US energy sector still ripe with investment opportunities

Aethon Energy, fresh from its first co-investment with a Canadian pension fund, discusses what’s driving the firm’s energy sector activity

Aethon Energy, a private equity firm specialising in energy, had already fully deployed its Fund II when it closed in November, and is now drawing capital from existing investments to keep buying quality assets at low prices.

Aethon marked its first co-investment with a Canadian pension plan last month when it acquired J-W Energy’s oil and gas assets for about $400 million to $500 million with the Ontario Teachers’ Pension Plan and RedBird Capital Partners. Including the J-W transaction, Aethon and its partners have invested more than $600 million in the Rockies and the Haynesville Shale, which spreads across parts of Texas, Louisiana, and Arkansas. 

With his operational understanding of this market, Albert Huddleston, Aethon’s founder and chief executive, along with Daniel Lee, its head of fundraising and investor relations, tell Private Equity International why it has been a busy time in the energy sector for the firm.

How was your latest fund’s deployment of capital during the oil market’s downturn?

DL: When we held the final close for Aethon II in November 2015 [on $240 million of fund and co-investment capital], we were just about fully invested across three platform acquisitions. And this most recent acquisition [of certain J-W Energy oil and gas assets] we made with OTPP actually fits within that strategy, as a complement to those previously acquired assets. What we’ve actually done between the fund and the co-investing with Ontario is we’ve made strategic acquisitions to build what looks less like a traditional private equity portfolio and more like an exploration and production company.

AH: We do well during the good times [of the oil market], while we do brilliantly well during the poor times because we’re going in at cheaper prices with quality assets. In good times, companies can cull from the bottom and sell things, but in difficult times, they might be forced to sell their high-quality assets to raise capital. Therefore, they’re selling things they would never want to part with. So, in that regard, in the environment like this that we’re having currently, all the good assets are coming into the market. So, in the last 18 months, we have been quite busy and very active. When you have these many quality assets coming into the market [for sale], you need to respond quickly; that’s what we’re doing.

Aethon made its first co-investment with a Canadian pension fund last month. Is this a strategy the firm will continue to pursue?

AH: When you go out and do fundraising, it takes a certain period of time. In order to capture the opportunity [to acquire the J-W Energy oil and gas assets], we invited in other capital sources. That’s where OTPP came in, because it’s important to bring in the right partners at the time these assets are available. We didn’t want to miss this window by raising a fund; we wanted to go ahead and move forward.

If the velocity and the amount of high-quality assets keep coming to market, and we find something that meets our criteria and discipline, then we’d rather be able to act fast. I don’t have the ability to raise money and then force someone to sell me something. I have to react when they are selling or when the marketplace forces them to sell.

But right now, the opportunity is so significant and high quality that we’ll continue to look at acquiring anything that makes sense to us, particularly in our core areas, by inviting outside capital like OTPP’s if necessary.

Where are you drawing capital from to make these acquisitions, if your fund is fully deployed?

DL: Any further acquisitions we make would be more analogous to strategic platform acquisitions paid for by the cash flows or borrowing capacity of our platform, as opposed to raising and deploying additional LP capital. We have more than $600 million in assets that we’re working and we’re not sitting here with dry powder in a fund. We’re going all-in with these assets that have essentially become one entity.

AH: We want to capture opportunities without changing our discipline or strategy with which we invest. We’re not going to do this with everybody unless someone out there correlates with how we behave, what we do, and our discipline. Working with investors like OTPP has made sense for us.

What is your view on the tremendous amount of capital raised to enter the down cycle in this sector?

AH: Whenever you have a calamitous time in our industry, banks get very nervous and tend to be withdrawn. But you have companies with debt trying to resolve how they grow and stay active. That forces creativity when traditional methods [of investing] are interrupted. Creative capital, distressed capital, and capital that loan to potentially own assets come into the marketplace, and there’s opportunity for them to back or capture assets. 

These types of structures fill a vacuum when typical mainstream deals move away. As a result, there are opportunities for certain kinds of risk profile players. I think that’s what you’re seeing now. But they tend to go away when you get back to normalcy in the health of the industry. When the industry gets back to being healthy, the one-off unique investment structures will subside.

Regarding generalists [coming into the oil & gas industry], they’re likely to make mistakes because their velocity of money lasts three to four years, as opposed to a longer-term cycle of oil. We ride more off seven-year cycles, in my opinion, so you need to be able to survive longer down cycles than some private equity investors are constructed to do. So there’s a bit of pressure for them, and they might find it difficult to get the yield to stay in this business. Most of my friends who are deploying generalist capital tend to want to invest in things that are larger and more broad-based, so they don’t get into the weeds.

Those who are energy-focused and really understand the business make great competition [for us]. In difficult times, they’re running to the dinner table [like we are], whereas the generalists are running away from not only the dinner table but also the kitchen and backyard. Our business seems easy in really good times, but when the prices drop, only those that have strong operational expertise will survive the down cycles.

Aethon Energy, a Dallas, Texas,-based private equity firm that manages and operates more than $1.6 billion in assets, specialises in the North American onshore oil and gas sector. It has recently been heavily active opportunistically acquiring upstream natural gas assets in basins around Texas and Louisiana. Aethon was founded in 1990 by Albert Huddleston, whose career includes positions at Hunt Energy Corporation and Houston Oil and Minerals.