Even with the rumblings of politics and environmental opposition in the background, and languishing natural gas prices front and center, the E&P industry continues to flourish. Part of the reason is that capital keeps flowing from agile private-equity sources that understand how energy cycles work.

When New York-based global alternative investment manager Apollo Global Management began its foray into energy investments several years ago, the management team understood these cycles. Greg Beard, senior partner and head of natural resources, and Jeff Bartlett, energy portfolio manager, are relatively new to the firm, but they bring decades of experience in energy investing to the table.

Apollo is a value-oriented, contrarian investor with multiple pockets of capital to invest in private-equity, capital markets and real estate. As of March 31, 2012, Apollo managed approximately $86 billion of capital, $38 billion of which was attributable to private equity. On the equity side, the firm considers investments as small as $50 million and up to $1 billion in the energy, metals and mining or agriculture space. On the mezzanine side, its targeted range is from $20 million to $200 million for E&P, oilfield services, midstream and alternative energy subsectors.

The firm's recent energy investments include Midland, Texas-based Parallel Petroleum Corp., which it exited in December 2011 for $771.5 million. Parallel was one of only a few public-to-private transactions ever done in the oil and gas industry.

Apollo also backed the management teams of recent E&P start-ups Athlon Energy LP and Gulf-focused Talos Energy LLC with equity commitments. And, most recently, Apollo led the group that agreed to acquire El Paso Corp.'s E&P business for $7.15 billion.

"The transaction represents one of the largest buyouts ever in terms of total oil and gas reserves," says Beard. "With EP Energy, we were able to secure what we believe to be a highly attractive set of assets at a compelling purchase price, largely due to the complexity surrounding the process. Apollo is a value-oriented investor. We like trading value for complexity. Complexity can come in different ways, including company-specific considerations, industry-wide concerns and deal process dynamics.

"Second, the bench strength of the management team was phenomenal. Prior to the announced Kinder Morgan/El Paso Corp. merger, the E&P business had already filed to be spun out to the public, so they were ready to go as a stand-alone entity. The deal was completed in a very tight time frame, which wouldn't have been possible if the management team hadn't already done a lot of that work.

"Finally, while most of the company's production is currently natural gas, El Paso has acreage in some of the best oil and liquids plays in the country, including the Eagle Ford, Wolf-camp and Altamont, and all of these plays have already been substantially de-risked. We have a high degree of certainty that we will be successful in converting a large portion of the production to oil and liquids during coming years."

In the case of Athlon, an oil and gas acquisition platform Apollo created, the firm partnered with an experienced technical and land acquisition team that had successfully worked together at Encore Acquisition Co. To date Apollo has made two significant oil-focused acquisitions through Athlon.

"At today's oil prices, the wells that we are drilling offer very attractive economics and we are counting on the Athlon team to more fully develop those assets and optimize value. Also, given that Athlon has over 60,000 acres, we've got years of drilling ahead of us."

Investment strategy

"What makes Apollo different is that the firm is not solely an equity investor; it has a long-standing expertise in investing across the capital structure," Beard says. "To further build on that philosophy, Jeff and his partner Craig Fox joined Apollo at the start of the year to build an energy mezzanine investment group."

Bartlett and Fox worked together for more than 10 years at Enron Producer Finance, Amaranth Partners and, for the past five years, at Guggenheim Partners.

"Although Craig and I are both petroleum engineers, I focus on the commercial side of transactions and Craig's focus is on the technical evaluation side," says. "We both believe that the key to long-term success in the energy mezzanine business is to avoid capital loss, which can best be accomplished by making sure you know the underlying assets. Together with our private-equity team, we can focus on a wide variety of opportunities and we are willing to trade complexity for value."

Apollo has considered investments in most of the producing basins in the U.S.; however, Beard says it probably wouldn't want to do raw acreage deals in areas that haven't been drilled. On the equity side, Apollo is interested in both E&P and midstream investments, but it's generally not as interested in oilfield-service transactions given recent valuations.

"However, owning E&P assets gives us firsthand insight into the service sector, which may lead to future interest and investment opportunities. Ultimately we will likely invest in oil-field-service deals, but at this stage of the cycle we prefer to avoid chasing value."

On the mezzanine side, the firm is evaluating select oilfield-service opportunities, including water management and certain subsectors of the oilfield-service space that are expected to benefit from increasing capital investment in liquids plays requiring artificial lift, stimulation and cleanout operations.

Beard says, "We are building a broader platform than most investment firms, seeking to participate in debt and equity investments of any size. We also offer a wide variety of financing structures, from green field buildups to acquisitions of mature producing assets. Our geographic focus includes onshore and offshore assets, and also outside the U.S., so our opportunities set is pretty wide. At the end of the day, we take an opportunistic approach to finding value and focus solely on where we see the best risk/reward.

"We are relatively commodity agnostic, so we evaluate both oil and natural gas investments. Although we recently completed a large natural gas equity investment, what people may not fully realize is that investment should also benefit from a focused effort to increase investment in certain oil and liquids plays that are within the companies' inventory."

With the size of the asset market in North America, the Apollo team is comfortable backing experienced, top-tier management teams to buy assets in most common basins, Beard adds.

"When you acquire E&P assets, you are often buying producing assets or assets that can be ramped up quickly—they have true operations and quantifiable asset value. From where we sit, we much prefer the real asset play from a risk/reward standpoint."

Market outlook

Private equity is becoming a lot more active in the oil and gas space, but Beard says he doesn't fear increased competition.

"First, the sector is so large, with approximately $1 billion of asset sales per week on average in North America alone, and private equity is such a relatively small part of the overall story, that there is ample opportunity to go around. Second, energy investing requires a specific set of skills that are best accumulated through experience. I don't think a firm can simply show up with capital and be successful."

Depressed natural gas prices have sparked mixed reactions from capital providers. Beard says one of the natural results of this pricing situation is that the need for capital is exacerbated. He expects to see more divestitures of non-core properties.

"For us it's a good thing, because it will drive more activity. Any time you have an industry that is long on opportunity and short on capital, it's good for the capital providers."

According to Jefferies & Co. Inc., over the next several decades more than $2 trillion will be required to develop domestic oil and natural gas shale plays. Another $500 billion will be required for midstream infrastructure.

"In context of such large numbers, the amount of private equity and mezzanine debt chasing investment opportunities is quite small. I think the biggest challenge will be for investors to remain focused and not simply chase an asset because it's for sale," Bartlett says.