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:
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
|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|
|Bankrupt York Power Holdings divests a Texas||ArcLight Capital||N/A||Jan-03|
|US/Australian TXU sells stake in consumer elec-||CSFB Private Equity, Berkshire Hathaway||$750m||Dec-02|
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.?