Private equity (PE) investments have bolstered the energy sector historically, and they will continue to do so, even as investment has lagged in the past two years because of languishing energy profits. Partly in response to the slowdown in profits, PE firms have looked to less-traditional methods of return. In a few unusual instances, PE investors even have harvested upside themselves and drilled proved undeveloped reserves.
A dive into liquefied natural gas (LNG) and renewables has become a way to broaden portfolios. “PE firms are branching out,” said Kyle Reid, partner, Transaction Services, Grant Thornton LLP. “That’s not to say they won’t use their capital and know-how to invest in more traditional energy assets and turn them around. But at the same time, they are expanding their scope and looking to the future.”
The next PE opportunity: LNG
Much PE opportunity right now is coming from liquefied natural gas (LNG), with the United States a big player in LNG exports. The “shale revolution,” fortified by innovative technologies in hydraulic fracturing and horizontal drilling, or fracking, has led to a boom in natural gas production; and the related LNG exports provide a market for the excess gas.
“Absolutely an area ripe for PE investment is LNG,” said Kevin Schroeder, Grant Thornton’s national managing partner for the Energy industry. While PE has been instrumental in funding producers, he said, it now is moving to LNG infrastructure. “I can see PE investing in big LNG projects. We’re producing a lot, but we need more ways to move it along. We need LNG facilities and the means to transport the product all over the world.”
“An area ripe for PE investment is… in big LNG projects. We’re producing a lot, but we need ways to move it along. We need LNG facilities and the means to transport the product all over the world.”
Kevin Schroeder, National Managing Partner
Energy, Grant Thornton
Reid agreed. “In West Texas,” he said, “we have to pay people to take the product away because we have no capacity to store it. There’s a lot of opportunity for PE in building liquefaction facilities.”
Another area for PE investment lies within the copious amounts of water needed for fracking and across the energy sector generally, said Schroeder.
“PE investors may look to innovative companies investing significant resources in creating better ways to clean and recycle drilling water on-site,” Schroeder said.
“We brought advanced technology into the production process and doubled output in the past six years,” he continued. “Now we need to invest in infrastructure, move the product to the right places and export it ̶ and that’s where PE may want to be.”
For more on LNG, see U.S. LNG offers long-term investment returns
Looking farther out: Renewables
Seemingly on the flip side, institutional investors are increasingly seeing renewables as a way to invest in energy. Said Schroeder, “A general reliance on renewables is not imminent, yet it is the wave of the future, and the industry should be prepared to evolve.” Putting more R&D into renewables also presents the added benefit of drawing younger people to the industry, Schroeder said.
Some PE firms see renewables as attractive for environmental, social and even governmental reasons, as state and local governments show more interest in them. In particular, PE funds have taken a shine to “impact” projects that are sustainable. Wind and solar are a main driver in the renewables area, partly because these vehicles have evolved to the point that their ability to generate power has been proven. Investors see this area as safe and growing.
Backing up: A brief chronicle of the industry
Energy fundraising has been strong in the past, so strong from 2014 to 2015 that by the end of 2015, PE had $100 billion in dry powder and was pouring significant money into the energy market. In 2014, oil was more than $100 a barrel, and margins were huge.
Then oil prices dropped dramatically at the end of 2015 and start of 2016, with forecasters predicting many companies would go bankrupt. Some did. But the economy remained strong, and banks were more lenient than expected, working with companies to create favorable workouts. Oil field services (OFS) companies cut wages, initiated a hiring freeze and dropped prices by 20%. They also began shedding nonessential assets, which allowed PE investors to buy those assets at attractively low prices and revamp them. At the same time, PE backed the efficiency gains from an E&P sector that was streamlining.
PE investment leads to turnaround
Reid recounted how one PE firm played a significant role in a successful turnaround. “The PE firm bought OFS assets from an E&P company that wanted to raise cash and pay down debt,” he said. “That gave the E&P company the cash it needed.
“The PE firm was able to improve earnings by expanding the customer base, controlling costs and leveraging the relationship with the portfolio company,” Reid continued. “All of this resulted in higher EBITDA [earnings before interest, tax, depreciation and amortization], and the PE fund monetized the benefit when the portfolio company was sold.”
OFS is foundational
OFS backed by PE remains a mainstay of the upstream O&G industry, said Reid. In 2019 revenues for oil field products and services have continued to rise as production volumes climb and as E&P consolidation continues. The same trend should continue in OFS as service providers consolidate around key customers and focus on efficiency gains. As O&G investments go up and consolidation persists, the ability of OFS companies to hold pricing should improve as well. That steady improvement will see a return of PE investors.
“While the public markets may not favor OFS companies today, we shouldn’t be surprised when PE jumps back in to take advantage of low values and potential improvements in efficiencies,” Reid said. If the global markets slow, investors may once again see OFS and energy stocks as a “buy” recommendation as the United States continues to benefit from its position as the No. 1 producer of O&G.
National Managing Partner, Energy
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Partner, Transaction Services, Energy
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