With the oil market facing one of its worst ever crises, could private equity be the financial knight in shining armour that some in the industry are looking for?

DISTRESSED TIMES

In the past 12 months, the price of oil has rarely been out of the world’s media. With worries of  over-supply due to the US shale boom and OPEC’s refusal to reduce its crude output, the price of  Brent plummeted to a  low of US$45 per barrel in January 2015 from a 2014 high of over US$115 per  barrel. While there has been a slight recovery, Brent remains well below US$60 per barrel.

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With their revenues decreasing and many projects modelled on higher oil prices, it is no surprise that many oil and gas companies are  struggling. In June 2015, one AIM-listed independent oil and gas company was forced to announce  that it was urgently seeking alternative funding sources. Many other privately held UK independents have been searching for new investors or alternative forms of finance to help them to meet upcoming  work commitments and to reduce the extent of their exposure to higher risk assets.

Meanwhile, across the Atlantic, US based oil and gas companies have not been exempt from the challenges created by a declining oil price. In  2015, as many as four US based oil and gas companies, focused on onshore and offshore operations,  have so far filed for bankruptcy protection in the US courts.

PRIVATE EQUITY: A KNIGHT IN SHINING ARMOUR FOR SOME?

The conventional private equity model is largely based on a PE house investing into a company  (often in conjunction with new debt financing), making strategic decisions about value creation, streamlining operations to achieve financial efficiencies (often involving  the removal of less profitable units and reducing employee costs), securing a targeted internal  rate of return, and making  a capital gain on exit within three to five years of the initial  investment.

For some time there has been investment by PE houses into oilfield service companies whose  operations are reasonably well suited to the traditional private equity model. The model has not, however, been considered to be  as well suited to oil and gas companies, particularly in the upstream space where companies have significant  capital expenditure commitments in the early stages and there is a lengthy timeframe for achieving returns.

In recent years PE houses and other financial investors have shown greater flexibility in their approach and are applying new models,  with greater tolerance around the timeframe for achieving income and capital returns, allowing  investment into oil and gas companies. For example,

  • Helios acquired a 12.4 per cent stake  in Africa Oil Corp., a company focused on exploration and  development in East Africa in May 2015.
  • L1 Energy acquired RWE Dea, a German exploration and production company with assets in 13  countries in March 2015.
  • The Carlyle Group invested in Discover Exploration Limited, an independent oil and gas company  with assets in the Comoros and New Zealand in December 2013.

Others may follow. In late 2014 and early 2015, Blackstone, Carlyle, KKR and Warburg Pincus all closed US$ multi billion funds raised specifically for energy investment, with many having a significant focus on oil and gas.

Carlyle has already started allocating funds to oil and gas opportunities. In June this year, Carlyle and CVC Capital Partners agreed  to fund Neptune Oil & Gas, a new venture set up to acquire  oil and gas assets in north Africa, south east Asia and the North Sea, armed with £3.3 billion of  funding. Carlyle also agreed in June to commit an equity line of up to US$500 million to Magna Energy,   an upstream  company targeting assets in the Indian subcontinent.

Other funds have also continued to commit to the sector, with Blue Water Energy investing US$250  million in June in Wellesley Petroleum Holdings, a new exploration company established to explore the Norwegian Continental Shelf.

THE NEXT 12 MONTHS

A significant amount of funds have been raised to invest in oil and gas companies and assets but  there are actually relatively few examples of investments to-date. Will things change in the next  12 months?

It is a challenging market and some are  of the view that meaningful levels of investments will not  take place for some time yet. The alternative view is that the combination of the flexibility being  shown by investors, funds being available, the gulf between buyer and seller expectations on price  shrinking, and the increasing number  of distressed players in the market, will result in serious  amounts being invested in the not too distant future.

If the opportunities in the market are attractive enough for PE houses and other financial  investors, perhaps they will begin to drive oil and gas M&A, and give some hope to those distressed  players struggling in these challenging times.