National Post (National Edition)
FEDERAL AID FOR AIR CANADA, `BITTERSWEET' FOR WESTJET, CALGARY AIRPORT.
INVESTORS' FLIGHT COMES DESPITE OIL'S RECOVERY TO US$60
Avital source of funding for the U.S. oil sector is drying up as private investors retreat, prompting stricken operators to make “last gasp” efforts to boost production and cash flow to lure in buyers.
The exodus mirrors shale's experience in public markets, where even before last year's crash investors had soured on an industry notorious for poor returns and weak environmental, social and governance performance.
“Private equity has been decimated in this downturn,” said Wil VanLoh, head of Quantum Energy Partners, one of the largest PE investors in the shale patch. “The total quantum of money available out there to private companies has shrunk and is going to stay much, much smaller.”
Now scores of oil producers are “dying on the vine”, said Ben Dell, managing partner at rival Kimmeridge, as they are left without the regular cash infusions to bankroll the capital spending needed to keep on drilling.
The private flight comes despite oil's recovery to US$60 a barrel — a price that allows many operators to break even and has raised investors' hopes of a profitable final exit from the sector.
Those notions gained strength this month when Pioneer Natural Resources, a large listed operator in the prolific shale fields of Texas's Permian Basin, agreed to buy privately owned rival DoublePoint Energy for US$6.4 billion — the biggest public-private deal in the U.S. upstream oil and gas business in a decade.
DoublePoint, which made national news last year when Donald Trump delivered a stump speech in front of one of the company's rigs in Texas, was backed by VanLoh's Quantum, Apollo Global Management, Magnetar Capital and Blackstone credit.
But investors say deals of that scale are unlikely to be repeated.
“DoublePoint is one and done,” said Adam Waterous, head of the Calgary-based private equity group Waterous Energy Fund. “There's a risk that people will see it as a return to 2013,” when private equity enjoyed a bumper shale harvest. “It's not.”
The private mood has been shifting for some time.
Between the start of 2015 and the end of 2019, 136 private funds closed after raising an aggregate of US$86 billion to spend in U.S. oil and gas, according to Preqin, a financial data provider.
The influx helped to finance an unprecedented surge in American oil production to a record high of about 13 million barrels a day last year.
But the “dry powder,” as PE groups refer to investors' capital, has diminished and the same “war chest mentality” is not evident in this recovery, according to Raoul LeBlanc, head of North American unconventionals for the consultancy IHS Markit.
Just 11 funds closed last year and only US$4.5 billion was raised as oil prices crashed, according to Preqin. Production plunged and remains around 11 million bpd now.
“What's different this time is there's very little new private equity going into forming new private companies, because they don't have capital to deploy,” said Kimmeridge's Dell. “They are not confident they can raise more capital.”
Some private oil operators are spending an unexpected bounty from higher oil prices into more drilling, hoping extra output will lift valuations and attract buyers — a “last gasp” effort to secure a profitable exit, said Van Loh.
Rigs operated by private companies have climbed to about 50 per cent of the contiguous 48 states' total this year, according to the consultancy Enverus.
While public operators slashed capital spending and output last year, some private ones did the opposite. Quantum's portfolio companies boosted total output by a quarter to 500,000 bpd by December, according to the consultancy Rystad Energy.
The strategy paid off for DoublePoint, one of the most active drillers in the Permian even during the bleakest months of the price crash.
But exits are dwindling. According to PitchBook, another data provider, private equity deal values last year amounted to just US$13 billion from 35 exits — a fraction of previous years.
The market does not seem to be rewarding deal-making if investors think it points to more growth from public companies, analysts say.
Pioneer's shares are down more than 10 per cent since April 1, the eve of the DoublePoint deal, partly because of a perception that the company — which will be by far the Permian's biggest producer after the deal closes — was chasing supply gains again.
The company stressed the acquisition was done to lift free cash flow, not just output. Pioneer said it would reduce the number of rigs DoublePoint was operating.
Initial public offerings, the other main exit route for private equity, are also difficult given capital markets' lack of enthusiasm for fossil fuel producers and a shale sector that generated such poor returns in recent years.
Shares in Blackstone-backed Vine Energy are down about 16 per cent since its mid-March IPO, the first from a shale producer since 2017, far underperforming the sector.
Another underlying problem, investors say, is the lack of assets of sufficient quality to attract public operators that have sworn off the fastgrowth strategy and landgrab mentality of previous years.
The list of juicy private operators includes CrownQuest, Endeavour Resources, Mewbourne Oil and a few other smaller operators, which each own large Permian positions that have been pored over by public suitors.
But the tail of weak assets across the shale patch is long — and was exposed by last year's price crash.
Private money is behind as many as 500 producers in the U.S., accounting for about a third of total American oil output in recent years. The bulk are now lossmaking and will never repay the cash plowed into them, said Waterous.
“We think about 80 per cent of them are illiquid,” he said. “There is no bid. So 400 of the 500 are unsaleable.”
Recent transactions included sales by Bruin E&P, a PE-backed company that went bankrupt in July, and Grenadier Energy Partners II, backed by EnCap and Kayne Anderson, two big private oil industry investors.
Some PE firms are also spending unused fund capital instead of returning it to limited partners, according to investors, or are taking advantage of divestments from public operators that are streamlining portfolios. That has triggered a flurry of small deals.
“What you're seeing is this little bit of a last gasp of the capital that was committed to funds three or four or five years ago,” said VanLoh, referring to recent deals in which private equity groups have bought assets from public operators. “It's spend it or lose it.”
Failing companies are likely to be starved of capital and forced into “blow down” mode, said Waterous, producing what oil they can as quickly as possible and as long as possible, just to keep some cash trickling in.
“This business is broken,” said Waterous. “The industry is going through a multiyear process of wringing capital out of the sector, not bringing new capital in.”
Specialist funds will remain in the sector, some investors say, but the generalists are moving on, seeing greater opportunity outside a volatile fossil fuel business and in fast-growth and low-carbon businesses favoured by ESG-minded investors.
It is the end of an era in which private equity was often the shale sector's crucial financier. The available cash pile has dwindled.
“There's not a lot of dry powder left,” said VanLoh. “And once it gets spent, these guys aren't going to be able to go reload.”
WHAT YOU'RE SEEING IS THIS LITTLE BIT OF A LAST GASP OF THE CAPITAL
THAT WAS COMMITTED TO FUNDS THREE OR FOUR OR FIVE YEARS AGO.