Private eye: the shale gas boom

Some hailed it as an "energy revolution" and, in November 2014, private equity (PE) firms were desperate to get a piece of the action. Prompted by innovation in drilling technology, the US was becoming a world leader in natural gas production - and PE firms were "salivating" at the opportunities on offer, according to a CNBC report from that month.

"There are incredible numbers of ripples that go out from the splash," said the head of BlackRock's $18.8-billion Private Equity Partners division, likening the search for good energy investments with what happens when a small boy throws a rock into a pool of water.

"Well, the energy revolution right now is the rock. The ripples are all of the things in the economy that support the energy revolution [...] that provide all kinds of investment opportunity."

These companies had generated enormous sums for investments. Between 2009 and 2014, PE funds had clubbed together to raise $157 billion to invest in energy, according to Preqin. By the same estimates, firms that focused on energy and launched between 2002 and 2011 saw average net returns of close to 14%. In other words, there was big money around to invest in a wide range of projects.

"Private equity has played an important role in the sector since the economic downturn, providing a key source of investment for the mid-cap community," Andy Brogan, global oil and gas transactions leader at EY told Financier Worldwide in a round-table discussion last June. "Compared with other sectors, PE firms find it relatively easy to access finance when investing in the oil and gas sector."

"The capital requirements of the oil and gas sector are high, which leaves room for PE players to invest. The field of active players is expanding, with new entrants joining specialist and generalist funds that have been active in the space for decades."

Going down

But then something happened that took everyone in the industry by surprise. In what was referred to as "the big drop", oil prices, which had been stable - and high - for so long, took a dive. Having reached peaks of $110 a barrel in June 2014, January 2015 saw prices plummet to under $50.

The drop hit the business hard, from countries whose economies rely on high oil prices for currency stability to the firms once proclaimed as the saviours of the US energy sector. February saw Apollo Global Management announce a 79% drop in profits in the months leading up to the new year, and KKR and Carlyle announcing decreases of 94% and 68% respectively. So, was this investment just a bubble? And what now for the relationship between PE and shale gas?

At IHS CERAWeek in Texas in April, Blackstone Energy Partners CEO David Foley told luminaries from the world of oil and gas that the days of PE firms like his engaging in 'drill and dump' were over. "Those days are history," he was quoted by Bloomberg Business as having said in a presentation.

Spurred by the decreasing price of oil, companies could no longer pick up assets in shale acreage, drill to prove the existence of oil or gas, and then sell them on to big energy companies to make a quick buck. Instead, he said, a new model was taking shape: PE firms could play the long game, turning discoveries into fields and developing management structures to drill themselves, he argued. Blackstone is a big player - the company has invested in wells in major deposits in Haynesville, Louisiana.

Also speaking at the event in April, however, was Roberto Simon, head of project and energy finance in the Americas at Société Générale, who argued that investors could take advantage of the debt in the market following the oil price drop to buy up depreciated assets and take some risks.

"There's a lot of liquidity in the market," he said. "When you have a lot of money to put to work, your credit standards come down a little bit."

The conversation has shifted, and the tide seems to be turning to more long-term investments and the role of PE funds in helping shale gas companies, which might have spent significantly during the boom, stay afloat until prices increase again in return for generous shares when things improve.

Contracts could also be getting smaller, believed Michael Smith of Freeport LNG, so PE funds aren't pressed to pour all their money into one project. Charif Souki, CEO of Cheniere Energy, agreed, suggesting that more low-key projects could be the way forward - costing closer to $1 billion, rather than the $15 billion his company's export terminal based in Louisiana cost.

On the table

Despite the downturn, private equity firms are "more interested than ever" in shale gas, The Economist reported in February, comparing it with the collapse of property that took place in the US, and across the world, in the aftermath of the 2008 financial crisis, where indebted investors were put under pressure to sell as prices fell.

Despite the fall in prices, demand remains high, and even when oil prices were at their lowest in January, Houston-based Linn Energy signed an agreement with GSO Capital Partners, the credit division of the Blackstone Group.

The deal announced that the two companies had lined up $500 million in investments and that GSO would pay for new infrastructure for five years in exchange for 85% interest until their investment saw a 15% rate of return. Financial news site The Street was quick to point out that this agreement, while demonstrating the continued interest that PE funds had in gas, was a far cry from the more generous deals seen when oil was about $100 a barrel, citing other firms that had recently engaged in similar deals, from ArcLight Capital Partners to EIG Global Energy Partners.

"As long as commodity prices stay in the range of where they are now and don't go up to $80 or above, this is going to be the wave of financings," the site quoted an unnamed source as saying.

Getting back on top

So why private equity in particular? A lot of it has to do with the nature of the oil and gas financing structures. PE funds can provide much-needed extra financing for energy companies with ongoing operational investments, such as in maintenance, particularly when it comes to more-expensive operational techniques, that might have fallen on hard times when the oil price fell.

"High oil prices, above $100 a barrel, attracted new investment," said an article on the financial analysis site HedgeThink in April. "Many small companies backed by private equity came up. They were highly leveraged.

"With a 50% fall in oil price, these companies have cash flow problems. Most of these oil assets are now available for deals at a bargain price."

PE funds represent real options for energy companies, whether the oil price is high or low, and according to The Economist, many firms are preparing their war chests for the coming months.

Blackstone has announced that it has amassed funds of $9 billion for the purposes of energy investment and Warbug Pincus, another PE firm, had a $4-billion fund as of late 2014. With the price of oil set to remain relatively stable this year, they'll have plenty of options to spend on.