In 1988, Joe Foster, then the CEO of Tenneco’s oil and gas business, was out of a job. His parent company had sold his well-functioning division in pieces for approximately $7 billion to a diverse group of international oil and gas companies. Undaunted, Foster and twenty-two of his fellow executives pooled $3 million of their severance money and started Newfield Exploration. Aided by an incremental $3 million from friends and family and another $3 million from the University of Texas Endowment Fund they promptly drilled two dry holes and had “issues” with a third well in the shallow waters of the Gulf of Mexico.
Entrepreneurial efforts are not for the faint-hearted or for those without great perseverance. Despite the difficult start, Foster led his team forward raising $20 million of new funds from private equity providers and more funds from other university endowments to finance their next wave of drilling activity. With this added capital, Newfield Exploration hit its stride with a string of successful discoveries and began a steady climb to success. Newfield Exploration is a wonderful case study of successful entrepreneurship that brought together great leadership, strong execution skills, and sufficient risk capital to build a company of scale.
While thousands of oil and gas companies have been started in North America since Colonel Drake’s famous oil well in Titusville, Pennsylvania, in the mid-19th Century, most have financed their early days by raising money locally to pull together a grubstake to buy acreage and drill a few wells. Successful results meant that you had sufficient credibility and cash flow to keep going. For a small handful added financing came from a few risk tolerant endowment funds or wealthy family offices.
However, the upfront risk capital required to launch, grow and nurture an exploration and production company to reach sufficient scale has grown substantially over the past twenty-five years. Everything has gotten much more expensive – acreage, people, data, drilling rigs, steel pipe, deeper and more complicated wells, new drilling technologies, etc. – and the bar that defines “scale” has risen to a level where approximately one billion dollars of value has become the threshold to allow access to much lower cost capital either from a corporate acquirer or the public markets. For most E&P entrepreneurs, these capital needs can no longer be met by passing the hat around the neighborhood.
During the last year, private equity has come under increasing attack in the popular press due in part to the heightened profile of Mitt Romney’s presidential campaign. Lumped together with the excesses of Wall Street financiers and hedge fund billionaires, private equity’s negative reputation has gotten painted with too broad a brush. Admittedly there have been a few bad actors and some disappointing results. But, there is a meaningful segment of the private equity industry, especially for the oil and gas business, where private equity is providing the enabling capital, strategic guidance and financing skills to launch and grow new companies. In this realm, acting as venture capitalists, private equity wears a well-deserved large white hat.
E&P companies have been huge beneficiaries of an increasing wave of private equity following the model of Newfield Exploration. Throughout North America, and increasingly around the world, experienced private equity providers are investing billions of dollars annually to launch and grow new companies. The list of highly successful private equity-backed E&P companies includes a wide variety of strategies, geographic focus areas, corporate cultures and entrepreneurial experience: Antero Resources, Bill Barrett Corp., Cobalt International, Common Resources, Concho Resources, East Resources, Enduring Resources, Kosmos Energy, Laredo Petroleum, MEG Energy, Spinnaker Exploration, and Spring Energy in Norway, to name a quick dozen.
The preceding listing represents only a small sample of the hundreds of companies around the world that have recognized the benefit of tapping the funds controlled by the growing number of large investment firms that bring both money and expertise to the most talented operational management teams to build companies of scale. The success stories have followed a wide variety of strategies and basins ranging from offshore West Africa to the Canadian oil sands and the North American oil and gas shale plays.
Once the province of a specialized group of funders, private-equity support for oil and gas companies has gone mainstream. Early pioneers in the space such as Yorktown Partners, Warburg Pincus, and First Reserve have been joined by dozens of other firms that have raised tens of billions of dollars of fresh capital to deploy behind these entrepreneurial ventures. More recently, as financial engineering-based private investing has gone out of fashion, the well-known traditional leveraged buyout firms such as KKR, Blackstone, and Apollo have built investment teams dedicated to the oil and gas space. Despite all of the obvious risks, for most it has been a very lucrative endeavor where the value creation has come primarily from fostering an increase in reserves and production and less so from sly trading around hydrocarbon price movements.
The entry of these very large, high-profile firms has also meant increased capital flows and more headlines. This trend will likely continue as long as the big global providers of private equity funds – pension funds, endowment funds, and sovereign wealth funds – increase their allocations to the energy sector seeking returns uncorrelated to general stock market performance. At some point too much money will overwhelm the system and investment returns will suffer. But, so much equity capital is now required to feed the manufacturing-like operations of the expanding shale plays and the deepwater exploration activities that the supply and demand of equity should remain in balance for at least a few more years. Moreover, with access to larger private equity funds, sometimes working together in a collaborative fashion as a consortium, newly-born E&P companies are able to get to scale quickly and go up against large independents and even super-majors competing in lease sales, deploying hundreds of land brokers, and working the corridors of energy ministries around the world to access the most significant new opportunities.
Quality management teams will have the luxury of selecting their financial partners from those anxious to deploy capital. However, savvy entrepreneurs in search of equity will learn quickly that all private equity firms are not the same nor are all of their dollars of equal value. Not surprisingly, some private equity firms and the partners within them bring varying degrees of experience, judgment, and track records of success in addition to the dollars. Reputations for creating incremental value post the investment separates the top-tier private equity investors from the enlarged pack. If the ultimate goal is creating a very large pie, then aspiring Joe Fosters will want to align themselves with those who can make each slice substantially bigger by providing the counsel and advise to help develop winning strategies and avoid previous mistakes made by other young E&P companies.
The now well-established private equity-based business model for new E&P companies has made it easier for the more entrepreneurially-minded E&P executives to leave the comfy confines of big oil and start out on their own, knowing that they can afford sufficiently high-quality resources, such as people, data and acreage positions, to ease the transition from large company to small. Access to plentiful equity capital and those investment partners that have developed the scars of prior efforts greatly reduces the risk of starting a new enterprise. Much as it has worked for the past forty years in Silicon Valley where the local venture capital ecosystem consistently spawns innovative new businesses, the E&P world now follows a similar track able to form new, well-capitalized start-ups on a regular basis whether they are based in Houston, Denver, Calgary, London, Beijing, or Sao Paolo.
Perhaps most interesting is the number of serial entrepreneurs who have honed the private-equity model to build one successful company after another usually with each larger than the last. Randy Foutch of Laredo Petroleum is on his fourth such endeavor. George Solich at Cordillera Energy has scored the hat trick. Roger Jarvis, the founder of both Spinnaker Exploration and Common Resources, retired from active duty after two home runs. Other entrepreneurs see the path and are hopping on board the start-up express anxious to execute on their proprietary ideas and take advantage of new technologies, confident that ample funding will be available to grow a good-sized company in relatively short order.
When Joe Foster launched Newfield Exploration he hoped to create a successful independent E&P company. Not only did he attain his primary goal but he also proved to be a pioneer in tapping the private-equity world and charting a course that other entrepreneurs in the sector continue to follow and build upon.
Jeffrey Harris recently founded Global Reserve Group, LLC a new firm dedicated to advising and investing in growing oil and gas companies around the world. Previously he spent the past twenty-nine years at Warburg Pincus where he helped finance and advise numerous oil and gas ventures.