June 10, 2014
Interviewed by: David Snow
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How Innovation Shaped PE’s Energy Boom

As the energy opportunity expands for PE investment, so do the risks. Panelists from ArcLight Capital Partners, Trilantic North America and Pine Brook Partners discuss changes in the energy opportunity in the past decade, and what keeps them awake at night.

As the energy opportunity expands for PE investment, so do the risks. Panelists from ArcLight Capital Partners, Trilantic North America and Pine Brook Partners discuss changes in the energy opportunity in the past decade, and what keeps them awake at night.

Technological Advances Boost PE’s Energy Interest

Opportunities and Risks for Private Equity in the Energy Sector

David Snow, Privcap:

We’re joined today by Glenn Jacobson of Trilantic Capital Partners, Andre Burba of Pine Brook, and Dan Revers of ArcLight Capital Partners. Gentlemen, welcome to Privcap. Thanks for being here.

I’ve been hearing a lot about energy lately. It’s an important and hot topic. All of you know this very well. You are all investing in the energy opportunity in North America, so I’d love to get your views on what is going on. First, all of you have slightly different investment strategies within energy, so it might be useful to start out with a brief self-description. Let’s start with Glenn from Trilantic.

Glenn Jacobson, Trilantic:

Sure. Thanks for having me here. Trilantic Capital Partners is a multi-industry, private equity firm and we like to focus specifically on four industries: consumer products, business services, financial services, and energy. Energy is where I spend time; it has been, historically, a large focus area of ours. We’ve committed an excess of $2 billion to the space. And while we’ve seen a lot across the energy spectrum from midstream to services, we now focus predominantly on upstream E&P. That’s been about 60% to 70% of what we’ve done. The rest has been services and equipment and the like.

Snow: Andre, briefly, how is Pine Brook involved in energy?

Andre Burba, Pine Brook:  

Pine Brook is a growth-oriented, private equity firm that invests in two sectors: energy and financial services. Like Trilantic, our energy practice focuses primarily on exploration and production. Our investments tend to be business-building investments where we back a management team with an allocation of capital and they gradually deploy that capital to build a business. We are currently deploying our Fund Two, which is $2.4 billion. We just finished raising it in the first quarter of the year. Again, our expectation is that, of the energy investments in Fund Two, most are going to be E&P.

Snow: Dan, ArcLight only does energy, right?

Dan Revers, ArcLight:

Yes. ArcLight is an energy-only private equity fund; we’ve been around since 2001. We invest across the entire energy value chain, from the wellhead to the wall socket, primarily in hard assets that generate a lot of current cash flow. We’ve invested $11 billion over five funds since 2001 and our focus is a bottomed-up approach.

Snow: It’s been remarkable to see the growth of energy-focused private equity firms and even firms that have energy as a strategy. What is different in the energy opportunity now, particularly in North America, that compares to 10 years ago? Why is there a different conversation, a different game taking place now?

Revers: The big buzzword out there is “shale.” A lot of people talk about the shale revolution and you can’t really understate how much this is transforming the energy industry. It’s creating opportunities in scope and scale that didn’t exist 10 years ago. Just the size of the opportunity is much more dramatic, but it’s also a much more dynamic business than it was 10 years ago. You go back even 20 years—highly regulated business. Even at the wellhead there was a lot of regulation. But, as you move upstream into midstream areas and power and the like, they were all very regulated.

Now, we have a completely unregulated, multitrillion-dollar industry that is finding its way. So, both the size and dynamism of the industry have changed. Lastly, the public market likes this. There’s a lot of capital out there; from a private equity standpoint, it’s obvious you have to source your investments and manage your investments, but then find good avenues to exit those at profitable levels.

Snow: Do you agree, Andre? Are those some of the factors that make the conversation about energy different from what it was even 10 years ago?

Burba: Yes. That’s spot-on. The technological changes we’ve seen in the industry over the last 10 years, the development of the unconventional drilling and of modern completion techniques have unlocked a vast amount of resource in the U.S. In the last five years, we have seen that the industry has gone from returning capital to its investor base to actually being a voracious consumer of capital. So, it’s a huge transformation in the U.S. industry and in the U.S. energy industry. The interest in the energy sector among investors, both public and private, is fully justifiable.

Snow: Glenn, what’s your view? What feels different or what is different about today’s opportunity?

