November 25, 2016
Interviewed by: David Snow
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Bullish on ‘Intermediate-Term’ Energy Recovery

The co-CEO of one of private equity’s largest energy investors, First Reserve, says that a coming supply constraint will make well-financed North American oil and gas platforms the go-to players in the global energy market.

The co-CEO of one of private equity’s largest energy investors, First Reserve, says that a coming supply constraint will make well-financed North American oil and gas platforms the go-to players in the global energy market.

Bullish on “Intermediate Term” Energy Recovery
With Alex Krueger of First Reserve

David Snow, Privcap:
Today, we’re joined by Alex Krueger of First Reserve. Alex, welcome to Privcap. Thanks for being here.

Alex Krueger, First Reserve:
Thanks for having me. I appreciate it.

Snow: You are the President and Co-CEO of a major investor in the energy industry. I have a lot of questions for you about what you see going on in today’s market. Why don’t we start with a question about the supply of capital? In the run-up to peak oil, there were a cast of characters providing capital to energy. After the collapse in oil prices, that list of suppliers dried up. What types of capital providers tended to go away?

Krueger: The banks have materially reduced their exposure to the sector and continue to try to reduce their exposure, both naturally as well as being influenced by the Fed to decrease lending to the space and to eliminate where they continue to try to eliminate systematic risk from the system.

But then, you also saw the capital markets dry up. There were very few equity issuances and very few debt issuances. This is really that bifurcation between “haves” and “have-nots” has continued even today, where companies that are well capitalized and people have confidence in have been able to tap the capital markets quite regularly and successfully. And those who continue to have balance-sheet challenges or concerns about asset quality find getting any type of capital debt or equity—private or public—quite challenging.

Snow: Talk more about the deals you’ve done recently, after a bit of a pause in creating new platforms. In 2016, you’ve created a number of new platforms. Is there a common theme across those platforms, whether it’s by way of investment thesis or type of asset?

Krueger: In 2015, on the private equity side of the business, we didn’t invest in a single new platform. As we turned to 2016, we saw a lot of the dynamics that had set up in 2015 start to change. That was primarily buyers and sellers expectations being quite different; people expected to quickly recover to the levels of activity they were enjoying in 2014. So, as we moved into 2016, we’ve seen much better risk/reward between how buyers and sellers are pricing risk.

In terms of what we’ve been focused on, I’d say it all comes down to quality and that translating into resilience of new portfolio platforms. We’re looking for niches within the business that we think are incredibly defensible. We’re not looking for very high-levered beta plays. We’re looking for very sustainable businesses that are generating strong cash flow along trends and themes that we think work well in the current part of the trough of the recovery—or the cycle—but will also set up well for recovery and looking to build those businesses through incremental M&A or organic growth to expand product offerings.

Snow: Can you give an example of a defensible niche that is of particular interest to you now?

Krueger: A good example would be we just acquired a business called Applied Cleveland, focused in the mid con. It has a national footprint that is looking at providing integrity services, as well as quality review of instillation of new projects. And we see a consistent trend around pipeline integrity as an area that gets increasing regulatory focus as well as increasing scrutiny by the utilities. So, as there’s more and more spend in that space with an aging infrastructure, we see that as a trend that will continue for the foreseeable future, and a very unconsolidated space as well, where we see a lot of opportunity to expand that business model.

Snow: How did services do in the depth of the downturn? Were they particularly hard hit because their customers were pulling back in what they were willing to pay?

Krueger: It really all depends upon what service you were providing. There were definitely critical services around safety in this case and quality control, where you had quite resilient through-cycle spending. There were other services that were viewed as more discretionary and therefore, there wasn’t as much spending, or were science-oriented around how do we optimize? How do we take advantage of expanding a resource? Those services are waning, while services in focus around how you remove costs or drive capital efficiency—there’s a lot more interest in at this point.

Snow: Can you think of any anecdotes that would illustrate to you the state of today’s market? Any conversations you’ve had in the negotiating room or maybe conversations with some of the CEOs of your portfolio companies that you think are illustrative of the idiosyncratic nature of today’s market?

Krueger: Most recently, we had our CEO conference just three weeks ago, where we had all of our portfolio company CEOs from infrastructure and private equity, as well as about 50 industry CEOs representing about a quarter of a trillion dollars of market cap and over 300,000 employees globally. What clearly comes across is there is no real consistent message and strong belief in exactly where the market is going. There’s clearly a sense of optimism, but as you dig down into it with each of these individual people as to why and what they’re focused on, I would say it is more of an innate optimism around a recovery and thinking things can’t really be this bad for this long more than fundamentals around how they see a recovery coming about.

Snow: Was it clear that many of these CEOs were relieved or encouraged by the fact that other CEOs in other industries also felt a similar sense of bullishness or at least optimism?

Krueger: When you start to ask people who are operating in other sectors what they really feel good about, they actually don’t have data points to show that they’re having a recovery. But everyone around them seems to be feeling better so they definitely tend to jump on that bandwagon.

Snow: What makes you bullish to be an energy investor in today’s market? What facts can you think of or anecdotes or trends you’ve seen that make you feel or continue to feel optimistic?

Krueger: I think we’re going to be in a very challenging environment for a couple more years very possibly. I don’t fall into the bullishly optimistic at this point in time. But I would say I’m fairly bullish on the intermediate term. I think the bigger story right now is just how much capital is being constrained and removed from the market, whether that’s forced by the capital markets as we talked about before, or whether that’s by increased focus on return on invested capital and more capital discipline. Whatever the reason, you now have a lot of projects being deferred—very large-scale projects that would have been coming online in 2019, 2020, 2021.

As those projects get deferred, you’re starting to create a supply response that will be very hard to turn around and I think that leaves the U.S. in a very interesting place. As the repeatability and confidence in the ability to ramp up activity in the shale plays and the resource plays, North America will be the go-to place for ramping activity when those declines start to set in and when the world needs some industry response. For us, it’s how do you position companies to get from here to there and survive and be well positioned at that point in time?

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