Expert Insights
Webinar Debate: Are We Witnessing the Death of The PE Company?
July 2020
The cyclical nature of the oil and gas industry is a known feature in which investors have accepted the risk and volatility in favour of exceptional returns. And as technological advancements have allowed for greater exploitation of wells, a belief that both frontier and maturing fields could be exploited for exceptional gain whet the appetite of private equity firms the world over, especially in North America. Shale gas exploration & production had advanced technological efficiency to such an extent that The Permian was awash with acquisitions by private equity firms who saw an opportunity to acquire and exploit assets themselves.
The United States soon became the world’s largest oil and gas producer but, when demand faltered, a supply glut saw the longest consistent drop in oil price in nearly 50 years between 2014-2016. These private equity firms held steady in their belief that the cyclical market would correct if they held on just a little longer…. It may have, at least until Covid-19 made its mark.
With a timeline for a global economic recovery unclear, the models of the past now outdated and technological advancements stuttering, we ask the question – are we witnessing the death of the Oil & Gas Private Equity Company?
The Oil and Gas Council invited five of the industry’s leading voices to share their opinions on the motion:
In favour :
- Geraldine Murphy, Managing Director, Investment Banking at Tudor Pickering Holt & Co.
- Fergus Marcroft, Strategic Advisor at Hannam & Partners
- Eskil Jersing, Director at Eskoil
Against:
- Adam Waterous, Managing Partner at Waterous Energy Fund
- Yash Kaman, Partner, Investment and Portfolio Management at Kerogen Capital
We took a poll at the start of the debate to see where our audience sided with the motion “We Are Witnessing the Death of The PE Company?“
Geraldine Murphy (Managing Director, Investment banking Tudor Pickering Holt & Co.) set the scene, emphasising that the private equity oil and gas vehicle plays a significant role in the energy landscape. However, despite more than $100 Billion entering the market since 2016 and involvement by private equity firms rapidly expanding their portfolios outside of America – the returns and technological advancements prophesised at the bottom of the 2016 cycle – failed to materialise. The concern, Geraldine says, is that even before the global pandemic shale gas players were in trouble; CapEx reductions had already been implemented through 2014-2016, the break-even margins for shale became dangerously thin and ultimately, the buy-flip model had found itself redundant in an unpredictable global pandemic.
Geraldine presented an alternate view in that, should private equity vehicles persevere, their model and approach to acquiring returns, geographical commitments and investment life-cycle all need to be reviewed for future success. The demand for capital in the oil and gas sector remains, but with traditional sources of capital.
Eskil Jersing (Director and Founder of Eskoil) is a generational oil and gas man, born and raised on the Nigerian Delta. One might expect a full-blooded defence of independent exploitation, instead Eskil proposes that as “all the easy oil has been found,” the capacity for E&P grows increasingly limited, and therefore an alternate motion should also be considered – “Have we reached the end of cheap peak oil?”
The modern technological efficiency of conventional oil and gas production had lowered E&P risk significantly, mitigating one of the historic concerns for private equity ventures. Eskil posits rather that risk has shifted from sub-surface to the surface as a result of modern ESG policy and constraints, which in turn have “polluted the investment value proposition”.
Although portfolio restructuring can extract the equity value that shareholders seek, the maximisation of these opportunities would require exceptional timing at the appropriate point of the cycle. Eskil insists this level of, “serial serendipity is proving to be a unicorn in the sector”. Value of equity in the Permian has evaporated over the past 5 years, and non-OECD jurisdictions only add external complexities to harvesting value.
From Eskil’s perspective only the majors, largest PE firms and APAC NOCs can assume the pressures and added risk of ESG policy and energy transition pressures.
Fergus Marcroft, (Special Advisor at Hannam & Partners), joined Ms. Murphy and Mr. Jersing in the ‘for’ camp, listing many overlapping concerns with the state of the market as his team had. Two critical factors Fergus noted were; the “appalling” historic returns within the oil and gas sector over the past decade, and how the rise of ESG principles had closed the door to traditional and institutional sources of capital.
Pointing to the returns of the 15 largest O&G companies outside OPEC and the supermajors, pre-Covid-19 and the Russia/Saudi price war, few had delivered value above the cost capital and the typical rate of return of 10%.
The greatest challenge as Fergus sees it, is the ability to attract institutional funds which have shut shop to new carbon intensive investment, in favour of making ‘sustainability’ a central pillar of their business models. This has the two-fold problem of suppressing supply, in turn raising prices and the knock-on consequence of the oil and gas sector ceding control to interests working outside of ESG principles, global carbon concerns and competitive markets.
Unless there is a significant shift by society-at-large to secure the production of oil and gas until the energy transition has been complete, we may be hearing “the death-knell tolling for private equity in the oil and gas sector.”
Adam Waterous, (Managing Partner & CEO Waterous Energy Fund) began the defence of the private equity model with an acknowledgement to the preceding arguments – the historic, backwards-looking models for private equity appear “very bleak”. Not only have the vast majority of private equity oil and gas investments been focused toward North America, but 80% of those are currently illiquid. If the strategy were once to find buyers and seek an exit, it would follow a now-failed business model – insofar as many firms mistook a structural change for a cyclical change, and are now paying the price.
The failure, as Adam sees it, was the lack of understanding of horizontal multi-stage fracking technology and its capacity to increase efficacy over time. It was nonsensical to expect the same or even similar rates of return from $100/barrel when at $50/barrel.
To mitigate the losses going forward, private equity ventures must seek a longer-term view that provides cash dividends from the equity investment overtime via an “equity pay-out model.” The constraint in this regard is that there are very few appropriate assets capable of delivering the required rates of return.
Yash Kaman, (Partner at Kerogen Capital), joined Adam’s defence by presenting two scenarios which may facilitate the continued involvement of private equity; firstly if returns can continue to be generated, and secondly if investors provide capital for investment in the sector. To this first point, Yash believes that the state of the market should be analysed from a macro-perspective. The cyclical nature has long tempered investment at the trough, but rallies as new opportunities emerge, supply slows and prices rise. Supermajors will not be taking the opportunity to acquire mid-size assets as their strategies had already accepted and mitigated against cyclical risks, instead supermajors will continue the “pruning” of assets by placing good quality assets on the market at attractive prices. In these positive deal-flow conditions, it is almost inevitable to stoke the interest of LPs seeking to play a role and take advantage of opportunities.
FINAL POLL RESULT
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