What's the cure for high gas prices? More oil.
And how do we get more oil? With the help of private equity capital.
In my last post, I outlined the thesis that oil prices are likely to stay aloft amid strong demand and constrained supply. US energy companies will be at the center of this, with the latest forecast from the International Energy Agency showing the United States is expected to satisfy 60% of demand growth over the next five years. According to IHS Markit, conventional discoveries of oil and gas outside the US in 2015 hit their lowest level since 1952.
After a drought of investment as management teams aggressively trimmed expenses to stay afloat, an aggressive ramp-up in spending is needed. Morgan Stanley believes that daily output needs to increase by 5.7 million barrels per day by 2020, a pace of increase that's happened only once since 1984.
While prices have cooled slightly in recent days on reports that OPEC and Russia could consider easing their output caps at the next policy meeting in late June, that's far from a sure thing: According to estimates from the International Monetary Fund, Saudi Arabia's fiscal breakeven oil price is between $85 and $87. As the holder of the bulk of OPEC's spare capacity of around 2 mbpd, Riyadh isn't going to be in any hurry to turn the spigots back on.
That's where private capital and US shale fit in. According to Deloitte, the industry has a Capex need of $3 trillion through 2020. Of that, there is a funding gap of $750 billion to $2 trillion that will need to be met with outside capital, depending on debt repayments and investor payouts.
All of this is a perfect scenario for energy investors. Orion Energy Partners CEO and co-founder Nazar Massouh told me that not only is the demand picture looking good—quipping that we haven't yet found a way to grow the economy without needing more hydrocarbons—but industry IRRs are looking strong too, as companies have become increasingly efficient with each dollar deployed into places like the Bakken shale.
He noted that well completion times have fallen by roughly half since 2013—meaning a dollar invested goes roughly twice as far now. His firm's focus is on midstream infrastructure like pipelines and refineries, but Massouh sees the entire industry attracting money, since "tomorrow looks pretty good" amid record production and record consumption.
As for Andre Burba, managing director of the energy investment team at Pine Brook, he believes the situation in the US energy industry should be a top-of-mind opportunity, as the confluence of different tailwinds represents the best opportunity in years—if not decades—for the sector.
Looking at the fundraising and dealmaking environment, Burba told PitchBook he sees a disconnect between rising oil prices and a relatively tepid performance by publicly traded energy stocks. For instance, investors are demanding these companies boost profitability by trimming balance sheets and dumping noncore assets in less productive shale plays.
That's creating opportunities for private energy startups—often led by former division managers in major oil companies that want to be CEOs of their own outfits—to snap up these properties and start drilling. But in order to do that, they need capital. And get that capital they must, Burba notes, if US oil production is going to balance world markets.
LPs should take note. Cambridge Associates confirms that energy-related private equity funds enjoy improved performance in times of rising oil prices, offer attractive diversification benefits and have enjoyed solid returns over the last two decades relative to public energy stocks.
US oil & gas PE dry powder
US oil and gas PE funds are holding more than $52 billion in dry powder, down from a peak of $70 billion in 2015, according to PitchBook data. EnCap Investments is holding the single largest stash, with $6.75 billion waiting to be deployed in its 2017 vintage Energy Capital Fund XI. Riverstone Holdings is next, with just over $3 billion in its 2014 vintage Riverstone Global Energy and Power Fund VI.
For LPs looking to get in, industry titan Blackstone could soon come to market with a new fund, as the firm's 2015 vintage Energy Partners II fund has drawn down about half of its total, with $2.7 billion in dry powder remaining. NGP is also worth watching, with 94 deals in the space since 2007—making it the third-most active investor—but only $1.7 billion in dry powder in its 2014 vintage NGP Natural Resources XI fund. That's just 32.3% of the original allocation.
Related read: Energy investment to soar as oil rises