The oft-hailed “revolution” in the global oil and gas industry is indeed “completely transforming the nature of the energy complex,” according to Marc Lipschultz, Member and Head of Energy and Infrastructure at KKR. In a Privcap interview, Lipshultz discusses the way that KKR likes to partner with operators in the energy space and how the firm brings more than capital to its investments, describes the challenge of turning assets in the Marcellus and Eagle Ford Shales into producing assets, argues that the new oil and gas opportunity is not even midway to its full potential, and describes why he believes that “not all shales are created equal” and the market will begin to bifurcate into winners and losers. This is essential viewing for anyone serious about allocating capital to the real assets and energy strategies.
Privcap: What is KKR’s current view on natural gas as an investment play?
Marc Lipschultz, KKR: We’re highly interested in natural gas as an investment play. The revolution that has been spurred by, caused by the advent of unconventional resources or shale resources, it really can’t be understated. It is completely transforming that nature of the energy complex, certainly here in North America, but really globally. We’re talking about going from a world where North America was viewed as the destination for natural gas from other parts of the world, an importer, to the U.S. being a natural gas exporter, belonging the product, and now being able to redevelop an industrial base on the basis of a newfound level of energy independence. So, with all of that change, there is tremendous opportunity. Now obviously it takes a lot of capabilities to be able to invest behind that change because one, there’s a lot of change. Of course there are a lot of unknowns, so getting after the opportunities is indeed the daunting challenge, but it is a, I think, I nearly unprecedented opportunity.
Privcap: What opportunities do you find most interesting?
Lipschultz: So a couple of thoughts on how one might invest around natural gas, what is interesting. So first off, I would say that investing in a lot of different parts of the energy complex we view as just wise strategy. That is to say, within any given segment, there are going to be interesting places and interesting times to participate, and they’ll be other times when you’re better off not to be involved, when a particular subsector gets overheated, when there’s too much capital chasing a particular opportunity. So what we’re trying to do is find ways we can marry our capital and our operating capabilities and our technical capabilities with partner companies that say, “Look, I have a real opportunity here, and I really need someone to help me take that opportunity and really convert it into a new asset, a new business, an ultimately profitable investment.” So, for us, I don’t think it’s so much that there’s a single sector or subsector one belongs. Arguably, one ought to have a portfolio and ought to spend one’s time understanding the full supply chain. With that being said, we do think that within the energy complex, the upstream sector, so the actual production of oil and gas from these unconventional resources, quite frankly from conventional resources for that matter, are really interesting areas. A lot of capital is required. There are a lot of people who have now established good asset positions, but need capital and other capabilities to turn those assets into, in fact, producing assets. So we think the upstream space continues to present some really interesting opportunities, and certainly the midstream or the infrastructure that’s going to support this newfound resource is a really interesting area as well. If you think about the global infrastructure, as we’ve discussed in the past, it was really configured decades ago around the idea of producing oil and gas in the Middle East, and essentially delivering it to North America. We’re now talking about production in completely new centers. We’re talking about North America as a producer and exporter, and the growth in consumption coming in the Asian markets and in India. So it’s really a complete reconfiguring of the global energy infrastructure, and that presents quite an interesting opportunity to.
Privcap: From an investing standpoint, where are we in the natural gas “revolution?” Will KKR still be deploying capital in the space a decade from now?
Lipschultz: So, the word revolution gets used quite a bit, and you could argue that perhaps the term is overused, but I actually don’t think it’s exaggerated. The changes are, in fact, revolutionary. In terms of where we are, it’s hard to say. We’re not in earliest innings. The early innings were really the founding and really the early development of critical fields like the Marcellus Shale and the Eagle Ford Shale and the Bakken, and we now understand a lot more about these positions, so we’re not in the absolute earliest innings, but we’re not midway through the game at all. We’re now into the phase of saying we understand a lot more about what’s out there. Now we have to figure out which ones really work, which ones work well, what are the right operating techniques, what kind of infrastructure do we need to actually get the product out of the fields to the places they’re going to be used. We’ve got to have to ultimately develop all the downstream capabilities to use this newfound bounty, so we’re certainly in the first half of the game. We can debate if we’re in the first quarter or not. It’s certainly early days. When we look out ten years, obviously it’s pretty hard to say with any certainty what we’ll be doing ten years from now, but certainly looking out many years, the opportunity to continue to be a partner to this sector as we develop these shales, that part I think is crystal clear and I fully expect that will continue for ten years, but it will be in different ways and in different places. Even over the last couple years, I think the role that we see for people like us is continue to evolve and change, and the needs the industry has for people like us. The early days of things like resources, were really about having a very strong technical view and investing behind a great company with a great operator and a great set of assets but a lot of unknowns about what would happen with that asset, and that fortunately was able to generate very attractive results for the company. They were able to really grow significantly in a newfound realization about what the Marcellus Shale could mean was brought, if you will, to the light. I think we’re past some of those really big early discoveries, but now we have lots and lots left to do as we develop the industry.
