More and more, the pools of private capital aimed at the energy space are swelling. One might even say they're at flood-stage. But that isn't altogether good news for the small fry of the energy sector.

The problem is that as institutional investors continue to pour more dollars into private-capital funds, the investment threshold of those funds is correspondingly rising.

Thus, whereas a private-equity provider may have considered a few years ago committing $25 million or less to a start-up E&P, midstream or service-sector entity, the burgeoning level of institutional capital available to that same fund today dictates making commitments in the $50- to $100-million range, or even higher.

Fortunately, however, a number of new private-capital funds-and intermediaries of those funds-have emerged in the past five years with a bias toward smaller-cap companies. What's particularly notable about these capital sources is that they have an appetite to provide needed energy-related equity or debt backing in much smaller amounts-even in the $1- to $10-million range but certainly below $50 million.

Also notable is that their level of investment appetite extends well beyond the E&P space, to the midstream and service sectors-anywhere value-creation can be achieved. Their rationale for focusing on the lower end of the energy market: if a start-up with growth potential can be helped to the next level in its development, that's going to present further opportunities for even higher levels of private-capital infusion.

Three such sources of private-capital funding are Denham Capital Management, BPI Energy Partners LLC and Rivington Capital Advisors LLC.



Broad approach

A familiar face with a new name, Denham Capital Management is a Boston- and Houston-based private-equity firm with $2.3-billion of assets under management that invests in commodities-based businesses including oil and gas, energy-related infrastructure, power, coal, metals, mining and timber.

Denham was formed this July 1 after Sowood Capital Management divided its hedge fund and private-equity-fund management efforts into two independent management companies.

Since 2004, the private-equity firm has invested about $1.8 billion in 27 portfolio companies across the commodities and energy spectrum. Of that $1.8 billion, about $750 million has been invested in 18 E&P, oil-service and midstream companies, with the upstream accounting for about $465 million of that total through five investments.

Currently, the $1.24-billion Denham Commodity Partners Fund IV has committed $467 million, $223 million of that related to the E&P, oil-service and midstream sectors.

"Our strategy within the energy and natural resource sector overall is to seek out the most attractive areas where capital can be applied to create the most value," says Carl Tricoli, senior managing director and head of Denham Capital Partners' natural resources group in Houston. "In the upstream, that at times may involve the acquisition space; at other times, it may involve the development of, or exploration for, oil and gas assets.

"Right now, we believe there's a lot more value that can be created through exploring for and developing oil and gas assets-and the subsequent monetization of those assets-versus buying those assets in the acquisitions market and later selling them."

Bill Zartler, another Denham senior managing director and head of the company's infrastructure group, sums up this strategy another way: "We look for dislocations in value between where one creates or develops assets and where one sells those assets."

Also Houston-based, Zartler explains that this strategy, as applied to the midstream sector, might involve investing in a new pipeline or adding a new gas-storage or -processing facility to take advantage of value-dislocation opportunities that may exist in the midstream market.

Implementing its strategic thinking in the E&P space, Denham in late 2006 made a $100-million private-equity commitment to Alta Mesa Resources, a private Houston-based operator, to advance the organic growth of that producer's portfolio of development-drilling opportunities, as well as its exploration efforts along the onshore Texas and Louisiana Gulf Coast and Oklahoma.

More recently, this past March, the firm provided a $32.5-million private-equity infusion for C&C Resources, a Calgary-based private producer whose oil and gas assets are in Colombia. The funding was aimed at backing the operator's exploration efforts in that South American country.

Applying the same mindset to the midstream space, Denham in early 2006 funded Houston-based Freebird Gas Storage.

This allowed that company to expand a very small gas-storage facility in northern Alabama by a factor of five, then connect that facility via a new pipeline to Tennessee Gas Pipeline, which had more liquidity in the natural gas market. The result: Freebird was able to add new customers.

Explains Zartler, "The value dislocation in a development opportunity like this is that one can expand and connect such a storage facility at a lower valuation than the gas markets are willing to pay for that kind of asset once it's fully operational."

Providing capital assistance further down-market, Denham in the fall of 2004 invested less than $10 million of private equity in Galveston LNG, a Calgary-based company with a regasification terminal project in Kitimat, British Columbia.

Currently, the capital provider is looking at about $500 million worth of equity infusions for five private E&P companies-two in Canada, two in the U.S. and one in South America.

But as its past deal flow indicates, the upstream isn't the firm's only focus. "Right now, there are significant opportunities worldwide to deploy capital to develop resources, whether that's oil and gas or the infrastructure needed to store, transport and deliver energy supply," says Tricoli. "So we're very much unconstrained in our approach to investing-with respect to sector, geography, where a company is in its corporate life cycle, or the size of the deal."

Adds Zartler, "We don't invest based on where commodity prices are. Rather, we focus mostly on creating value through operational enhancements-and we do that across the entire energy spectrum."



Eye on the little guy

Begun in late 2006, BSI Energy Partners LLC is a Dallas-based private-equity investment firm whose principals do a lot more than simply provide money to the smaller end of the upstream and oil-service market-those companies with capital needs of less than $10 million. The company's team also brings hands-on operational experience to an investment.

That's credible, given the team's experience. Between the mid-1990s and 2005, the group successfully built Bentley-Simonson Inc., a private Ventura, California-based E&P company, from an operator with zero assets to one that was ultimately sold for $119 million to Plains Exploration & Production.

That 2005 sale was no small feat, considering the team early on experienced substantial difficulty in financially jump-starting their company's acquisition and exploitation of mature oil and gas fields in Los Angeles and Ventura counties. Indeed, to fund their company's growth, the team initially relied on digging into their own pockets, even taking out second mortgages on their homes.

