Friday Letter The need for fuel

In the PEI 300, a ranking of the world’s 300 largest private equity firms which accompanied the May issue of Private Equity International, the numbers were big. Together, these firms have raised $1.34 trillion in private equity direct-investment capital over the last five years. TPG, the biggest of the bunch, has collected more than $52 billion over this period.

At least, it was easy to assume the numbers were big – until reminded that everything is relative. At this week’s PEI Global Energy Forum in London, Bill Macauley, the erudite chairman and chief executive of Greenwich, Connecticut-based energy investment specialist First Reserve, said that the capital requirement to meet the world’s energy demand by 2030 is a mind-boggling $26 trillion. At the moment, energy-focused private equity firms on the PEI 300 list have between them around $80 billion of capital. Which – Macauley pointed out – was a mere “rounding error” in the overall scheme of things.

Energy investment is no doubt full of complexity. Highly specialist knowledge, experience and outstanding networks are vital in any area of private equity. Hearing Macauley detail a few projects his firm has been involved in made clear that these qualities are demanded in abundance if you’re in the energy game. Cultural adaptability is arguably a further requirement: First Reserve has recently completed deals from Venezuela to Angola. Therefore, it’s unlikely that – even if they appreciate the scale of the opportunity – mainstream buyout funds, or start-up funds for that matter, will suddenly leap on the energy bandwagon. It’s just not that easy.

One thing’s for sure, however: governments around the world need to co-opt the private sector into providing as much investment as possible – and private equity funds will surely play an increasing role in this. However, as speakers at the Forum also pointed out, this demands careful regulation. Of the $26 trillion total capital requirement, $20 trillion is accounted for by infrastructure (exploration accounts for the remaining $6 trillion).

But investment from private sources in regulated energy infrastructure such as power grids will only be forthcoming if the rules and regulations governing these sectors provide ample incentives to investors, without at the same time jeopardising the interests of the general public. And that’s a tricky balancing act, which some governments pull off well – and others less well.

While regulation makes private investment in this area less than straightforward, there is a bigger dampener on activity. Private equity investment in the energy sector has its idiosyncrasies, but what it shares with all kinds of private equity investment is a markedly higher cost of capital than during the debt boom. Pentti Karkkainen, founder and general partner of Calgary-based KERN Partners, said a more discriminatory financing environment means “assets will ultimately end up in the hands of the most efficient owner”. It also presumably means fewer assets changing hands at all – not good news, given the need for big numbers.