Addicted to oil

As a recent spate of private equity fund closings and transactions makes clear, it’s not just the American public that is hooked on oil—institutional investors are junkies as well. By Paul Fruchbom.

Bush: counseling oil addicts

In his fifth State of the Union address, delivered earlier this year, US President George W. Bush laid out a number of policy initiatives including increased government funding for scientific research and the establishment of a bipartisan commission on Social Security and Medicare. But his most prominent remarks, particularly coming from a former governor of Texas and the one-time head of an oil company, called for the country to reduce its reliance on Mideast oil and increase its development of alternative energy sources

“America,” the President said, “is addicted to oil.”

If the past several months are any indication, the same could be said for institutional investors. Just as scientists and government officials around the world are exploring oil alternatives such as ethanol, private equity LPs are exploring how to profit from the world’s taste for “black gold.”

Earlier this week, EnCap Investments, a Houston-based private equity firm, raised $1.5 billion to invest in oil and gas exploration companies. Energy Capital Partners, a buyout firm that is focusing on power plants, electric and natural gas distribution companies and gas and pipeline storage assets, is currently on the fundraising trail with a vehicle that is expected to hit its hard cap of $2.25 billion. And late last year, the joint venture between The Carlyle Group and Riverstone Holdings closed its third energy-focused fund on $2.5 billion.

That may be a lot of money, but private equity GPs have recently demonstrated they can spend it just as quickly as they raise it. In the past week alone, DLJ-spinout Avista Capital Partners invested $50 million in Celtique Energie to fund oil exploration in Europe and Africa; Newbridge Capital signed an agreement with Xinjiang Guanghui Group to invest up to $200 million in a liquefied natural gas project in Northwest China; and last, but certainly not least, a group of investors have proposed a $22 billion takeover of US pipeline operator Kinder Morgan.

Though some notable LPs are looking for investments in clean tech vehicles, the growth of private equity interest in these types of funds is clearly stymied by the amount of time it will take before alternative energy sources become economically viable. According to the Investor Network on Climate Risk, US institutional investments in greenhouse gas reduction strategies totals approximately $1 billion, a figure that may barely surpass the investment banking and underwriting fees in the Kinder Morgan deal.

Private equity interest in the oil sector is, of course, understandable. Many experts believe that the price of oil will continue to rise, fueled by growing demand from China and India and unrest in the Middle East. And as oil gets more and more expensive—some predictions call for it to hit $80 a barrel in the near future—companies in the sector clearly benefit.

But the price of oil is one thing and the price that private equity firms pay to access that oil is another. With so much capital poised to invest in the sector, competition for available assets is sure to intensify, meaning not every investor will be able to strike it rich.