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Private equity’s energy moment

By Richard Aube, Pine Brook

To the casual observer, late 2014 through 2017 was a rough time to be invested in the energy industry.

The oil market was awash in oversupply, creating a down cycle for the industry and a volatile commodity-price environment that few understood.

As a result, even today, someone who took only a cursory glance at the energy sector would find it easy to pass it over in search of returns in less risky segments of the economy.

However, an investor looking carefully at the energy industry would find that current market conditions make this an ideal time to invest.

As with prior cycles, macroeconomic forces have returned supply and demand to equilibrium, and one can see that reflected in commodity prices.  Since 2010 global oil demand has grown at an average of 1.7 million barrels a day and will likely continue on this trajectory for many years to come.

With the industry back in a phase where the world needs more oil, it’s important to consider where production can be increased to meet that demand.

Saudi Arabia and other OPEC nations probably will be unable to boost production significantly in the near term.

Moreover, production capacity is largely limited in the rest of the world. Even when oil was more than $100 a barrel, the RoW was unable to grow its production capacity, so those producers are not very likely to be able to develop meaningful capacity increases at current prices.

U.S. producers are left as the clear winners in this recently balanced market.

The downturn in the oil industry over the past several years, while difficult, has created a U.S. oil-and-gas industry that is stronger, smarter and more capital-efficient than ever before.

As an example, consider the rig count, a commonly quoted metric in the oil patch.  At its peak prior to the downturn, the rig count hit a high of 1,600, in October 2014. Today, rig count is a bit more than half that, 860, with production per rig more than doubling in the interim.

As a result, the U.S. has the unique ability to increase production efficiently to meet the growth in worldwide demand.

Production growth requires capital. When an oil company, or the industry in general, is shrinking (as it was from 2014 to 2016), it is a net provider of capital. When a company or the industry is growing, it is a net consumer of capital, as first depletion is replaced (the natural runoff of reserves) and then new production is added.

The final component of the current energy-investment opportunity lies in the capital markets.

I sometimes am asked whether too much dry powder in the energy private equity industry will drive down returns. Not really. It’s actually the public equity markets, and their inextricable link to the M&A and A&D markets, that drive asset prices to unattractive levels for the private markets.

Historically, the vast majority of energy funding has come from the public equity and debt capital markets.  But these markets are not cooperating today. In fact, the equity and debt markets (and the resulting capital available to energy companies) have been shrinking.

So exactly at the moment the public capital markets need to be funding the production growth that global markets require, traditional capital is nowhere to be found.

To be fair, the equity capital markets for energy have not disappeared – but they have become a lot more disciplined in what they are looking for.

Today, public-market investors appear focused not on production growth (as in years past) but rather on traditional KPIs like earnings and margins, capital-efficiency ratios, and the ability to send profits to shareholders via dividends.

Just when the world oil markets are calling for production growth, and the world is looking to U.S. companies to provide it, the capital markets are not there to fund it.

As the capital needed to support production growth has to come from somewhere, the opportunity for private equity to step into energy has never looked better.

Richard Aube is co-president and head of the energy investment team at Pine Brook, a New York-based private equity firm focused on making business-building investments in the energy and financial-services sectors. He can be reached at or +1 212-847-4333.