2013 PRIVATE EQUITY OUTLOOK: Trends that are driving private capital investment

Chris Manning, Trilantic Capital Partners, New York City

Wildcatters discovered oil gushers to make their fortune beginning in the late 1800s by searching through rough terrain in the US Southwest and Appalachia. That same pioneering spirit is evident today, albeit it with much more sophisticated tools, as private-equity investors and "strategics" alike unearth opportunities in the domestic energy sector.

With the continued demand for homegrown energy sources and advancements in technology, there are plenty of investments to go around. In fact, according to the International Energy Agency (IEA), infrastructure spending—just to get the supply from the source to the end user —could reach as high as $33 trillion by 2035.

Opportunities in 2013

As the United States strives for energy independence and is likely to become the largest hydrocarbon producer in the world by 2017, a number of trends across the energy spectrum are likely to drive continued capital investment over the coming years.

Upstream: Spending will be driven by the high number of drilling rigs in the country targeting economic oil and natural gas prospects. According to Baker Hughes Inc., there are currently a total of 1,664 rigs drilling for oil and 516 for gas in North America. There is a significant demand for drilling as companies are applying advanced drilling technologies, including horizontal drilling and multi-stage hydraulic fracturing, to both emerging and existing plays. Significant reserves remain economic at today's prices.

Midstream: Over the last several years, there have been many emerging plays in North America that are considered to be high production areas. Significant investments will be required in order to bring this production to market. Some of these include processing plants to separate liquids; pipelines for transportation of oil, natural gas, and natural gas liquids; and additional natural gas export facilities.

Developing technologies: Investments such as natural gas-powered vehicles and infrastructure tied to fueling stations will be needed. Given US budgetary concerns, the vast majority of this funding will need to come from private sources.

Renewable energy investments: According to a recent Worldwatch Institute report on global investments in renewable energy, investments in renewable energy technologies rose steadily in 2011, with new investments in renewable power and fuels reaching $257 billion, compared with $220 billion in 2010. In the US, this is a major component of the White House's energy policy.

Capital always needed

In the United States, demand for energy clearly is growing and there are significant capital requirements necessary to finance these opportunities. Internal cash flow is an obvious source of funds, particularly for the major integrated oil companies and large independents. Capital markets are another obvious source for public companies but they are not always the best or most receptive option. The fact is, public companies require capital markets financings that may or may not be available. Equity markets today aren't friendly to E&P companies and many are unwilling to issue stock at today's prices. The debt market, however, is available for many at very attractive borrowing rates.

There will be capital needs beyond the sources mentioned above. Enter private equity, which has a huge role to play given the large number of dollars needed for this industry and the attractive returns that can be generated. In addition to growth capital for private companies or take-privates of public companies, private equity firms are providing capital to public companies using alternative structures, such as joint ventures or PIPEs. Private equity is also found buying family-owned businesses and helping management teams to grow them into even larger enterprises.

Private equity has played a big role in the oil and gas industry for some time now. According to Preqin, the alternative investment research firm, capital investments in energy being raised by private equity firms doubled in the past three years, to $33 billion. PricewaterhouseCoopers also showed that private equity oil and gas deal volume was also at a 20-year high during the first quarter of 2012, as the volume of M&A activity reached 11 transactions and a total deal value of $11.5 billion, a 267% increase in volume of activity compared to 2011. There's more: Private Equity Analyst reported that investors have committed $18 billion into upstream oil and gas companies since the beginning of 2011.

Industry analyst firm IHS Herold said that open market private equity deals in upstream oil and gas companies were around $4 billion from 2006-2010. The latest numbers show that it is now at $18 billion (from January 2011 through April 2012).

These aren't small transactions either. Research from Seattle-based PitchBook Data Inc. showed that in the second quarter for 2012 alone, private equity firms did 18 energy deals valued at $8.4 billion. This is compared with 34 transactions valued at a total of $10.9 billion in the second quarter of 2011. There were fewer deals in Q2 2012 but a significantly higher value.

From the big buyout funds to specialist energy funds to middle-market firms like Trilantic, the opportunities in energy are abundant. Some recent, large leveraged buyouts have been in this space, including KKR's acquisition of Samson Investment Co. for $7.2 billion and the Apollo-led group acquisition of El Paso Corporation's oil and natural gas exploration business for $7.2 billion. Further, Blackstone recently announced an investment of $2 billion in Houston-based Cheniere Energy Partners to go towards building a liquefied natural gas facility to export the fuel.

Demand versus supply

With money, opportunity, and interest – there's only one prediction. The demand for oil and gas is not slowing down any time soon, and both the goal of energy independence and the demand from emerging markets will continue to drive extensive investment opportunities.

Private equity will continue to be a vital capital provider to the energy industry and will work alongside strategic partners to finance discovery and production of hydrocarbons, as well as building the infrastructure needed to deliver it to end users.

About the author

Christopher ("Chris") Manning is a partner and member of the executive committee of Trilantic Capital Partners. His primary focus is on investments in the energy sector. Manning joined Lehman Brothers Merchant Banking in 2000 and was concurrently the head of Lehman Brothers' investment management division, including both the asset management and private equity businesses, in Asia-Pacific from 2006 to 2008. He was also a member of the global investment management division executive committee and the private equity division operating committee. He holds an MBA from The Wharton School of the University of Pennsylvania and a BBA from the University of Texas at Austin.

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