Privcap: What sort of expertise are operators of energy assets looking for in a private equity partner? How does a PE firm differentiate itself?
Lipschultz: I think that having a strong technical capability and having a strong operating capability is part of the value add, so being able to really work with a oil and gas company as a partner, really, in a manner they’re used to working with other strategic parties. In a manner, they’re used to working with other oil and gas companies. To us, we think this is very important. It makes it much easier for an oil and gas company to plug into a company that has its own technical team. We have that. So what we’ve spent the last several years doing is building out what looks like the equivalent of a mini, little oil and gas company inside of KKR. So we have our own technical capabilities attach to the firm, we have our own back office. We can manage the daily flows of oil and gas, drilling wells and receiving cash flows and managing our own hedges, and so we can come in at the asset level in many cases, or use those capabilities to do due diligence at the corporate level and really be a fairly seamless partner to the industry participants, and we think frankly that’s a bit of a necessary condition to be able to (a) understand well what it is you’re investing in; and (b) make yourself an easy and value-added partner for the companies you’re working with.
Privcap: Many people are focused on natural gas, but are there still good opportunities in other parts of the energy world, such as power?
Lipschultz: I think there are definitely opportunities in other areas. Indeed, the amount of opportunity available in upstream oil and gas is substantial. Again, with the right capabilities, we think you can create some quite compelling risk-rewards depending on how you construct your investment and whom you work with, but I don’t think that excludes the opportunity for investment in other parts of the energy value chain or the energy complex. So, for example, the midstream we talked about. A lot to be done in developing the pipelines and the transportation and the processing that goes along with all these new upstream developments. Renewable resources remain an area of interest, and obviously in the case that depends more on government policy and power purchase agreements than it does on things like, what’s the NYMEX trading price of gas, but all of those can be a role for investors like ourselves, firms like ourselves, to help meet the needs of a partner enterprise. So, I don’t think that upstream, if you will, crowds away everything else. It certainly does present a very large target and one against which we, and many others, are putting quite a few resources.
Privcap: Given the flood of opinions and talk concerning energy today, what important points may be getting lost?
Lipschultz: I think what’s interesting today is, we’re past the sort of go out and do the land rush, right, so the gold rush phase, the “let me go stake a claim.” A lot of the claims have been staked, so now we’re going to get down to, who can really execute well? Who really has the good assets, and I think what we’re learning, and this, I guess, both on the one hand presents opportunities, but also as a tale of caution, which is not all shales are created equal. Not all unconventional resources are created equal. Not all have equal access to markets because of these constraints today in infrastructure, and so I think what we’re going to see and already are seeing is a much greater dispersion of winners and losers, a much greater dispersion between the people who’ve got the really assets, even in the same play, and those who perhaps have pretty marginal assets, and while that probably, that distinction may not be very significant when oil is $90, it’s extremely significant when gas is $3 something because that means there are only a finite number and in fact probably a very few number of sale resources that are even economic at those kinds of commodity prices. So, I think that what we end up finding out is, this is a very heterogeneous proposition. This analogy to manufacturing that’s been used, sort of this now, shales are about manufacturing, is right in some regards because what we are talking about is a lot of repetitions where there aren’t dry holes. You don’t drill a shale well in a once understood formation to find you have nothing, but you absolutely can drill a well, spend too much money, and find out you have no return, or you can drill a well and find out you’re producing a product at a price point that delivers no, not return. So, I think we are at a stage where operational excellence is going to count more, kind of technical delineation, really being able to pick your asset positions will count more. Diversification will count too, so having a large expanse of assets, because there’s going to be an element of unknowns, there’s going to be to an element of, “Gee, this piece really worked well. We perfected the techniques for completion in Area A, but you know what? Area B just doesn’t really work in this kind of commodity price environment.” So, I think we are at a stage of much greater delineation, and I think it’s an important theme, and again I’d say it does present opportunity, but probably more a point of caution which is I think it’s a probably a fairly precarious time to just sort of make the macro call. I think there is a lot of capital coming into sector. Energy private equity has gotten a lot more crowded, so if something is sort of relatively easy to digest, comes with its own team, comes with a relatively easy to understand controlled development position, there’s an awful lot of buyers for that, and I think that area to us feels relatively crowded, compared to going again at that sort of more asset level or working really closely with the company to develop a partnership, to develop a position of mutual interest. So I think it’s a time of great interest, but I think people need to choose carefully how to participate in this very wide spectrum of opportunities.