Friday Letter Reaping what others didn't sow

As far as private equity investment in the energy sector is concerned, the credit crunch hasn’t been much of a spoiler. According to numbers published by data provider Dealogic earlier this year, energy-focused funds investing in oil and gas assets accounted for 25 percent of total private equity activity in the first four months of 2008, making it by far the busiest industry sector for buyout investors this year. During the period, deals worth more than $10 billion were inked – nearly as much as for the whole of 2007, which saw just $11.7 billion of transactions.

Equally significantly, sponsors specialising in energy investments are confident that they will be able to continue to deploy capital at pace. Delegates at PEI’s Energy Forum in London earlier this week were left with a strong sense that in terms of new investment opportunities, buyout groups and venture capital firms like what they see in the market today.

The opportunities abound not just in oil and gas, but across the entire spectrum of the energy business – including biofuels, wind power, solar power, waste-to-energy, fuel cells and, possibly increasingly given the way the political winds are blowing, nuclear energy. On top of that, there is the array of industries affiliated with energy: manufacturing and services, finance and insurance.

Bill Macaulay, chairman and CEO of First Reserve, the world’s largest private equity firm with an exclusive focus on energy, told the Forum that exploding commodity prices were in no small part the consequence of more than 20 years of chronic underinvestment in relevant infrastructure and people across the world. Making up for such a long period of neglect would take a long time and keep skillful providers of capital busy for many years to come, he said.

Make no mistake: this is a truly vast playing field. According to Macaulay, more than $20 trillion will be needed through to 2030 to get the world’s energy infrastructure into shape, with developing countries poised to soak up about half that expenditure.

“Of course we’re not buying a lot of oil at $130 a barrel,” Macaulay added. However, investing in makers of the proverbial picks and shovels needed to provide all the energy that the world so desperately requires right now is obviously a compelling proposition – in part because commodity prices are so high.

Add in the enormous pressures on this – as well as pretty much every other – industry on account of climate change and environmental concerns, and it is easy to see why energy investors today are a relatively cheerful bunch. With many leading practitioners gathered at the Forum, it was not difficult to gauge this refreshingly positive mood.

For private equity as an asset class, the energy story has only just begun. Expect more limited partner capital looking for a way in. Expect also more generalist private equity funds out there to take a long, hard look at the First Reserve investment formula. Developing the requisite know-how at their own firms will not be easy. But that’s hardly a reason for the generalists not to give it a serious try. For those who get it right, the rewards could be enormous.