Private equity steps up for energy

Capital need spurs growing role

One of the truisms in the oilpatch is the continuous need for capital.

Last year was a record one for capital raised in the Canadian energy sector with mostly small and mid-sized companies tapping equity markets for more than $20 billion before the taps dried up in the fourth quarter.

According to Dealogic, the same segment of the American sector raised $875 billion US between 2007 and 2014, with the money used for going after tight oil plays.

This shouldn’t come as a big surprise considering a comment made by ARC Financial’s Peter Tertzakian, who said while $500 billion US was spent every year over the past decade outside North America, that money was only enough to keep reserves and production constant.

That’s why the need for money doesn’t go away, even in times of weak prices.

However, not every energy player is an Exxon, Cenovus or Encana with the ability to raise money in the public equity or debt markets. Since mid-February, those companies have raised more than $10 billion from the public markets. It’s therefore the small to mid-sized companies — who don’t have that same access to capital — that are facing some challenges, and why private equity will play a bigger role than ever in capitalizing the energy sector through this downturn.

This is a new phenomenon. There were no private equity firms on the horizon in 1986 or 1998 and the 2008 downturn didn’t last long enough for companies to become as challenged as they are today.

While it’s difficult for those in the midst of the current cycle, the private equity firms are on record saying the current downturn presents an unprecedented opportunity for investment in the energy space.

More than $100 billion US was raised by private equity firms south of the border between 2012 and 2014 for energy-related investments and at least $10 billion was raised in January to take advantage of distressed valuations of good assets.

It’s also important to note the private equity landscape in Canada has more depth and scope today than a decade ago.

Today, ARC Financial is in the process of closing its eighth fund and one of the bigger players to emerge in the energy space is the Canada Pension Plan and Investment Board.

The CPPIB is one of the biggest investors in Seven Generations Energy Ltd. It holds a large interest in Teine Energy, is an investor in Black Swan Energy and lent Laricina $150 million in debt financing.

Its chief executive, Mark Wiseman, said late last year that the energy sector presented investment opportunities for long-term investors such as the CPPIB and it’s no secret it was in the Talisman Energy data room before the company was eventually sold to Spain’s Repsol in December.

The private equity world is primarily known for seeding new companies and allowing them to stay as private entities for a longer period — usually between five and seven years, the typical life of the private equity funds.

This time, however, their role will expand to include the debt side of the ledger.

In addition to the traditional equity investment model, these firms are also buying distressed debt issued by energy companies and getting involved in the debt refinancing space. GSO, the credit arm of Blackstone, is but one entity active in that space, getting involved in everything from leveraged loans to distressed debt, mezzanine and ‘rescue’ financing.

These players will also look at structures such as putting debt in place in return for an equity stake or an interest in producing assets. Word has it Natural Gas Partners out of Houston is looking at setting up an energy fund with the sole purpose of buying distressed debt.

The challenge in all this, as always, is price.

The valuations at which the private equity firms are ready to invest are not necessarily aligned with what companies believe they’re worth. One finance type wryly observed that even though valuations are likely going to where the PE firms are willing to invest, the companies are not ready to go there.

The risk to the private equity firms is that if they wait too long — and there is an uptick in commodity prices — they might miss their window to invest at the bottom of the cycle.

These days, that’s looking like a big if. And then, it’s anything but an easy gig for those management teams that sign up.

Those familiar with the private equity world say it’s “expensive money” because the hurdle rate — the minimum accepted return — is eight per cent. It’s beyond that number where returns to management are realized.

Not everyone wants to play that game, but they may not have a choice.

The smaller and mid-sized players tend to rely more on the commercial banks, which lend on the basis of reserve valuations. When the value of the asset goes down, the amount available for lending drops, too. It wouldn’t surprise anyone to hear the commercial banks are looking to reduce their exposure to the sector.

And while the commercial bankers aren’t necessarily wired into the PE world, it’s not out of the question the banks will reach out to those firms, to help companies with the right assets and strong management teams get through this current cycle.

Those companies teetering on the edge may not have the choice on whether they want to play this game.

How this all plays out is still undetermined.

What’s clear, however, is that the energy landscape as a whole — and how companies are capitalized in the smaller to mediumsized side of the spectrum — is set to change dramatically going forward because of the interest and financial capability of a relatively new player on the street.

The valuations at which the private equity firms are ready to invest are not necessarily aligned with what companies believe they’re worth.