"Upon the sale of their company to Plains, this team took a hard look at the energy-finance market and concluded that there had to be better way for small producers and other energy companies to attract private capital that large institutional investors typically are reticent to provide," says Dustin Gaspari, a principal with BSI Energy Partners.

Gaspari was formerly a member of Union Bank of California's oil and gas lending team in Dallas that helped spur the later growth of Bentley-Simonson.

This conclusion led the team, prior to the formation of BSI Energy Partners, to make investments in three Ventura-based private energy companies.

These stakes included a total $1.2-million funding for California Well Services LLC, which provides workover-rig services to major oil companies in that state; a less-than-$1-million capital infusion for Pacific Industrial Services Technologies Inc., which provides upstream, midstream and power-related facility maintenance and construction services; and $8 million in private-equity commitments to South Flank Energy LLC and its affiliates, an E&P entity focused on the development of oil and gas properties in Ventura County.

In addition to this backing, the group also provided overhead and back-office support, as well as filling in operational gaps, so these companies' managements could focus solely on building value in their particular businesses.

Formalizing this business model, the five-member team in fourth-quarter 2006 formed BSI Energy Partners and created BSI Energy Partners Fund I LLC, a $50-million fund backed by the personal capital of the firm's principals and one large institutional investor with a long-time exposure to the oil and gas sector.

Says Gaspari, "This institutional investor understood our track record, that the small end of the energy market was underserved, and that an on-the-ground level of expertise was needed to invest in that market successfully."

BSI Energy Partners' strategy: to make investments, primarily in small E&P companies with private-equity financing needs in the range of 1- to $10 million, or even $15 million.

"Our focus really isn't on the amount of capital we're providing, but on the growth potential of the company being helped, the nature of the investment-ideally one with which we have some familiarity-and whether there's an appropriate fit between our skillset and the expertise of the management team that owns a particular asset or project," says the former banker.

"In short, the best investments for us are those where we're using some of our historical operating expertise to help increase the size of the pie for all parties, as opposed to just providing capital," he emphasizes. "After all, we know what it's like to be out on a well in the middle of a rainstorm at midnight and struggling to make payroll-as opposed to having a more New York institutional approach to investing in the E&P sector."

At press time, the investment firm expected to close before summer on a $2- to $4-million commitment to a small, publicly traded Dallas producer to assist that operator in an exploitation and development project-with some exploration upside-in North Louisiana.



Filling a void

Formed in January 2002, Rivington Capital Advisors LLC is a Denver-based boutique investment-banking firm specializing in intermediating private equity and debt, almost exclusively for energy companies.

On the private-equity side, the firm has completed within the past five years 10 transactions worth about $600 million; on the private-debt side, it has intermediated 12 transactions totaling roughly $700 million. In the vast majority of cases, these equity and debt transactions have involved accessing capital for small-cap, private E&P companies.

"Recently, private debt transactions in the upstream space have been hot simply because they are less dilutive to existing equity-holders but offer advance ratios that approach those of private equity," says Scott Logan, a Rivington principal.

As to the rationale for starting up the firm, Chris Wagner, another Rivington principal, says that coming off the energy trough of 1999-2000, "we felt there was a lack of quality firms focusing on the small-cap energy space-that there was a void that needed to be filled."

And fill that void Rivington did. In January 2005, it assisted PPC Energy, a private Houston producer, in raising roughly $40 million in mezzanine debt from Houston-based Petrobridge Investment Management LLC. "The transaction allowed the operator to close on the acquisition of some West Texas upstream assets, as well as providing development-drilling capital," says Logan.

In November of the same year, Rivington also helped Texas American Resources Co., a private Austin, Texas-based producer, raise $55 million through a second-lien financing underwritten by BNP Paribas in Houston. The use of proceeds: the purchase of upstream assets in Colorado's Denver-Julesburg Basin.

During the spring of 2006, the firm assisted Bonanza Creek Energy Co., a private Bakersfield, California-based independent, in raising $50 million worth of subordinated notes with warrants from Laminar Direct Capital, a Houston institutional investor. That funding allowed Bonanza Creek to refinance existing debt on more favorable terms and close on an acquisition, with the remainder of the proceeds earmarked for development drilling and future acquisitions in the Rockies and onshore California.

But it wasn't until later last year, in September, that Rivington showed its true capital-intermediating prowess. That month, it helped August Energy Partners, a private Billings, Montana-based E&P company, raise $228 million in private equity from Greenhill Capital Partners, Kayne Anderson Energy Capital and Lime Rock Partners. In tandem with this, the firm aided the producer in accessing a $225-million credit facility led by Wells Fargo in Denver and co-agented by Union Bank of California in Dallas.

"The dual funding for this start-up company, which is run by Steve Durrett and other former members of United States Exploration's management team, is essentially dry powder for future acquisitions in the onshore U.S.," says Wagner.

In a much smaller transaction this year, the firm helped Black Diamond Resources, a private Denver operator, raise $40 million in private equity from Natural Gas Partners. The use of proceeds: to refinance debt and have capital available for future Rockies acquisitions.

Rivington, which has also completed some $1.1 billion worth of M&A advisory deals through 10 transactions, observes that there is more private capital coming into the upstream space than ever before.

"What we're also seeing is that the investment time frame by private-capital providers is becoming stretched a little longer," says Logan. "Deals are getting done that don't have pressure to turn over until six to 10 years out versus the traditional three- to five-year period."

Any hot spots for private capital within the E&P space? Not really, says Wagner. "Our experience is that private equity and private debt will move in the direction of any producer where the deal makes economic sense-where the expectation of returns is still 30%-plus."