Energy: One of the richest areas for co-investments?

As oil prices recover, so do fundraising and deal volumes, but the bigger picture tells another story for the energy sector: that of an evolving market where funds have become more specialised and the number of GPs multiplied.

This is translating into greater choices for limited partners but a more competitive environment for general partners.

Oil prices have come a long way in the past couple of years. They fell to below $30 in January 2016, bounced back to more than $60 a barrel at the end of 2017 and hovered around $75 a barrel in early June. This is nearly half of prices seen in 2008 at the peak of the commodity boom.

But the future of oil supply is unclear, making it difficult to point to further increase. Output from Venezuela has nearly disappeared amid political chaos in the South American country, and the fallout of the Iran nuclear agreement could also impact production. Meanwhile, demand continues to be strong.

Despite the uncertainty, low commodities prices in recent years have forced players in energy to be more cost conscious and have allowed private equity energy firms to find pockets of opportunities.

For example, private equity firms active in energy have focused on the Delaware Basin in West Texas in recent years where energy companies have found more favourable drilling conditions at a lower cost than traditional drilling thanks to new techniques such as fracking.

Additionally, publicly traded energy companies, which have been limiting their capital expenditure and spending as they faced cash constraints due to low oil and gas prices, have divested non-core parts of their businesses, in turn creating acquisition targets for GPs.

There have also been opportunities in public-to-private transactions as share prices were hit by the commodity price correction and management teams chose to operate away from the spotlight of public markets. One example is the $5.6 billion takeover of Calpine by a consortium including Energy Capital Partners and Canada Pension Plan Investment Board, which closed in March.

“This downturn has been a positive for private equity capital, because they’ve had access to some quality assets and management teams in specific basins from publicly traded companies that they’d probably not have been able to access had commodities prices stayed high,” says Brent Burnett, managing director on the real assets team at Hamilton Lane, speaking of energy GPs.

This is resulting in deal volume in dollar terms being slightly ahead of last year, although there are fewer transactions. There has been $31.1 billion invested in 67 buyout and growth transactions in 2018 as of 8 June, compared with $59.8 billion in 222 deals in 2017 and $55.5 billion in 290 deals in 2016, according to data from Pitchbook.

On the fundraising side, the recovery has a little more strength but investors aren’t quite bullish yet, with $12.46 billion raised so far this year as of 8 June, according to data from PEI.

This is nearly as much as the $13.18 billion raised during the 12 previous months, with EnCap Investments’ latest fund, EnCap Energy Capital Fund XI, which closed above target at $7 billion in December, representing more than half of the total. But this is still below 2014 when 36 funds raised nearly $31 billion.

“I don’t think we’ve seen enough recovery yet to where investors are really wanting to pile back into energy,” Burnett says. “Part of that is driven by the fact that investors committed a lot of capital to the energy space in the years leading up to the downturn and drawdown activity has been slower than anticipated.”

He says Hamilton Lane has been more selective about where it puts capital to work and has focused in part on smaller funds, because they are well positioned to pick up some of the assets that aren’t core to large players.Overall, there’s still more supply than demand in the fundraising market, considering the multiplication of GPs throughout the energy landscape

“The upstream space is still a very crowded market, and yet we’re seeing investors increasing their appetite, but that demand is not outpacing the growth in the number of managers or the fund sizes that these managers are trying to raise,” says Jeff Eaton, a partner and the global head of origination at Eaton Partners, adding that some of the large established GPs have taken longer than planned to raise their latest fund.

He notes an uptick in the number of midstream funds as well as in funds focused on renewable energies, pointing to one of Eaton Partners’ recent mandates, Copenhagen Infrastructure II, which focuses on wind energy and wind energy infrastructure and closed on its €3.5 billion hard-cap in April.

Working together
Co-investment opportunities have also increased due to the current fundraising environment. “Energy is probably one of the richest areas for co-investments, especially as larger asset packages come out from publicly traded or large independent firms,” Burnett says.

“It has opened up an increasing amount of activity. There may be cases where GPs are midway through a fundraise but they have concentration limits. That causes them to go out for co-investments earlier and more often because there’s more uncertainty around ultimately what size fund they’re going to close at.”

Between the different sub-strategies in the energy sector that have become accessible to private investors, the multiplication of GPs specialised on energy and co-investment opportunities, investors have a lot more choices in energy today than they did even just five years ago.