A mature play

The world still runs on oil and gas, and as long as it does, the private sponsors who own oil and gas assets will require financing to drill, pump, transport and refine the world’s most precious fossil fuels.

“We definitely continue to see an opportunity for us (as a non-traditional provider of capital) created in part by the pull back from the banks but primarily the level of development in the energy sector globally,” says Rahul Culas, managing director and co-head of Carlyle’s Energy Mezzanine Opportunities team. “The upstream oil sector is probably the busiest for us in part driven by the level of activity currently across the US and Canada.”

Culas’ observation shouldn’t come as a surprise. The energy sector accounted for 10 percent of global buyout volume in 2012, 83 percent of which went to oil and gas properties, according to a Bain & Company report. Of those properties, approximately half are located in North America.

That level of activity has spurred commitments from institutional investors seeking access to the credit markets through the energy sector, which has enjoyed a renaissance with the emergence of alternative drilling techniques such as hydraulic fracturing and shale gas investments over the last six years.

In Europe, 49 percent of surveyed limited partners indicated that they believe the sector will be one of the five most active in the upcoming year, according to DLA Piper’s European Acquisition Finance Debt Report. That has certainly been the case in the US, where institutional investors like the New Mexico State Investment Council and the California Public Employees’ Retirement System have committed heavily to the credit-related energy strategies in recent months.

In June, CalPERS reported that it had recently established a $400 million separately managed account through GSO Energy Partners, a credit affiliate of The Blackstone Group. Other fund managers have also seen recent success engaging LPs. For example, Energy Capital Partners closed its latest mezzanine opportunities fund $305 million above its $500 million target in February and Carlyle closed its first energy lending fund on $1.38 billion late last year.

“We closed our fund in November 2012, so I can’t say that I know how LP’s are reacting to the past six months,” says Culas. “But high level, there continues to remain a strong level of demand for energy related investments/co-investments.”

Some of that may be due to the maturity of certain oil and gas assets, many of which were still in the exploratory phase only a few years ago. As those assets have matured, the risk associated with providing credit to their continued development – as well as that of midstream and downstream assets – has declined.

“As we get a little more mature in the shale, we’re seeing a lot more credit opportunities. For instance, in the Marcellus, there were four or five years there – through 2011 – where drilling was pretty broadly dispersed across the play,” says Dwight Scott, a senior managing director at GSO. “It’s only in the last couple of years that we’ve gotten enough data, and seen enough well results that we have a pretty good sense, as an industry, where the best parts of the play are.”

“In that early stage it’s very hard to be a credit investor because your borrower could buy a large acreage position, drill the acreage and have poor well results. Your credit quality is not very high there.”

Now that oil and gas exploration companies and their backers have had time to determine what areas of particular shale formations are most available, the need for capital to build up existing fields has grown, Scott says.

“Once an area has been drilled, you at least then have better reservoir information, better production data and a credit investor like us can provide capital with confidence.”