Private equity energy 'rescue' deals bring good press, more capital

Private equity firms have come to the rescue of struggling energy companies and their local communities, gaining much-needed public support with promises to save jobs and keep energy flowing.

These transactions are providing a respite from the drum beat of bad press private equity began getting at the height of the Republican presidential primary campaigns — and still continues.

Good will and positive press are not all that The Carlyle Group, KKR & Co. LP, The Blackstone Group LP and others are receiving from these investments.

Energy investments, especially natural gas, are extremely hot right now. Generalist alternative investment managers are bringing piles of capital to get in on the financial bonanza expected from building the infrastructure, support systems and plants needed to turn the U.S. into the natural gas supplier to the world.

The amount of capital being raised by the larger private equity firms to invest in energy doubled to $33 billion in the past three years, said Andrew Brown, senior investment consultant in the London office of Towers Watson & Co., citing data from Preqin, an alternative investment research firm in London.

Also, deals are getting larger. Private equity firms closed 18 energy deals with a combined value of $8.38 billion in the second quarter, up from 27 deals valued at $2.42 billion in the first quarter and 34 deals worth $10.86 billion in the second quarter of 2011, according to Seattle-based data research firm PitchBook Data Inc.

Mainstream private equity funds are now partnering with energy-focused funds on some of these transactions, said David Fann, president and CEO of La Jolla, Calif.-based private equity consulting firm Torrey Cove Capital Partners. “Liquefied natural gas should be huge” in terms of attracting money, he said.

Consultants are also boosters for the sector.

“Most limited partners and investors who have spent time studying the energy sector see this as a good opportunity,” Mr. Fann said. “We think, for most clients, a greater exposure to energy is a good tactical shift.”

Private equity firms are not making these energy investments alone. Examples of large firms teaming with energy-focused funds include the $1.25 billion investment in Chesapeake Energy Corp. by Blackstone, TPG Capital and energy investment firm EIG Global Energy Partners in April. Also, KKR joined specialist private equity energy firms Natural Gas Partners and Crestview Partners, and Japanese trading company Itochu Corp., for November's acquisition of oil and gas firm Samson Investment Co., Tulsa, Okla.

The most recent transaction was Carlyle's July 2 rescue of Sunoco Inc.'s Philadelphia refinery, which was slated to close before Carlyle's investment. The size of the investment is not being disclosed, but two-thirds of the more than $200 million in capital improvements is being supplied by Carlyle.

In February, KKR's money management arm, KKR Asset Management LLC, joined with Morgan Stanley Capital Group Inc. and Brussels-based AtlasInvest to provide a capital injection that kept Petroplus Holding AG from closing a refinery in Coryton, England. Petroplus, an insolvent Swiss oil and gas company, is the largest owner of refining capacity in the United Kingdom. The consortium provided financing that helped keep the refinery open, said William Sonneborn, member and head of KKR Asset Management in San Francisco.

Both Carlyle's joint venture with Sunoco and the Petroplus transaction had the side benefit of a huge amount of good press and support for the private equity industry. The Carlyle/Sunoco transaction had the support of the White House, the governor, mayor and a local congressman, said Christopher Ullman, spokesman for Washington-based Carlyle.

Along with the public-relations bonanza, Carlyle received a $25 million investment from the state of Pennsylvania because the firm is expected to save 850,000 permanent jobs and create 100 to 200 more permanent jobs, in addition to several thousand construction jobs, Mr. Ullman said.

Carlyle is not saying how much it is investing, but funds from Carlyle and the state are slotted to be used for $200 million in capital projects related to the refinery, including building a high-speed rail spur in the facility, Mr. Ullman said. The investment is being made through the Carlyle Energy Mezzanine fund and the Equity Opportunity fund, a midcap private equity and special situations fund.

The Petroplus deal, on the other hand, does not appear to be headed for a happy ending. While the consortium's cash infusion saved the U.K. plant from immediate closure while a buyer for the plant was found, the plant is expected to close anyway, said Kristi Huller, KKR spokeswoman. (Coincidentally, Petroplus itself was the result of a Carlyle deal, which the firm exited in 2007 by taking the company public. Investors ended up earning five times their original investment on the deal, sources said.)

Still, the consortium was praised for giving the administrator, PricewaterhouseCoopers, time to conduct an orderly sale and keep oil flowing into the refinery to be processed, saving jobs for four months, Ms. Huller said.

Not all the energy transactions by alternative investment firms involve struggling companies.

In May, Blackstone Group made a $2 billion investment in Cheniere Energy Partners LP, which has a natural gas facility in western Cameron Parish, La. A total of $3.4 billion will be used to convert the plant to an export facility from an import one, making it the only export facility in the continental U.S., said Christine Anderson, spokeswoman for New York-based Blackstone. Half of Blackstone's investment is from Blackstone Energy Partners, which is not yet closed, and the other half from $16 billion Blackstone Capital Partners VI.

The opportunity set is huge, Mr. Brown said, citing the large need for capital to convert the U.S. energy infrastructure to exporting natural gas from importing it.

“Five years ago, no one was talking about shale. Five years ago, the U.S. government was talking about importing natural gas from places like Russia ... today (government and industry executives are) talking about exporting natural gas,” he said.

The conversion requires everything from new piping and refining facilities to new transport ships, Mr. Brown noted. And as the public shifts to natural gas from a reliance on oil, the price of natural gas, which is now low, should rise, he said.

But the good-news energy stories might not last forever.

There's a giant sinkhole in the room when it comes to natural gas investments. That is the environmental impact of the process used to extract shale gas — slick-water or hydraulic fracturing, also known as fracking.

“The reality is that people don't know the impact of the drilling on the water table and the earthquakes,” making environmental fallout probably the biggest investment risk, Mr. Brown said.

“If (scientists) find that fracking contaminates the water, ruins the water table or causes earthquakes ... it would put a chill in the opportunity,” he said.

“If the environmental impact leads to regulation, that would drive down returns because regulation would make the fracking technique more expensive.”

Some private equity managers are avoiding that risk and the controversy surrounding fracking by investing in only the technology, rather than the actual drilling, he said. They are investing in a “closed loop” technology that might be a solution to the negative environmental impact of fracking should there be more regulation, Mr. Brown added.

In addition to the environmental impact, there is a danger that too much capital is rushing into the sector.

“We like energy. It's definitely an interesting sector, but again you have to be very selective,” said Benoit Verbrugghe, senior managing director and head of AXA Private Equity U.S. in New York.

“We are cautious because ... when you have a lot of people taking a look at the same sector, you have to make sure at least the selection of the (general partner) and the underlying companies are very strict.”