Energy has long been a favoured private equity specialism among institutional investors and fund managers. Warburg Pincus, Hellman & Friedman, TPG, the Carlyle Group and KKR are among firms that target the sector alongside specialist energy-focused groups like First Reserve, Quantum Energy Partners, EnCap Investments, Denham Capital, Lime Rock and HitecVision.
But the energy story has changed dramatically over the past decade. LPs with exposure to the sector today may have committed capital to funds dating back to 2006-07, when oil prices hovered around $70 per barrel. Or during boom times like 2014, when the price hit nearly $110. That’s quite different to today, with a supply glut having pushed prices down to just $30 and slowed the ‘shale revolution’.
Yet, LPs that Private Equity International talked to remained steadfast in their long-term support for energy funds, stressing that any write-downs in their portfolios – while painful in the short-term – weren’t realised losses. And shouldn’t result in any material action on the part of LPs.
“One of the worst things you can do is hit the panic button when you don’t need to,” says Charles Wollmann, director of legislative affairs for the $19 billion New Mexico State Investment Council (SIC). “It just doesn’t make sense for us to try to sell any assets or deviate from long-term plans, which we put together with considerable thought and analysis.”
Gary Bruebaker, chief investment officer of the $103.4 billion Washington State Investment Board (WSIB), echoed these sentiments, saying the WSIB didn’t try to time the market or make decisions based on short-term performance, but instead hires fund managers it trusts to exercise their own views on buying and selling.
Paul Matson, executive director of the $36 billion Arizona State Retirement System (ASRS), takes the view that the supply-demand imbalance in today’s energy markets will return to equilibrium in the next year or so. That will, in turn, normalise prices to be in line with costs of production, a process that may take several years, but will make energy exposures a positive contributor to ASRS’ returns, he says.
Kay Olschewski, vice-president with Swiss-based asset manager Unigestion, noted LPs weren’t trying to ‘play the oil price’ via an energy-focused private equity fund – they’re expecting GPs to add operational value and grow companies over time.
He also stressed that oil-and-gas GPs weren’t the only fund managers who find themselves needing to survive and thrive in rapidly changing market cycles – and that investors must remain resolute: “Once you’ve decided to invest, you can’t just push the pause button. You have to be convinced that you selected the best manager and the best strategy.”
Secondary market statistics suggest the LPs we spoke to were representative of market sentiment. Advisory firm Setter Capital estimates only 3 percent of fund stakes sold by investors last year were for energy vehicles; its year-end report found approximately $826 million-worth of energy stakes had been traded, down more than 51 percent from the prior year.
While investors may be standing by their current investments, whether or not they pour as much money into energy strategies in the future is another matter.
At the $14.5 billion New Mexico Public Employees Retirement Association (PERA), chief investment officer Jon Grabel says PERA’s real assets portfolio, which includes most of its 3 percent energy allocation, fell at least 20 percent largely because of its energy exposure. As a result, PERA didn’t make any commitments to 2015-vintage energy vehicles. “At 3 percent, it’s not driving the whole portfolio, but nobody wants any allocation to underperform,” he says.
It’s also a sharp reminder as to the need for diversification within and beyond certain sectors, he adds. “It’s something we take for granted in the bull market and we become complacent,” Grabel says. “I think in the correction we’re having now, in particular with deflationary pressures in the energy [sector], it comes down to having a diversified portfolio.”
Wollmann suggests there is likely to be a shift towards income-producing assets as a hedge against volatility, while Arizona’s Matson said market distress was “presenting very interesting investment opportunities across the capital structure” and prompting some GPs to raise capital for distressed energy plays.
What’s certain is LPs’ appetite for energy isn’t expected to wane – even if it takes some different forms in the future.