They invest when Wall Street won’t
Private equity poised for oil growth as public companies pull back
FROST Cochran’s firm spends millions of dollars every month to build and expand pipelines that move crude oil in West Texas. But drillers are pumping so much oil that the Houston investor has stopped guessing when it might finish paying crews to dig trenches and weld steel as demand for the pipeline network, which now stretches across 850,000 acres, appears insatiable.
“We’re really not sure how far it will go,” said Cochran, managing director of Post Oak Energy Capital, one of the Houston private equity firms investing in the pipeline system. “It’s taken a life of its own.”
The $640 million project is one typically associated with large public companies like the Houston pipeline operators Kinder Morgan and Enterprise Products Partners. But the sprawling, ever expanding network is owned by Oryx Midstream Services, a little known, privately held firm that is in many ways symbolic of the rise of private equity in U.S. energy industry.
Investors like Post Oak Energy Capital are expanding their reach into the nation’s resurgent oil and gas industry by backing companies like Oryx, rushing to fill a gap created by public companies under pressure from Wall Street to abandon riskier ventures to concentrate on their most lucrative holdings.
“Public companies are focusing on what they have,” said David Habachy, managing director at $44 billion private equity firm Warburg Pincus, which opened its first Houston office in February. “The next wave of investment and growth is coming from the private sector.”
In the oil industry, private equity firms play essentially the same role that venture capitalists play in Silicon Valley’s tech startup sector, betting millions of dollars on small, promising companies in the hope they’ll pay off big. Private equity was instrumental in the first U.S. shale boom, backing companies that experimented with drill bits and rocks, and literally sketched out the landscape of burgeoning shale plays still in their infancy.
Private equity firms have raised more than $200 billion in funds for energy investments since 2014, including $50 billion set aside for shale
drillers, according to research firm IHS Markit. They have stakes in more than 350 privately held U.S. oil producers, including 73 companies launched last year with $12.4 billion in investments, according to research firm 1Derrick. Those investments came in about one-third higher than in 2016.
Private equity firms also were involved in $15 billion worth of oilproduction transactions last year, three times more than from 2008 to 2012. They were party to 15 of the 20 biggest deals last year. Now, roughly 40 percent of the 979 rigs drilling across the continental United States are tied to private equitybacked companies, investors said.
“Over the last decade, private equity has become mainstream for the energy sector,” said Neil Wizel, managing director at Connecticut private equity firm First Reserve in Houston.
In Houston, 20 local private equity firms have raised a combined $56.3 billion in funds over the past decade, most of it meant for the oil industry, according to Preqin, a company that collects data on alternative investment industry. A portion has been set aside for investments in the health care, manufacturing and other industries.
The city’s largest such firm by far is EnCap Investments, a 30-year-old company with $13.5 billion in available capital for investments, according to Preqin. It manages money for hundreds of institutional investors, pouring cash into more than 240 oil producers and pipeline operators since the late 1980s. It has raised $31.3 billion in the past 10 years.
Following EnCap in size are Houston’s Quantum Energy Partners, which has raised $7.9 billion over the last decade; the Sterling Group, $2.3 billion; White Deer Energy, $2.2 billion; CRG, $2.1 billion; Post Oak Energy Capital, $2 billion.
Late last year, Wall Street investors began pushing publicly traded oil producers to improve shareholder returns, increase quarterly dividends and stock repurchases, often at the expense of the rapid oil production growth that characterized the last few years. But private equity firms haven’t signaled any plans to slow down.
The secretive investors operate outside the scrutiny of Wall Street analysts and investors, taking risks that public companies avoid for fear of making a bad bet. If a private equity firm can build a portfolio company that makes a steady income with potential to grow, it typically seeks to cash out by selling the company to a bigger firm or taking it public by selling shares on exchanges such as the New York Stock Exchange.
That makes the pullback of publicly traded oil companies — not to mention the lack of enthusiasm among investors for the energy sector after several years of poor returns — a double-edged sword for private equity companies. The big players, focused on returns, have been reluctant to take on the costs of gobbling smaller competitors that can hurt earnings.
Meanwhile, only a handful of private energy companies have launched initial public offerings in recent years because investors remain gunshy about buying shares in young companies after getting burned in the oil bust of a few years ago.
“It’s a tough environment, but hope springs eternal in the private equity business,” said Steve Chazen, a former oil executive whose recent $2.7 billion acquisition will soon make him the CEO of Magnolia Oil & Gas Corp., a new energy producer. “They think, maybe next year Exxon will show up, and maybe the IPO market will show up.”
Private equity companies have put more money on the line in the past few years. A decade ago, before the advent of capitalintensive shale plays, big private equity firms typically invested $150 million in U.S. oil company deals. Now, their investments usually run in the $300 million to $500 million range, because U.S. shale drillers have to spend more cash on drilling in order to offset the sharp natural decline rates of shale wells.
After a land rush last year, when companies were spending upwards of $30,000 an acre for land in West Texas, private equity investors are making a new push into another side of the oil industry. Private equity-backed companies spent $9.4 billion on U.S. pipelines, storage terminals and other energy transportation assets last year, up from $4.3 billion in 2015, according to data collected by S&P Global Market Intelligence.
“We see great opportunities to put money to work,” said David Krieger, managing director at private equity firm Warburg Pincus. “We’re by no means in the late innings.”
In West Texas, Post Oak Energy decided to invest in pipelines because the oil producers among its portfolio companies, as well as those owned by its investment partner Quantum Energy, were drilling in remote areas without pipelines to carry away their oil. Large pipeline operators wouldn’t build anything in the region, afraid their investments would sour if the oil fields proved unprofitable.
Last fall, Post Oak and other investors started bankrolling the construction of Oryx Midstream’s pipeline system in the Delaware Basin, with the plan to triple the size of the crude gathering and storage network. Once complete, the system could transport at least 600,000 barrels a day from remote well sites in Reeves, Pecos, Ward and other counties.
With demand for pipelines skyrocketing, the investment is an example of how private equity risk-taking can pay off, said Cochran of Post Oak Energy.
“But,” he added, “you don’t know how big it could be until you start building.”