Petroleum and Private Equity: PE Firms Increase Investments in the Oil and Gas Industry

Posted on by Zachary Anderson

Demand for global energy resources has made the energy industry an attractive target for private equity investment. According to a 2013 report by Bain & Company, the strength of recent fundraising activity by PE funds indicates that energy investments will be popular in years to come.1 Within the energy industry, the most attractive area for PE investors is the oil and gas sector. Discoveries of new shale deposits filled with hydrocarbons, combined with new advances in drilling technologies, have led to a surge in opportunities to cash in on oil and gas development.2 A report by Ernst & Young (“EY”) also notes the need for capital, the rise of national oil companies and resource nationalism, and renewed industry consolidation and infrastructure challenges as additional factors creating opportunities for PE investors.3 As development increases, PE has played an increasingly large role in oil and gas investment. In 2008, PE activity in the oil and gas industry constituted 65 deals valued at $18.4 billion.4 The value and number of deals declined to 34 deals and $3.6 billion in 2009, but rose in 2010 to 51 deals and $8.3 billion and 45 deals and $23.2 billion in 2011.5 In 2012, PE investors completed 56 deals valued at $27.2 billion in the oil and gas industry.6

According to a survey conducted by EY, two-thirds of global PE managers plan to raise funds this year targeting specific subsectors in the oil and gas industry.7 These firms are seeking to profit from an industry flush with opportunities and in need of capital. Oil and gas is attractive to PE firms because it is a capital-intensive industry, with projects often requiring billions of dollars.8 PE firms are well positioned to play a key role in driving future growth of the oil and gas industry, which is currently experiencing major capital investment.9 Yet PE firms contribute more than just money. Increasingly, they offer expertise in oil and gas, combined with disciplined financial strategies, to increase returns. According to the EY survey, managers felt that the main ways they add value to oil and gas companies is through access to growth capital, allowing geographic expansion, and providing operational expertise.10 Michael Rogers, EY’s global deputy private equity sector leader, notes “PE firms can leverage their operational and commercial insight, oil and gas sector expertise and financial discipline to influence outcomes.”11 PE funds have found that the oil and gas industry is a good match for their model of bringing operational and commercial expertise to their portfolio companies to develop and execute winning strategies.12

EY survey respondents expect the United States, China, Russia, and Brazil to see the highest level of PE activity.13 While North America will likely remain the primary target for most PE investment, Latin America and Asia are expected to attract the largest increase in investment from PE firms over the next two years, according to EY.14 Eighty-two percent (82%) of PE managers expect PE activity to rise in Latin America and seventy-nine percent (79%) anticipate activity will rise in Asia.15 Andy Brogan, EY’s global oil and gas transaction advisory services leader, says the company has seen an influx of capital investment into emerging markets.16 Brogan says, “The risk profile of emerging markets investments can be very different from those of developed markets.”17 Companies are proceeding with caution, but are optimistic about the potential for high returns from emerging market acquisitions.18 Political risk in Europe and Africa was rated highest by PE managers due to the effects of the Eurozone crisis and political instability in North Africa.19 Operational risk, including health, safety, and environment, was listed as one of the biggest threats to investment in Latin America and the Middle East.20 In North America and Asia, fiscal and tax risks were cited as primary concerns among PE investors.21

According to a report by PricewaterhouseCoopers, there are investment opportunities for every risk appetite within the oil and gas industry.22 PE investments in oil and gas can be broken down by industry segment and fall along a risk continuum.23 Each sector involves different capital requirements, risk exposure, and exit opportunities.24 At the lowest end of the risk continuum is the midstream sector. This sector includes transportation, storage, and gathering and processing.25 Steady, low-risk cash flows have made the midstream sector one of the most popular for PE investors, combined with a full range of exit opportunities, including initial public offerings (IPOs) through master limited partnerships (MLPs).26 Next on the risk continuum is oilfield services. This sector includes companies that drill, as well as those that provide materials (such as water, chemicals, and pipe) and those involved in well operation and maintenance.27 The attraction of oilfield services companies is that they are less directly affected by swings in commodity prices, and they enjoy a strong range of exit opportunities.28 For example, numerous companies can be combined into a single IPO, or one company can be sold to a major industry player looking to add to its portfolio.29 Further up the continuum is the downstream sector, which encompasses refining and marketing.30 This sector is attractive since it offers the greatest number of distressed asset opportunities, yet is presents higher risk due to its greater sensitivity to shifts in supply and demand.31 Last on the risk continuum is the upstream sector. This sector includes exploration and production, both onshore and offshore, using conventional and unconventional techniques.32 The upstream sector involves greater exposure to commodity prices, and risk escalates with deepwater and international plays.33 While upstream attracts fewer PE investors, PE funds typically invest in this sector by buying properties directly or backing experienced management teams to build companies.34

  1. Bain Insights, Private Equity Drills For Growth In The Energy Sector, Forbes.com (Apr. 25, 2013, 10:09 AM), http://www.forbes.com/sites/baininsights/2013/04/25/private-equity-drills-for-growth-in-the-energy-sector. ↩

  2. Id. ↩

  3. Karen Bowman, Private Equity to Play Greater Role in Oil, Gas Investment, Rigzone (Dec. 6, 2013), http://www.rigzone.com/news/oil_gas/a/130492/Private_Equity_to_Play_Greater_Role_in_Oil_Gas_Investment/?all=HG2. ↩

  4. Id. ↩

  5. Id. ↩

  6. Id. ↩

  7. Emily Pickrell, Private equity sees growing investment opportunities in oil and gas, Fuel Fix (Dec. 4, 2013, 2:05 PM), http://fuelfix.com/blog/2013/12/04/private-equity-sees-growing-investment-opportunities-in-oil-and-gas/. ↩

  8. Id. ↩

  9. Bowman, supra note 3. ↩

  10. Pickrell, supra note 5. ↩

  11. Bowman, supra note 3. ↩

  12. Id. ↩

  13. Id. ↩

  14. Id. ↩

  15. Id. ↩

  16. Id. ↩

  17. Bowman, supra note 3. ↩

  18. Id. ↩

  19. Id. ↩

  20. Id. ↩

  21. Id. ↩

  22. PricewaterhouseCoopers LLP, The U.S. Energy Revolution: The Role of Private Equity in Oil and Gas 2 (2013), available at http://www.pwc.com/en_GX/gx/oil-gas-energy/publications/pdfs/pwc-usenergy-revolution-role-of-private-equity-v2-pdf.pdf. ↩

  23. Id. ↩

  24. Id. at 2–3. ↩

  25. Id. at 4. ↩

  26. Id. ↩

  27. Id. at 6. ↩

  28. PricewaterhouseCoopers LLP supra note 22. ↩

  29. Id. ↩

  30. Id. at 7. ↩

  31. Id. ↩

  32. Id. at 8. ↩

  33. Id. ↩

  34. Id. at 9. ↩

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