UK: Private Equity’s Love Affair With Oil And Gas—Will The Romance Continue?

Keywords: oil, gas, private equity,

Over the past decade, private equity (PE) investment in the energy industry and, in particular, the oil and gas sector has increased dramatically. Fundraising reached an all-time high in 2013, with US$36 billion raised for specific energy-focused funds, and Thomson Reuters estimates that as of August 2014 global PE-backed oil and gas M&A totalled US$5.9 billion for the year, up 48 percent on the same period in 2013.

Some of PE's biggest names have been at the forefront of this increased investment. KKR, Blackstone, Warburg Pincus and Carlyle have all closed multi-billion dollar funds focused on the global energy sector. They follow in the footsteps of the pioneers of oil investment, First Reserve and Riverstone.

New entrants to the market include Blue Water Energy, a London-based PE firm founded in 2011, which raised $861 million last year and is already putting that money to work. It recently agreed to provide $500 million, jointly with Blackstone, to UK-focused oil company Siccar Point Energy in one of the largest ever private equity investments in North Sea oil.

What Is Driving This Trend?

The oil and gas industry is fundamentally capital-intensive, and as traditional sources of funding became harder to obtain during the economic downturn, PE firms moved in to meet the shortfall. In North America, PE investment historically has focused on the oilfield services industry, downstream sector and the midstream sector. The last few years, however, have seen increased investment in the upstream sector as stock markets have cooled on exploration and the race to develop US shale reserves has intensified.

With the majors continuing to divest non-core assets in the face of pressure from shareholders to improve returns, and independents looking to farm-out stakes, there is no shortage of assets on the market. Despite increasing competition from national oil companies—notably from China—PE continues to be an active buyer. Blackstone is currently closing in on the US$1.2 billion acquisition of Shell's 50 percent stake in the Haynesville Shale formation in Louisiana, as the Anglo-Dutch major looks to reduce its exposure to North American unconventional assets.

The increased investment has coincided with a cultural shift in the mindset of PE in relation to oil and gas investments, away from the traditional model of a strict three- to five-year investment period to a longer term horizon, often around seven or eight years. This shift has followed an understanding and acceptance of the investment requirements of the upstream sector, where successful exploration tends to lead to significant additional capital requirements rather than instant returns. As a result, PE-backed companies are often under less pressure to hit production milestones than their publicly listed counterparts, freeing them up to pursue longer term strategies.

Which Regions Are the Focus for Investment?

Traditionally the vast majority of PE investment in oil and gas has flowed to North America, particularly the United States, although the landscape appears to be shifting. Kosmos Energy, the small explorer initially funded by Warburg Pincus and Blackstone, discovered the huge Jubilee oilfield off the coast of Ghana in 2007 with its partner Tullow Oil, and similar success stories have emboldened PE firms to continue to look further afield. Late last year, Carlyle committed up to $200 million to Discover Exploration, a new E&P company led by the former management team of Cove Energy plc, the African explorer that discovered significant gas finds in offshore Tanzania. Discover Exploration is drilling for oil off the coast of New Zealand.

UK North Sea investment reached record levels of £14.4 billion in 2013, raising hopes that oil and gas production could start to pick up again after years of decline. The investment in Siccar Point Energy follows a number of other PE investments in the North Sea in recent years, including Warburg Pincus and Riverstone's backing of Fairfield Energy, the acquisition of ATP's UK assets by Petroleum Equity and HitecVision's take-private of Bridge Energy UK.

PE firms are also casting their gaze toward emerging markets, where the need for oil and gas funding is exacerbated by thin capital markets and weak banking systems. Africa, Asia-Pacific and Latin America are all target regions for growth, while countries that were previously closed to foreign investment, such as Myanmar and Mexico, begin to open up their oil and gas sectors. In September 2014, Riverstone announced a $225 million commitment to Mexican start-up Sierra Oil, which plans to capitalise on Mexico's recent energy reforms and bring new technology, such as horizontal drilling, to the country.

What Next?

In recent years PE has played an increasingly important role in funding the oil and gas industry. This trend looks set to continue as the global economy recovers, emerging market investments become more viable and PE seeks out frontier deals to achieve the high returns demanded by its investors.

Africa is expected to feature in the strategies of a number of PE firms, as political tensions are alleviated and security is restored in parts of the continent. Earlier this year Carlyle closed its first sub-Saharan Africa fund at $698 million, surpassing its target by 40 percent, as it hopes to capitalise on the region's oil and gas discoveries and growing consumer class.

The oil and gas industry's need for PE funding shows no sign of abating, and with the oil majors expected to try to divest more than $300 billion of oil and gas assets in the coming years, PE's flourishing relationship with the sector looks set to endure.

Originally published Winter 2014

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