Cost of capital forces change in energy sector

A rising cost environment and lack of available capital has precipitated a change of approach for energy-focused GPs and will ultimately “cleanse” the space.

Energy-focused private equity general partners are adapting to an environment of lower commodity prices and a higher cost of capital, according to panellists at the PEI Global Energy Forum in London.

“Financial engineering is transient,” Stu Porter, chairman and chief executive officer of global energy-focused private equity firm Denham Capital, told delegates, adding that when weighing up investments he now asks himself two questions: “What if I had to hold this asset unleveraged for the rest of its life? And would I make this investment if it was my last investment in a declining asset?”

The lack of cheap capital will push up costs in all areas of the energy sector, said Porter, who added that the junior stock markets – such as London’s AiM – had provided a lot of the “silly prices” for capital and would not be open again for some time.

As well as forcing GPs to be more selective around deals, the lack of available capital will have a “cleansing” effect on the sector according to Pentti Karkkainen, founder and general partner of Calgary-based KERN Partners.

Rather than institutions with access to cheap capital being able to “hoover up” assets, “the market will become discriminatory,” he said, adding: “Assets will ultimately end up in the hands of the most efficient owner.”

Porter and Karkkainen were joined on stage by Michael McMahon, partner and founder of New York-based Pine Brook Road Partners. As is the case in other sectors, the panellists reported seeing a significant increase in the number of opportunities in the distressed space, with current activity focusing on bolt-on acquisitions for existing platforms.