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Private equity execs happy to spend in oil, gas while public lenders stay out

The idea that one person's trash is another's treasure appears to have come to upstream oil and gas, as private equity firms are relishing the opportunity to fill the void left by public lenders intent on avoiding the segment.

At the NAPE Global Business Conference in Houston, attendees got insight on Feb. 13 into both points of view, as partners in EnCap Investments LP and Chambers Energy Capital discussed the favorable playing field for private equity while a managing director at Wells Fargo Securities explained why public lenders are more apt to stay on the sidelines.

Chambers Energy Capital partner Phil Pace acknowledged that the market has been "brutal" for the past six months but said opportunities to make good deals are now readily available for private equity.

"I've watched a lot of cycles … and this is the best [acquisitions and divestitures] market I've ever seen. You can get real value," he said. Pace said he believed public equity issuers had become gunshy of the upstream industry because returns consistently failed to meet expectations, while opportunities in other areas presented much more lucrative opportunities. With the markets largely shutting them out, producers are turning to private equity to fund acquisitions or growth opportunities.

"As public markets have dried up, there's more demand for our kind of capital," he said.

EnCap Investments partner Jimmy Crain said upstream companies are now looking to private equity first to fund transactions as they know the public markets will brush them off. Private firms, which have raised billions of dollars in capital over the past several years, are more than willing to assist.

"Private capital is giving cash for liquidity purposes, and you have a lot of private capital out there," he said. "A lot of companies with dry powder are looking to put their money to work."

Crain said private equity will have to be more patient than in the past with their investments, as the current market is making it tougher to get in and get out of an upstream company quickly. But supporting producers as they build larger, "blocky" positions with good economics can mean better returns in the long run.

"We're trying to build billion-dollar-plus companies," he said. "We're building something someone ultimately wants to buy."

Wells Fargo Managing Director David Humphreys said that while private equity is happy to invest in the upstream arena, it remains a hard sell for non-specialized public investors who see consistent underperformance. Humphreys noted that, while the S&P 500 was down approximately 6% in 2018, the XOP oil and gas exploration and production index was down 30%.

"To state the obvious, the energy industry has been a very tough play," he said. "The XOP has underperformed the S&P the last five years. Not surprisingly, the generalist investor is not seeing the opportunity to invest in our space."

Public equity investors, Humphreys said, remain dubious about producers' claims that they will stop putting free cash flow into expansion opportunities and return it to stakeholders, as history is not on their side.

"They're still in 'show me' mode. They're on the sidelines," he said.

Humphreys noted that many smaller private firms have yet to move into the positive free cash flow range, but increasing numbers of companies are doing so. As more producers start returning cash flow to shareholders, interest from public equity holders may increase.

"Companies are taking 'the pledge' to make the appropriate returns while living within cash flows … and thankfully, we're starting to see some positive results," he said.