Big players power up their energy-sector investments

Blackstone, KKR and other mega private equity firms are starting to spend large chunks of their capital on energy investments, a trend expected to heat up.

Not only is energy considered a growth sector that will generate heady returns, but also it takes a lot of capital. Private equity firms have the cash. They started the year with a collective $1 trillion in unspent capital commitments, according to a Bain & Co private equity report.

“Energy is a big trend: Shale, fracturing, natural gas, energy infrastructure (pipelines, terminals), oil field services is the rage,” said David Fann, president and CEO of private equity consultant TorreyCove Capital Partners, San Diego.

Energy is a mammoth investment opportunity. It's estimated that trillions of dollars are needed for shale gas-related investments alone, Marc S. Lipschultz, global head of energy and infrastructure at Kohlberg Kravis Roberts & Co. LP, New York, said in a recent white paper on the “shale revolution.” The investment opportunity includes $2 trillion in upstream investments for natural gas and $205 billion in capital expenditures for gas infrastructure developmentthrough 2035, he wrote.

So far, there is no concern that investors' private equity portfolios will become top-heavy with energy investments because mainstream funds are just moving into the area, Mr. Fann said. There are specialized energy funds, but they represent a fraction of overall investment activity, he added.

Energy deals have done very well for the West Sacramento, Calif.-based California State Teachers' Retirement System and officials believe the $154.8 billion system's private equity portfolio will not become top-heavy with energy transactions, said Michael Sicilia, media relations manager.

“Shale and "fracking' ventures have done particularly well. CalSTRS benefited from this trend through both private equity fund investments and certain co-investments. But we don't comment on individual co-investment deals,” Mr. Sicilia said.

As for any issues regarding the environmental safety of hydraulic fracturing, Mr. Sicilia noted all of CalSTRS' managers are bound by its investment policy on geopolitical and social risks, the so-called 21 risk factors — requiring consideration of environmental issues.

In May, Apollo Global Management LLC rocked the sector, leading a $7.15 billion leveraged buyout of North American oil and gas producer EP Energy from El Paso Corp. The investment group included energy-focused private equity firm Riverstone Holdings LLC as well as three limited partner co-investors. Apollo's funds invested $1 billion, the co-investors invested a total of $800 million, with the other partners investing the remainder of the $3.3 billion in equity needed for the deal, said Greg Beard, senior partner and global head of natural resources in Apollo's New York office. He declined to name the investors.

“The El Paso deal is dynamic,” Mr. Beard said. “Apollo is an opportunistic investor and we bought the company for an attractive price. The company has an asset base that allows it to transition from gas to oil and liquids which will drive value over time.”

Apollo has a team dedicated to invest in energy; most of its funds, including its private equity and mezzanine funds, have energy exposure.

“Today, there is a shortage of capital given the opportunity and that shortage is creating tremendous investment potential,” Mr. Beard said. “The shale plays are the primary driver for the need for capital and I don't really see that changing for the foreseeable future.”

Indeed, the first quarter of 2012, marked a watershed moment for private equity-backed mergers and acquisitions of energy companies. Deals reached a 20-year high with 11 transactions totaling $11.5 billion in value, a 267% increase in volume from the first quarter 2011, according to PricewaterhouseCoopers LLP. In the third quarter of this year, private equity firms invested $2.6 billion in 18 energy companies, up from $1.98 billion in 16 companies in the second quarter, according to Dealogic, a London-based research firm.

Mergers and acquisitions does not include sales of energy assets, which Apollo executives estimate will be between $60 billion and $70 billion this year.

Likewise, Blackstone Group, New York, is diving into energy in a big way. Energy deals have accounted for half of the total capital deployed and half of the gains, realized and unrealized, over the last two years, said David Foley, CEO of Blackstone Energy Partners and senior managing director of Blackstone.

These investments were made both through general private equity funds and through a new $2.5 billion specialized energy fund— Blackstone Energy Partners. Blackstone executives have invested more than half of the fund's total commitments so far, Mr. Foley said.

Blackstone's energy fund had a gross 110% internal rate of return as of Sept. 30, which Mr. Foley said was “not sustainable.”

”We are shooting for (IRR of) the mid-20's. Historically, we've performed in the high 30s,” he said. “If we stay disciplined and stay creative, I think that is sustainable.”

This year, KKR invested in energy through its private equity funds as well as its natural resources, infrastructure and KKR Financial business units, noted Kristi Huller, KKR spokeswoman. It has made more than 10 large investments within the past 12 months.

In November, KKR invested C$75 million in Westbrick Energy Ltd., but announced it would potentially invest a total of C$250 million (US$252 million) in the Canadian oil and gas company based in Calgary, Alberta.

In October, KKR and Houston-based private equity firm White Deer Management LLC's White Deer Energy fund bought Acteon Group from energy investment firm First Reserve Corp.

Terms of the deal were not disclosed, but the transaction valued the company at more than $1.3 billion.

Earlier this year, KKR teamed with Chesapeake Energy Corp. in a $250 million partnership to invest in mineral and overriding royalty interests in oil and gas basins in the U.S. KKR provided 90% of the total commitment.

Also this year, KKR raised a $1 billion infrastructure fund and a $1.25 billion natural resources fund. Both funds aim to invest in energy assets.

The Carlyle Group, Washington, was an early energy investor through its joint venture with Riverstone. It raised its last joint funds, the $6 billion Riverstone/ Carlyle Global Power & Energy Fund IV and the $3.4 billion Riverstone/Carlyle Renewable Energy Infrastructure Fund II, in 2008.

Since both firms were caught up in a pay-to-play scandal involving placement agents and the New York Common Retirement Fund, the two agreed to go their separate ways, but Carlyle executives have made clear they are still interested in energy investing.

“We continue to evaluate options to enhance our energy offering.” said Adena Friedman, Carlyle CFO, during the firm's Nov. 8 third-quarter earnings call.

In the last half of 2012 alone, Carlyle created a joint venture in which it received a majority interest in a Sunoco Inc. refinery in Phil-adelphia.

Carlyle also bought the North American business of Cogentrix Energy LLC, an independent power producer owned by Goldman Sachs. The $1.38 billion Carlyle Energy Mezzanine Opportunities Fund, which closed in November, and Science Applications International Corp. provided $225 million to finance a Plainfield, Conn.-based biomass plant for power producer Enova Energy Group LLC.

Carlyle also has financed its energy investments through U.S. and European buyout funds: Carlyle Infrastructure Partners; Carlyle Infrastructure Partners II; and Carlyle Equity Opportunity Partners. n