LPs feel jittery about energy

As private equity firms took advantage of new technologies around oil and gas extraction in recent years, limited partners scrambled to put their money into these strategies. This created a frenetic environment for private equity energy funds.

But with oil prices falling – the per-barrel price fell from more than $105 in June to below $75 over as of November 13 – and the “land grab” for drillable acreage drawing to a close, some LPs are questioning the wisdom behind committing long-term capital to strategies that depend on the value of a volatile commodity.

“It is really hard to commit to long lock-up strategies there,” one public pension LP said. “We’re looking for more predictable real returns.”

Another LP said falling oil prices may be enough to sway one or two votes on its investment board, and that the LP had no plans to consider another energy fund until next year.

Some investors were already growing skittish about the energy sector even before oil prices fell, Hamilton Lane Managing Director Andrea Kramer said.

“Anytime you see a lot of money going into the sector, LPs start to worry about whether they’re the last dollar in at the lowest return,” she said. “Then you have the fluctuation and volatility in the pricing, which definitely worries LPs. Not only are we investing in an overinvested sector, now we’ve impaired the returns because of the volatility.”

Still, energy is a “dominant part of the discussion,” said John Haggerty, a managing principal with Meketa Investment Group. “I think people have to be very careful to parse through what the exposure is to oil prices. There are plenty of profitable operations that can withstand meaningful drops in oil prices.”

LPs have a lot riding on energy funds. (See “Big money riding on energy” table.) They pumped $18 billion into private equity energy funds in 2013 and poured in another $20 billion so far this year, according to Buyouts research.

Some LPs have gone so far as to take direct stakes in those businesses. In November, The Teachers’ Retirement System of Louisiana allocated $2 million for a co-investment alongside The Blackstone Group’s debut energy fund. Prior to committing to the Blackstone deal, Louisiana Teachers’ had allocated up to $365 million to energy-focused funds in 2014, a substantial sum for a retirement system with roughly $1.8 billion in private equity assets. The State of Wisconsin Investment Board also allocated for energy co-investment, taking a $20 million stake in an undisclosed energy company during the third quarter.

Whatever trepidation LPs may feel committing to private equity energy funds, GPs are looking to take advantage of oil price volatility, Blackstone Group Senior Managing Director Sean Klimczak told the New Mexico State Investment Council at its Oct. 28 meeting. New Mexico approved up to $75 million for Blackstone Energy Fund II following Klimczak’s presentation.

Blackstone generated “very nice multiples” on energy sector exits over the last two years, Klimczak said, including stakes in refinery PBF Energy and GeoSouthern Energy Corp, Klimczak said. (Blackstone’s energy and natural resources netted a 38 percent IRR through June 30, according to the San Francisco Employees’ Retirement System.)

“Candidly, we hope that there’s quite a bit of chop in the market such that that’s where we are investing our next fund, just as we did in 2004 and 2005 when we had some pretty choppy markets,” Klmiczak said. “We think that will ultimately be an interesting bottom (of the market) opportunity.” 

Energy-focused separate accounts

Customized accounts around energy investing have become more popular in recent years as big institutions look for tailored exposure to the strategy.

“Getting exposure to the sector is playing out in exactly the same way,” said John Haggerty, a managing principal of Meketa Investment Group. “If one has a relationship with a large institution, and you’ve made large commitments in the past, there’s an opportunity for a separate account or a co-investment.”

In 2013, the Alaska Permanent Fund Corp committed up to $750 million to The Carlyle Group to invest in natural resources, with a focus on metals and energy. The commitment included $375 million for NGP Natural Resources XI and Carlyle International Energy Partners. The New Jersey Division of Investment’s separate account with The Blackstone Group also includes an energy component, with up to $500 million dedicated to an energy fund run by the firm’s debt arm, GSO Capital Partners, and $150 million for its energy private equity team.

“Large LPs will approach it the same way they approach private equity,” Haggerty said. “It’s really about getting a certain amount of capital put to work and putting it to work at a reasonable cost.”