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EnerVest isn’t alone feeling the pain from oil price drop

EnerVest senior vice president Ron Whitmire
Ron Whitmire said the XIV fund shouldn’t have debt issues seen with earlier funds.

Losses expected in two EnerVest Ltd. energy funds underscore the issues faced by some investors that put more than $200 billion into the sector between 2009 and 2014.

EnerVest executives are trying to extricate the energy manager and its investors from a collection of issues: the oil price collapse in the second half of 2014; investing money when asset prices were high; new regulations that reduced the amount of energy loans banks can carry on their books; and fund-level debt tied to market values that dropped with the price of oil.

EnerVest's use of leverage put its two pre-2014 funds — the $1.5 billion Energy Institutional Fund XII and $2 billion Energy Institutional Fund XIII — in a bind. When oil prices fell precipitously, the portfolio value dropped with it, causing EnerVest's lender to accelerate its debt repayment.

"Leverage works well when everything goes as expected, but can be calamitous when markets turn volatile," said David Fann, New York-based president and CEO of private equity consulting firm TorreyCove Capital Partners LLC.

(TorreyCove client Illinois Teachers' Retirement System, Springfield, is an investor in EnerVest's Fund XII, which closed in 2010. Mr. Fann declined to discuss the investment. Illinois Teachers' spokesman Dave Urbanek, in an email declined comment.)

But EnerVest is not the only energy firm to face problems with its pre-2014 funds, investor reports referencing EIG Global Energy Partners and EnCap Investments LP funds show. EIG reported lower fee estimates for two of its funds — in one case, retroactively — as a result of the decline in oil prices and lower returns, according to a June 1 fee report to the board of the $14.4 billion Orange ​County Employees Retirement System, Santa Ana, Calif.

EnerVest reported lower fees for funds XII and XIII as a "result of the 2015 washout in energy production," according to the report.

Molly A. Murphy, OCERS' chief investment officer, could not be reached for comment.

EIG spokesman Brandon Messina and Julie Oakes, EnCap spokeswoman, both declined comment.

Performance drops

Not surprisingly, returns are suffering. The Florida State Board of Administration, Tallahassee, earned internal rates of return of -9.4% for EnerVest Fund XII and -79.1% for Fund XIII, as of Sept. 30, 2016, according to information on its website. The board oversees a total of $189.4 billion in assets, including the $151 billion Florida Retirement System.

The SBA's investment in EnerVest Fund XII was valued at $5.1 million, Fund XIII at $10.6 million and Fund XIV at $86.3 million, on commitments of $60 million, $100 million and $100 million, respectively, said John Kuczwanski, manager of external affairs, in an email.

The $14.9 billion New Mexico Public Employees Retirement Association, Santa Fe, committed $20 million to EnerVest's Fund XII in 2010. As of April 30, 2017, it valued the investment at $9.9 million, fund documents show.

The return on a pre-2014 EnCap Investments fund also has been slashed. The firm's eighth fund, EnCap Energy Capital Fund VIII, raised in 2010, has a net internal rate of return of -6.36% as of Sept. 30, 2016, according to an April staff report to the board of the Los Angeles City Employees' Retirement System. Florida SBA put its net IRR for the same EnCap fund at -6.1% as of the same date.

The returns are below the bottom-quartile IRR for 2010 vintage energy funds of -4.1%, according to London-based alternative investment research firm Preqin. They also are substantially lower than the 16.5% net IRR reported to the board in 2015 when LACERS made a commitment to EnCap's 10th fund, pension fund documents show.

Median internal rates of return for energy-related private equity funds raised between 2010 and 2014 were hovering below 3% as of Dec. 30, according to Cambridge Associates LLC data.

Details make difference

While debt is not unusual in energy funds, the level and type of debt can make a difference. "Only a handful of energy funds borrowed at the fund level during the 2010-2014 time frame," Mr. Fann said. "Those that put on leverage with mostly producing assets and hedged (locked in prices for selling either oil or gas), will generate reasonable returns on investment. Those that used borrowed funds for exploration or development purposes are generally facing a troubled outcome, unless a steep recovery in energy prices occurs very soon."

EnerVest's funds all had fund-level leverage limits of 40%, with typical leverage of 35% of net asset value.

"We added what we considered was pretty modest debt and commodity prices plunged," said Ron Whitmire, EnerVest senior vice president and chief administrative officer. The result was that the funds — Fund XII and Fund XIII — became overleveraged, he added.

EnCap invests with management teams that acquire and exploit oil and gas reserves. EnCap employs modest leverage, the LACERS report stated. EIG finances energy companies and projects in the oil and gas, midstream, infrastructure, power and renewables sectors.

Salvaging funds

EnerVest executives are "in the final stages" of discussions with a private equity firm that would recapitalize Fund XII and are in discussions to sell assets held by Fund XIII, which closed in 2013, Mr. Whitmire said. He declined to elaborate. Even so, the firm expects investors in both funds could lose money, he said.

This is not the first time EnerVest has tried a recapitalization. EnerVest executives told its limited partners in 2016 they had negotiated a deal for a recapitalization of Fund XII by a private equity firm. Under that proposal, EnerVest and the unnamed firm would form a new company for some of the fund's assets. But that transaction "fell apart," said Mr. Whitmire.

EnerVest does not anticipate issues with its debt on the $2.4 billion EnerVest Energy Institutional Fund XIV, Mr. Whitmire said. That fund, which closed while the firm was dealing with the debt issues of the earlier funds, began investing after the collapse of oil prices.

Lessons learned

Several investors in funds XII and XIII also invested in Fund XIV; Florida SBA, OCERS and the University of Michigan endowment are among them. Only officials of the Florida board could not be reached for comment by deadline.

"At the time of the investment in Fund XIV, we were familiar with the conditions of the energy sector and the impact it had on funds," Mr. Kuczwanski said in the email.

Minutes of a May 3, 2016, OCERS board subcommittee meeting show then-CIO Girard Miller saying that rather than the pension fund selling limited partnership interests in funds XII and XIII at a loss on the secondary market, "we have to eat what we cook." He added that later energy funds such as Fund XIV could capitalize on the problems faced by pre-2014 energy funds.

Mr. Whitmire could not elaborate on the leverage limit of Fund XIV but did say it is lower than in prior funds. EnerVest's website post concerning the fund's final close stated Fund XIV, the largest in the firm's history, had $3.8 billion in purchasing power. This gives EnerVest executives room to add leverage of $1.4 billion, or 37%, of total fund capital.

Mr. Whitmire said EnerVest's latest fund is performing well. So far, Fund XIV has spent $1 billion buying in the oil-producing Eagle Ford Shale as well as a coal bed producing methane. The fund also will have increased the wells it owns in Virginia to 200 in 2018 from 50 in 2016.

The New Mexico Educational Retirement Board, also in Santa Fe, which invested with EnerVest for the first time in Fund XIV, earned a net IRR of 12.81% as of Dec. 31, according to the latest performance report on the $12 billion fund's website.