With more than $13 billion of capital commitments across three private equity vehicles and one mezzanine fund, Energy Capital Partners is one of the world’s leading specialist energy investors. Formed in 2005 to focus on infrastructure investments in North American power generation, midstream oil and gas, environmental infrastructure and energy services, the firm is currently investing its third fund Energy Capital Partners III, which closed in 2014 at $5.05 billion, comfortably above its $3.5 billion target. The fundraising propelled the New Jersey-based firm to an all-time high of 16th place in the 2015 PEI 300 rankings of the world’s biggest private equity firms.
Doug Kimmelman, senior partner and founder of Energy Capital Partners, spent 22 years as a partner at Goldman Sachs focused on electric and gas utilities. He tells David Turner about how to invest successfully across the energy sector, and why both clean energy and ESG considerations are an important part of any portfolio.
What are the team’s different skills?
Since we founded the company 11 years ago, my partners and I have built a team based on the skills we required for the culture we wanted to create, picking people that brought different perspectives to energy investing. Some have operational backgrounds, some have expertise in commodity price risk management, and others are former bankers with decades of industry relationships. We also have legal and regulatory experts, project financiers and compliance professionals. Many were former colleagues, so we knew them well. This team is cycle-tested with over 500 years of collective experience working through the volatility of the energy markets.
What kind of investments do you like?
We are one of the leading private owners of power generation in the US: we’ve owned more than 20,000MW across approximately 100 facilities. Many investors are not interested in merchant power – power that is bought and sold in the short-term wholesale market, rather than through long-term contracts – but we have turned this to our advantage. The aim is to buy good assets more cheaply because they’re not tied into long-term contracts. For example, we recently bought wind power assets in California that were coming off long-term contracts.
We also like midstream oil, gas and in some cases water – we own more than 3,000 miles of operating pipeline and gathering systems, across seven different basins. We also invest in environmental infrastructure and services, including facilities that clean up emissions from fossil fuels, the decommissioning of nuclear plants and disposal of low-level radioactive waste.
And what sort of investments do you avoid?
We do not invest in oil and gas exploration and production (E&P). We view it as a more crowded investment area that comes with volatility and unpredictability, because returns are closely linked to commodity prices that are susceptible to macro events. For example, the oil price is determined by factors like the growth in developing economies, OPEC production strategies, one-off supply disruptions such as the Canadian fires and changes in environmental regulations. Moreover, 10 years ago I had never heard the word ‘fracking’, but this technology caused a 90 percent plunge in natural gas prices and was the leading factor behind the $100 oil price drop. In short, you can build the best model for future oil and gas prices and still be wrong for a decade.
How about start-up technologies?
Unlike venture capitalists, we do not invest in start-up technologies because we like commercially proven technologies. It is not enough to say, ‘Boy, this could be great for the environment.’ There has to be a customer that wants your product. We are also wary of projects that are supported by subsidies that may expire.
Do you hope to improve returns by investing in sectors that are less crowded?
Fewer investors concentrate on power generation than on oil and gas E&P. This doesn’t guarantee profitability, but it tilts the playing field in our favour. We’ve yet to realise a loss on a power generation asset, so this has been a very profitable area for us over many years.
What is the role of environmental investing at ECP?
Environmental considerations have always been core to us, and they should be embedded in every organisation. Complying with environmental regulations is a priority throughout our operations. But environmental compliance alone is not enough. Investors want us to make money for them, so they never say, ‘You must do a certain amount of green energy investment.’ If you invest to be an agent of social change, your returns are likely to suffer, because making money becomes a secondary priority. Also, the track record of dedicated green energy funds has not been good. So a balanced approach is a better one as volatile energy cycles often reward energy subsectors quite differently. The winners in a high commodity price cycle are invariably the losers in a down cycle. Our investors appreciate the time and effort we put into finding profitable clean energy investments within a balanced portfolio, and we have a good track record in finding profitable investments that have a positive environmental impact.
What are your thoughts on the different components of ESG investing, and on impact investing?
Looking at the ‘E’, or environmental aspect, we invest in wind, solar and waste-to-energy. We have a large nuclear services business called EnergySolutions, acquired in 2013, which disposes of low-level nuclear waste and decommissions nuclear facilities. We have also built the US’s largest activated carbon facility involved in reducing mercury emissions (see panel on next page).
On the ‘S’ side, investors express concerns about supporting businesses that provide no social benefit, or are harmful, such as tobacco or weapons manufacturers. But society would grind to a halt without reliable and affordable energy. We are proud, therefore, to bring this important resource to large numbers of people. We have also created thousands of jobs for society through our investment platforms. Ten years ago we had 10 employees, and now have more than 12,000 across our portfolio.
On the ‘G’ side, our culture is driven by high ethical standards, including transparency, and running safe, reliable and environmentally compliant operations in often harsh surroundings. Taking care of our employees, providing reliable and affordable energy products and having transparent governance is critically important. Our culture is driven by an avoidance of conflicts of interest, effective compliance procedures and proper corporate governance at our portfolio companies.
There are four metrics that guide us as an impact investor – profitable investments, products that help society, a positive environmental footprint and job creation. We have had about $1.8 billion in net realised investment gains since our inception across energy products that are essential to society and have a positive environmental impact while creating thousands of jobs. We are proud of this impact from our investing.
What do you think about the term clean energy? Can it be achieved?
A better term is cleaner rather than clean energy. It’s not possible to create a reliable and viable energy mix in North America without any emissions. There needs to be a balance between the cost, availability and environmental footprint. Unfortunately, wind and solar cannot provide enough baseload power, as they are not available all of the time, although future advances in battery storage will help. Perhaps someday we can approach an all clean energy supply system, but that day is a long way off.
Nuclear power provides a cleaner energy mix as it supplies large amounts of baseload power with no greenhouse gas emissions. But nuclear plants are being retired, so we’re perhaps going in the wrong direction. I think the future contribution of nuclear will be much debated. Natural gas is also on the rise – for good reason as it is the cleanest of all fossil fuels.
How do you think investors should structure their exposure to energy?
They have to think about their mix of public versus private investments. Private investments are probably better able to weather the inherent volatility of commodity prices, as the share prices of listed energy companies are usually heavily exposed to the short-term vagaries of commodity price volatility. A quarterly earnings focus can drive unproductive short-term decisions in a sector that is driven by long-dated assets. Private market approaches may be better suited to withstand this short-term variability.
Investors should be wary of over-leveraging when commodity prices are high, because the income stream available to service the debt may be challenged when prices invariably hit the downside of the cycle. Generally, leverage and commodity price exposure is a toxic combination.
Investors should also be nimble when choosing where to allocate capital across the various sub-sectors such as power, midstream oil and gas, and environmental services, because cyclical changes will make different areas more or less attractive over time.
If investors want a diversified portfolio they cannot ignore energy, because it accounts for such a large proportion of the economy. Energy and utilities account for over 10 per cent of the S&P 500 weightings. Your portfolio will be lacking if you do not have an energy allocation.
This article is sponsored by Energy Capital Partners. It first appeared in the 2016 Investing in Energy supplement of the July/August 2016 edition of Private Equity International.