Jacobson: I totally agree with everything these gentlemen have said. There also has been a fairly constructive commodity-price environment. There’s been this extreme technology shift that has taken a lot of the majors and large independents who have moved away from the U.S. and come back to the U.S. to develop these hydrocarbons. The reality is they require oil and gas prices which are not $10 and $20 a barrel but $60, $80, or $100 a barrel. So, we’ve had a lot of global economic factors that have contributed to a higher all price, which is quite helpful. But, from a private-investor standpoint and an investor-interest standpoint, on top of the supply and demand mismatch of capital, the industry’s done a very nice job through technology of mitigating dry-hole risk.

Snow: I keep hearing that an important change in today’s opportunity is that people know where the oil is, they know how to get it out, and it just takes the talent and the capital to get it out. Andre, why is that important for investors to understand?

Burba: Glenn’s right. Over the last decade, we have largely identified the areas where this resource in the ground exists. The challenge now is making these plays commercial. Not all of these plays will be commercial over time. So, there’s still a tremendous amount of risk in this business, but Glenn is correct. If you have the right management team with the right toolkit and the right set of experiences, the risk in this business has gone dramatically down over the years.

Snow: Of course, a lot of capital has been raised within private equity for energy. Many generalists, private equity firms, have added energy as a strategy. Dan, as someone who’s been investing only in the energy sector of more than 10 years, what does competition look like? How has it changed the way you source opportunities?

Revers: There’s a ton of money out there, both private and public, that wants to get into energy. So, you’re competing against a lot of different people who have different goals and objectives. The industry has changed quite a bit. A lot of these investors’ lens to the industry may be dated. One thing we see and we participate broadly in the market is this chronic underpricing of risk, because I don’t think people fully understand the risk. It’s fine to get the hydrocarbons out of the ground on a commercial basis. Now you have to get those hydrocarbons to market. So, understanding where basis differentials form and why one basin is more attractive to drill even if the costs are similar to others—I don’t think people quite connect the dots there.

Snow: Further to the point of risk, as Dan was saying, if we know where the gas is and we know how to get it out, where does risk lie?

Jacobson: It’s important to understand that not every well is going to be the same. We do a ton of analysis internally—as I’m sure they do at their firms—to identify what the range of results will be in a given play. Everybody has what they like to call a “type well,” or what your average well is going to be when you drill a play. But, in reality, it’s a sample. It varies.

Snow: It’s incredible the amount of data that can now be analyzed. Are there even people who have the wherewithal to effectively analyze this to generate returns?

Revers: We’ve always focused on being data intensive and, over the last five years, we’ve upped our quantitative game here in a major way. Having data is part of the story. Obviously, understanding wellhead economics and what type curves look like is critical, but you have to be able to put the whole story together. One thing about energy—it’s not just economics. It’s politics, regulation, finance, and more importantly, operational and management risk.

Snow: We’ve mentioned geopolitics, commodity prices, things that are outside the control of the investor and the management team. What would need to fundamentally change within, let’s say, the North American energy opportunity that would change the way all of you invest? What would make you pause and think you’d have to reassess your approach?

Burba: To us, the biggest uncontrollable risk is a prospect of a massive change in the regulatory environment. We’ve all been witnessing the pockets of opposition to certain types of completion techniques being used by the industry. If that movement gains momentum and results in regulatory changes, it could certainly have a material adverse impact on the industry. To us, that’s the single biggest uncontrollable risk.

Snow: How about you, Glenn? What keeps you awake at night?

Jacobson: As a firm, we are probably a bit less worried about a widespread ban on fracking, for what it’s worth. It is regulated state by state, so we worry about it. We tend to focus in states where we think there is less likelihood—states like Texas and Oklahoma that have long histories of being pro-oil and pro-gas. Frankly, we also have a lot of oil and gas. They happen to be good areas to operate. But we think it’s likely there will be a change in regulation that would lead toward more disclosure and requirements around well construction and cementing, making it more difficult to get a disposal well permanent. So, a lot of the ancillary activities that won’t necessary ban fracking but will make it more expensive. Fracking is the catchall, but the reality is banning this manufacturing of unconventional oil and gas may make it more expensive. It may knock some plays from being commercial to being uncommercial and we certainly worry about that.

Snow: How about you, Dan? What would have to change in the world, or in Washington, D.C., or on a state-by-state basis that would change the game dramatically?

Revers: The thing that keeps me up most of the night is regulation. We’ve seen it time and time again where it isn’t a banning of fracking but regulatory creep that certainly makes this more and more costly. As was mentioned earlier in the conversation, these technologies make a lot of sense at $60 to $100 a barrel, but if it comes down all of a sudden your costs go up, you get to a tipping point. I’m not overly worried about it, but it’s something we do worry about.

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