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To energy private equity, competitive power seen as black-sheep investment

Of the billions raised by private equity funds targeting the energy sector, only a modest sum may make its way into competitive power compared to upstream exploration and production and renewable energy, according to observers at an investor summit in Boston.

Speaking at the SuperReturn Energy conference in Boston on June 12, specialty private equity investors and their institutional backers acknowledged that the abundance of private capital chasing energy investments — E&P, midstream, power and renewables — has generally lowered returns for most players in the business, pressured by an influx of cheaper capital from large infrastructure funds and foreign investors with longer-term buy and hold strategies.

Indeed, one adage commonly expressed by the private equity set and their advisers remains true through the middle of 2017: There is too much capital chasing too few opportunities.

Dry powder

As much as $155.8 billion in dry powder, or unspent capital, was earmarked by private investors for energy transactions as of June 2016, according to research outlet Preqin's 2017 Global Natural Resources Report. On top of that, as many as 140 unlisted energy funds are seeking to raise more than $70 billion in additional capital targeting energy as of April 2017, Preqin data shows, with more than half of that parceled out for renewables.

"You are going to keep hearing the refrain around too much capital in the market, whether that's debt or private equity markets, and it's a symptom that all sectors face at this point in time," Tenaska Capital Management LLC Managing Director Grant Davis said on a June 12 panel.

But getting a piece of that capital in 2017 may be more difficult for power private equity sponsors navigating a creeping oversupply of physical capacity in major markets and shrinking load growth. Indeed, new-build projects steamrolling into major competitive markets like PJM Interconnection and the Electric Reliability Council of Texas are thought to be nipping away at margins, meaning larger institutional investors, acting as limited partners, or LPs, could be more skittish on their capital allocations into specialty power funds, with a generalist energy strategy looking like a better bet.

"It used to be that power had a clear space in the hierarchy of allocations, and now in any given meeting, there's a lot of guess work as to how power might fit into a given LP's allocation strategy," Hull Street Energy LLC Managing Partner Sarah Wright said. "LPs have become more focused on picking winning sectors and less focused on picking winning managers," she said, adding that power-oriented funds may be out of favor despite strong returns on asset optimizations.

Going long

Panelists noted that the proliferation of popular investments piling into the Permian and Utica basins and midstream projects out of those areas, as well as the growing appetite among large insurance and sovereign wealth funds to own stakes in portfolios of contracted renewable assets, have created a small pool of potential buyers for conventional power investments.

And while power private equity mainstays like ArcLight Capital Partners LLC, Blackstone Group LP, Carlyle Power Partners, Energy Capital Partners, LS Power Equity Advisors LLC and Riverstone Holdings LLC have had a buy-side foothold on merchant power during the market's most recent downturn, the entrance of larger North American infrastructure funds casting their nets into the power sector may mean a compression to potential returns associated with power if those assets are ultimately bought up and shelved by long-term owners.

"It really is a bunch of private players, and I think you have a lot of power-focused funds out there competing with general infrastructure funds," ArcLight founder and managing partner Daniel Revers said of the arrival of recent North American infrastructure funds. "A lot of that money was intended to go into traditional infrastructure like toll roads, ports, terminals, but power is a big user of capital, and money finds its way to where it is going to be used up."

Recent infrastructure funds that could be competing for power deals could include Global Infrastructure Partners, which raised a $15.8 billion fund earlier this year, as one such example. Other names include Stonepeak Infrastructure Partners, which Bloomberg reported may be seeking $5 billion for a new fund, or Morgan Stanley Infrastructure Inc., which launched a $3.6 billion fund last year.

"It's incredibly competitive to invest capital across all asset classes these days," Ares EIF Management LLC co-head and partner Herb Magid said, adding that the global pursuit of yield is also touching power. "You are seeing international investors, like Asian investors and sovereign wealth funds, stacking their own teams to do the right deals."