Rising prices and growing returns in oil and gas are enticing asset owners back to fossil fuels, despite those investors spending recent years building up exposures to opportunities in the energy transition.
So far this year, private capital funds worldwide investing in fossil fuels — oil, gas and natural gas — have raised a combined $27.9 billion compared with a total of $19.4 billion in all of 2021, Preqin data show.
Investors are attracted to the energy sector and its expected returns because prices are on the rise, pushed up by the ongoing war in Ukraine, pinched supplies and lower investment in fossil fuels when prices were lower.
The U.S. Energy Information Administration recently predicted that U.S. households will pay more for energy this year to heat their homes this winter (October through March) versus a year ago: 28% more for natural gas; 27% more for heating oil; 10% more for electricity; and 5% for propane. Also, the EIA forecasts that Brent crude oil's spot price to average $93 per barrel in 2022's fourth quarter and $95 per barrel in 2023. That compares with $79 a barrel in fourth quarter of 2021.
Meanwhile, in Europe gas prices in the first half of 2022, rose fourfold and coal prices rose more than threefold from the same period in 2021, according to the International Energy Agency.
Even with energy transition in the mix, investors seem poised to return to oil and gas strategies, said Fraser Van Rensburg, New York-based co-founder and managing partner of placement agency Asante Capital Group.
"The fundraising environment for oil and gas is better than it was in the last five years," Mr. Van Rensburg said. "It's all a juggling act in the sense that it is relative to other sectors and overall fundraising is down."
Still, there are oil and gas specialist managers that are either in the market with new funds or expected to soon start raising new funds. They include Quantum Energy Partners, NGP Energy Capital Management and EnCap Investments LP. The Carlyle Group owns 55% of NGP's management fee-related revenue, SEC filings show.
Pensions & Investments data show that Quantum and NGP have already received commitments for their new oil and gas strategies. Oregon Investment Council, which oversees the $93.3 billion Oregon Public Employees Retirement Fund, Tigard, in April committed $200 million to Quantum Energy Partners VIII and $50 million to a sidecar, both focused on investing in energy companies in the oil and gas upstream, midstream, oil field service and power generation sectors. The council also committed $150 million to NGP's new oil and gas fund, NGP Royalty Partners II, plus another $50 million to a sidecar fund. The $11.8 billion Sacramento County (Calif.) Employees' Retirement System is also an investor in the new NGP fund.
Mr. Van Rensburg said that as returns rise in the oil and gas arena, it could take as long as two years for oil and gas funds currently in the market to close.
Blackstone Inc. invests in traditional and energy transition assets through its $30 billion infrastructure business as well as its private equity energy and private credit energy businesses, its website and sources say. The firm is currently in the market raising its fourth private equity energy fund, Blackstone Energy Partners IV, P&I data shows.
To be sure, asset owners and their managers never really left oil and gas investments entirely behind, since many energy transition strategies include exposure to hydrocarbon investments.
"'Energy transition has become a very broad term," said Adam Toczylowski, Boston-based managing principal and private markets consultant at consulting firm Meketa Investment Group Inc. Managers' energy transition offerings vary from those that exclude any type of oil and gas investments to those that include upstream — referring to the exploration and production of oil and gas — and/or natural gas to replace coal, he said.
For example, BlackRock Inc. is currently in the market targeting $7.5 billion for its latest infrastructure fund, BlackRock Global Infrastructure Fund IV, which invests in energy assets.
"Earlier funds in the series carried the Global Energy and Power Infrastructure moniker and focused more narrowly on traditional energy and power assets," according to a staff report for the Aug. 23 meeting of the $37.4 billion New Mexico State Investment Council, Santa Fe. The council committed up to $100 million to the new fund, which is broader, at its Aug. 23 meeting. BlackRock has committed that at least 20% of fund capital will be deployed in projects that will directly or indirectly advance the energy transition, with 20% to 40% in low-carbon power, the report said.
But the fund would also be able to invest 30% to 50% of total fund capital in traditional energy for a mixture of energy including oil and gas and environmental projects. Other possible sector investments include 30% to 50% of total fund capital in digital infrastructure, 10% to 15% in transportation and logistics, and 5% to 10% in regulated utilities, which mainly rely on fossil fuels.
