton included, remain bullish on private equity’s long-term future in the energy sector, believing a rebound and stabilization in prices will contribute to improved distributions – and ultimately, solid returns.

In the meantime, managers with new offerings may have to slog it out a little longer.

To address fundraising challenges, Eaton recommends a differentiated approach to give managers “an edge” with LPs. For upstream funds, one alternative is a strategy that emphasizes the acquisition of E&P companies and assets, much like buyout funds do, he says. Other options include tweaking existing strategies to target specific growth opportunities and shifting to new areas of activity, such as renewable energy.

Several traditional managers in 2019 launched funds with a focus on renewable energy, sustainability and other climate-related objectives. For example, Lime Rock Management, which in 2018 secured $1.4 billion for its E&P and oilfield services group, unveiled a new platform for investments in renewables, energy efficiency and transportation electrification.

Lime Rock New Energy is approaching an initial close on its $600 million inaugural fund, Buyouts reported in November.

(Update: Final data provided by PEI confirmed that the pace of global energy PE fundraising in 2019 was the slowest in more than a decade. In all, 28 funds secured $25 billion at year’s end, roughly half of the $49 billion raised in 2018.)