Power play

The notoriously cyclical energy industry is increasingly drawing attention from private equity firms, which claim to have the long-term commitment required of most energy deals, as well as the capital to help bloated power and oil and gas conglomerates slim down. As a result, private equity firms are seeking out the right professionals and relationships to help them snap up the assets.

Many private investment firms looking to establish or grow their presence in the energy sector are setting up subsidiaries specifically for that purpose. A number of ventures were set up last year to focus on power plants. Examples included:

  • ? Boston's Bain Capital forged a $550 million (€441 million) partnership with Tenaska, the largest private independent power producer in the US, to jointly sponsor a $550 million investment partnership that will target US power generation assets.
  • ? New York financier Carl Icahn and Panda Energy International announced an agreement to co-fund a firm, Panda Acquisitions Group, to purchase US energy assets and related infrastructure.
  • ? Chicago's GTCR Golder Rauner launched a power generation platform with Chicago power plant operator Invenergy, with the stated goal of building a $1 billion business.
  • ? Warburg Pincus committed $100 million to Insight Energy, a company established to acquire power plants in Western Europe and North America.
  • In addition, a number of recent deals involving power-generation assets have taken place over the past year (see table on p. 58).

    The broader energy sector, including oil and gas, has drawn increased interest from generalist firms. In 2000, The Carlyle Group partnered with energy specialists Riverstone Holdings on a sector-specific investment programme. JP Morgan Partners, CSFB Private Equity, Kohlberg Kravis Roberts, Goldman Sachs and, in Europe, CVC Capital Partners, 3i and Candover, all now have significant energy investment programmes.

    Much experience required
    These generalist private equity firms are increasingly playing in a field once populated mainly by boutiques, such as First Reserve, Natural Gas Partners, FondElec Group, EIF Group, GFI Energy Ventures, ArcLight Capital Partners, EnCap Investments, Lime Rock Partners, Haddington Ventures, Birchill Resources, Quantum Energy Partners and Norway's HitechVision.

    In Europe a relatively new crop of specialist energy investors have been formed, including Burren Energy, 4D Global Energy Advisors and Russian Resources Fund.

    According to Frank Pottow, managing director at New York private equity firm Greenhill Capital, the four keys to success for an energy investor are: a high-quality asset base; attractive transaction structures that provides for a fair sharing of risk and reward; good timing; and good management. Pottow views good management as the most important of these.

    In establishing energy programmes, private equity firms must place a high premium on finding partners with specific sector expertise, as the nature of the energy market is unique. ?If you're simply a financier in this business you're not going to do well because you won't know who to trust,? says David Leuschen, founding managing director at New York-based Carlyle/Riverstone.

    The recent zeal for energy deals should elicit caution, as the energy sector is unkind to novices. ?What I've seen historically is that by the time uninitiated funds get involved they're probably entering at the peak of the market which is exactly the wrong time to be entering,? Pottow says.

    Notable recent power deals

    Transaction summary Buyer(s) Value Date
    El Paso, a Houston natural gas company, sells 25 power plants AIG Highstar $746m Jan-04
    Unisource, an Arizona utility, is taken private KKR, JP Morgan, Wachovia Capital $853m Nov-03
    Kansas City utility Aquila sells 12 power plants ArcLight Capital $309m Nov-03
    Indiana utility NiSource unloads six power plants American Securities, management $335m Oct-03
    Fox Paine sells United American Energy, a CSFB Private Equity N/A Oct-03
    power-plant holding company
    Florida's TECO Energy sells its 370-megawat GTCR, Invenergy $110m Aug-03
    Hardee Power Station
    Duke Energy sells Northeastern waste-to-energy CSFB Private Equity, AIG Highstar $306m Mar-03
    conversion plants
    Bankrupt York Power Holdings divests a Texas ArcLight Capital N/A Jan-03
    power plant
    US/Australian TXU sells stake in consumer elec- CSFB Private Equity, Berkshire Hathaway $750m Dec-02
    tricity division

    Power politics
    Government policies have had a huge impact on the power generation business, and proposed changes, if they become law, will have a further impact. Energy operates at the nexus of the private and public sectors. In addition to tracking the movements of the markets, private equity energy professionals have to be aware of what trends in both domestic and international politics are going to influence their business.

    In November, the US House of Representatives overwhelmingly passed the Energy Policy Act of 2003, which offered $23 billion of incentives mostly to companies using renewable fuels, eliminated a number of ownership restrictions that make it difficult to structure the acquisition of public utilities, and moved to eliminate the Public Utility Holding Company Act of 1935 (PUHCA), which makes it extremely difficult for public utilities to merge. Warren Buffett, for one, has said his firm would likely invest up to $10 billion in the utility sector if PUHCA were repealed.

    However, despite the backing of the Bush administration, the bill was defeated by three votes in the Senate ? reviving memories for some market observers of the proposed changes to US media ownership restrictions which suffered a similar fate last year.

    Warburg Pincus' Harris believes a number of the proposals in the energy bill would have a meaningful impact on prospective returns in power, but less in oil and gas. ?In the oil and gas arena there's a lot of politics involved, but it's international politics ? that has a big impact on prices.?

    Not all professionals agree investors operating in the energy sector need to have their finger on the pulse of politics. ?In the conversations we're having with our potential portfolio companies about how we create value and returns for our investors, the regulatory side is not a large part of it,? Carlyle/Riverstone's Leuschen says. ?The conventional wisdom links energy and politics more closely than I think is warranted.?