Indeed, in its fiscal year 2023 investment plan, New Mexico State Investment Council executives expect to continue investing in a mix of renewable power and energy transition assets and oil and gas, a staff report said.
While investor interest in renewables continues to grow, "investment returns have been squeezed in this sector," and renewable power generation assets are richly valued, the report said.
The council expects to search for investment opportunities in battery storage and power infrastructure as well as natural gas infrastructure.
"The energy transition is likely to be a decadeslong process and helping to build natural gas infrastructure that enables the marginal substitution of gas for 'dirtier' coal or oil is a benefit to the environment," the staff report said.
In 2021, 61% of U.S. utility-scale electricity generation was derived from fossil fuels — coal, natural gas, petroleum, and other gases — 19% was from nuclear energy, and about 20% was from renewable energy, according to the Energy Information Administration.
"We're starting to see renewed interest (in oil and gas) because of the increased price and also because of investor confidence in sustaining price levels," due to supply shortages, Mr. Toczylowski said.
"The way I see it, over the next couple of decades it (oil and gas) will be part of the energy mix that will be needed to meet this thriving demand" for energy, he said.
While there is more investor focus on renewable energy, that alone will not meet demand, Mr. Toczylowski said.
Mr. Tocyzlowski also expects oil and gas investments to increase in light of rising returns. Limited partners can invest in oil and gas as well as in the energy transition including renewables and decarbonization of traditional energy sources, he said.
"We've really seen a shift," he said. "COVID and the volatility in oil and gas prices created more focus on the energy transition. As investors continue to show renewed interest in oil and gas, it's more of a blend now."
Some managers such as The Carlyle Group Inc. contend that in order to lower carbon emissions, investors and managers need to continue investing in oil and gas. Earlier this year, Carlyle combined its global energy group with its global infrastructure business to invest in the energy transition across traditional and renewable energy, as well as infrastructure.
Carlyle also owns a stake in oil and gas manager NGP Energy Capital Management, according to Carlyle's most recent 10-K. Carlyle reported that as of Dec. 31, "funds focused on investing in carbon-based energy remain a significant part of our business" and accounted for 8% of its total $301 billion in assets under management.
Carlyle said in the filing that it has determined not to raise a successor fund to Carlyle Energy Mezzanine Opportunities Fund II or Carlyle Power Partners II. Instead, Carlyle's future investments in carbon-based energy are expected to be made primarily through NGP in the U.S. and its energy business, Carlyle International Energy Partners, outside the U.S., Carlyle said.
In the latest Private Equity Climate Risk Scorecard, released on Oct. 4, which analyzes the energy holdings of eight alternative investment firms with large energy portfolios, Carlyle and NGP ranked last with an "F" grade due to the amount of its fossil fuel holdings and what the groups called "weak climate policies." The scorecard is produced by the non-profits Private Equity Stakeholder Project and Americans for Financial Reform Education Fund. The Private Equity Stakeholder Project receives funding from unions and other non-profits.
In response to the non-profits' report, Carlyle said it's strategy is to invest in fossil fuel companies to make changes from within.
"Carlyle's approach to invest in, not divest from, the energy transition is a different one, grounded in seeking real emissions reductions within portfolio companies over the long term," the firm said in a written statement. "In order to work toward meaningful progress on climate change, we will continue to partner with companies across the energy spectrum to collect better data and strive for clear progress reducing greenhouse gas emissions."
The war in Ukraine has also put a spotlight on the speed at which the world can switch from fossil fuels to cleaner energy sources, said Benjamin Morton, executive vice president, and head of global infrastructure and a senior portfolio manager for listed real asset manager Cohen & Steers' infrastructure portfolios.
Governments around the world are now grappling with energy independence as countries in Europe find their energy is now in short supply as part of the fallout from the Russia-Ukraine war, he said.
"The world is going through decarbonization but the brakes are being pumped in certain places in the world which were going too far too fast" toward renewable energy and away from fossil fuels, Mr. Morton said.
