The Role of Private Equity in Oil & Gas Funding

By Mauro Fiorucci, EMEA Transaction Services Leader, in Rienergia

Developments in Oil & Gas Funding

Historically, the role of institutional investors in the oil and gas sector has been limited to investing in common equity and bonds of blue chip corporates. The lion share of oil and gas funding was borne by the banking industry through secured and unsecured loans.

This evolved during the years of the commodity boom when leading institutional investors participated more actively in the IPOs and capital raisings of small-mid size E&P companies. The growth markets of the London and Toronto Stock Exchanges were leading the way in funding ambitious explorers targeting international (outside US) and frontier oil and gas provinces. Among others, the likes of BlackRock, Schroders, Henderson and Fidelity joined the ranks of investors in oil and gas small-mid caps.

In the aftermath of the 2008 financial crisis, banks were forced to introduce tighter lending standards and boost their return on capital. This led them to significantly decrease the exposure to small-mid size borrowers in the natural resources sector. In response, companies started accessing alternative sources of finance:

  • IPOs and further equity issues for exploration and appraisal activities;
  • Reserve based lending, public bonds, retail bonds, project financing, private placement, mezzanine financing for development and production projects.
During 2012-2014, a significant divergence in the availability of capital emerged within the sector. While international (non-US) small-mid caps were struggling to raise capital, the near-zero monetary policy of the US Federal Reserves helped fund the resources boom in North America. US drillers relied heavily on debt financing to make up for cash shortfalls as they expanded and bond issuances had a key role in supporting America’s oil shale boom.

In addition to traditional and alternative sources of capital, year by year private equity firms emerged as key providers of funding to the oil and gas sector. They filled the gap in periods when both public equity funding and bank lending were constrained. This is more true for pure-play exploration companies that generally have no debt capacity and for which equity issuance is often the first and only funding option.

Institutional investors preferred investing in oil and gas through private equity rather than direct investing to benefit from diversification and mitigate market volatility.

Role of private equity in the current oil scenario

The recent downturn in the oil and gas industry has challenged private equity firms looking to protect their investments and grow their portfolio companies. However, those that are willing to commit fresh capital could benefit from the current low-for-longer price environment.

Since the oil crash in mid-2014, more than US$ 100 billion have been raised by private equity firms eager to acquire energy assets on the cheap. During this period, banks turned away from the weakest borrowers and started offloading their loan books. Some US E&P independents were then forced to file for bankruptcy while others quickly unloaded assets to stay afloat.

Some private equity firms targeted loans and bonds with an eye on seizing ownership in bankruptcy or restructuring while others snapped up assets directly from operators that were short on cash.

In a sector where cost-cutting and debt servicing are the main priorities, the need for operational and growth capital is as large as ever and private equity firms are well positioned to fill the gap.

Private equity investing outside the US

The epicenter of the oil and gas investing activity is in the US (representing c. 80% of the value of the global private equity deals in the oil and gas sector) but several private equity firms are implementing an international strategy by acquiring oil and gas producing fields from majors keen to conserve cash and divest non-core, mature and immaterial assets.

In 2017, private equity firms appetite for large scale M&A and bolt-on acquisitions (in particular in the North Sea) stepped up as the market may have bottomed and a reduced oil price volatility facilitated the execution of new deal structures with risk sharing mechanisms (on oil price, production and decommissioning liabilities):

  • Siccar Point Energy (funded by Blackstone and Blue Water Energy) acquired OMV’s North Sea business (November 2016);
  • Chrysaor (funded by EIG Partners, GNRI and NGP) acquired US$ 3.8 billion in North Sea assets from Shell (January 2017);
  • Assala Energy (funded by Carlyle) acquired Shell’s onshore assets in Gabon (March 2017);
  • Neptune Oil & Gas (funded by Carlyle and CVC) announced the acquisition of the E&P division of Engie (May 2017).
Private equity success does not come from industry expertise but instead from knowing a good opportunity when they see one and being ready to pounce when the majors are running out of steam and the traditional sources of funding are drying up. What private equity firms lack in operational and technical capabilities they make up with available cash and speed of execution.

Nowadays, private equity investing is based on conservative oil price assumptions with long term expectations aligned with current prices. Any future upside will bring a significant boost in project economics and returns.

OPEC’s decision, on the 25th of May, to extend oil cuts for another nine months and hopefully eliminate global oversupply and achieve a sustained price recovery shall come as good news to all private equity executives involved in the sector. Click here to read the original version of the article.

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