Circumstances in the upstream industry have been improving since 2009, and capital providers have once again begun to announce fundraising results and capital commitments. As the climate heats up, Oil and Gas Investor interviewed three companies with different perspectives to glean transaction trends and best practices in today's oil and gas market.

Private equity figures heavily into the E&P equation, and SFC Energy Partners is coming off a recent $596-million fundraising endeavor, its second. On the other side of the table, Petro Capital Securities, a boutique investment bank, recently helped guide $420 million in funding for an independent's E&P and midstream growth projects. Finally, Energy Ventures just closed its fourth fund: $350 million for upstream technology acceleration.

Senior managing director Mitch Solich, SFC Energy Partners.

When Mitch and Geoff Solich and Roger Flahive sold their E&P company, Medicine Bow Energy Corp., to El Paso Production Holding Co. in July 2005, each of them had more than 25 years in the oil and gas industry. They had traditionally sourced capital from private-equity funds for their own E&P companies.

This time around, however, they decided to form their own private-equity shop. In April of this year, the firm they assembled, SFC Energy (originally SBE), raised a second fund totaling $596 million. The Denver group will begin committing the new funds as soon as the third quarter of this year.

"We had known for a long time that we didn't have the corner on ideas or creativity, and we began to think through the possibility of forming our own private-equity fund," says Mitch Solich, SFC Energy Partner's senior managing director, who began his career as a banker. The drivers in starting a fund were the ability to tap into a bigger talent pool and diversify into more geologic basins. Although a Denver-based company, SFC is not Rockies-focused. The firm has made investments in the Marcellus, Wolfberry, Cardium and nearly everything in between.

managing director Geoff Solich of SFC Energy Partners

The more the partners talked among themselves, the more traction the idea of raising their own fund gained. They decided a person with corporate finance and direct investing experience would round out the team. That was John Cleveland, a geologist who had spent several decades in finance in positions with Chemical Bank, HSBC and Enron, and was coming from GE Capital in Denver.

The four initiated fundraising for their first fund in 2006, and launched it in 2007 with $415 million in subscriptions. Since then, SFC has invested in seven portfolio companies and may have room for one more investment in Fund I, even as it launched fundraising for Fund II.

"For many years, private-equity funding was for an acquire-and-exploit model only. In the last handful of years, private-equity dollars have gone more to drilling and development," says managing director Flahive, who oversees technical efforts at SFC. He says the firm will evaluate both types of opportunities independently.

Cleveland, a classic-pickup-truck enthusiast, says comparing SFC's niche to the prototypical "classic car in a barn find" is not a stretch. In fact, one of SFC's recent commitments is of a similar vintage. A 1950s' Permian Basin discovery by Gulf Oil, the deep Ellenburger reservoir was exploited, but half a dozen or more shallower zones were bypassed. SFC has committed $45 million to an E&P company targeting this field, with more funding possible.

"We identify the project, polish it up a bit and prove the concept. Then we articulate to a buyer that they can have the same success we have had doing the same thing," he says.

To prove the concept, enough data and production history is needed to convince a public E&P or an MLP the process and production are repeatable on the assets for sale. According to Cleveland, SFC feeds the public company machine, a beast that requires an increasing reserves base and cash flow to appease investors. That generally translates into more drilling locations, which can lead to buying private-equity-backed E&Ps.

“We are not ignoring gas deals, but I think it is difficult for us to do a dry-gas deal right now,” says SFC managing director John Cleveland.

Gulf Oil developed this particular field into the 1970s, at which point, Cleveland suspects, operator fatigue set in and the company moved on. Forgotten infield prospects like this can be unearthed and engineered using modern technology, and as such don't have the high costs of some of the hot, cutting-edge plays such as the shales. SFC identifies "dislocations" in the market that can be capitalized upon with investment. A typical situation arises when employees exit a major or large independent and take with them knowledge of a project that has been tucked away. According to managing director Geoff Solich, SFC's strategy is to find great management teams with compelling projects. The ability to do this is something they developed in the industry, and it affects how the group views its relationships with the teams that approach SFC.

"Coming from the oil and gas side of the business, we tend to partner with those teams in the same way we partnered with other companies when we were running our own E&P: in a very collaborative, iterative relationship," he says. "We all use the term 'partner' frequently, because solid partnering allowed us to exploit more opportunities. We've learned how to be a good partner." SFC tends to work with teams eyeing an opportunity that has been put on the back burner.

"Most often what they have is knowledge of opportunities 'lost in the files': some project they worked on that has been forgotten. Projects just sit as people move around," says Cleveland.

The firm evaluates those opportunities by starting at the finish: quantifying the exit. SFC researches and extrapolates the project to a logical conclusion. The team looks at similar transactions and compares possible monetization outcomes. If the project can be pried loose from the current owner, and is evaluated as able to benefit from the application of technology and capital, it could see investment. This evaluation is as technical as it is financial, and continues after investment.

Managing director Roger Flahive describes SFC’s investment style as “eyes-on, not hands-on.”

"We watch investments in an 'eyes-on, not hands-on' way," says Flahive, "observational over operational." The other area of technical effort is "in-house initiatives," including chasing geologic concepts, technology applications and play types. This forms the basis of decisions on how to allocate fund monies and align teams to support those decisions.

SFC has concentrated on opportunities onshore North America. Its largest commitment to date has been $75 million, and Fund I investments have ranged from $40-to $70 million.

The group has not done much in California, as the depth of the market for exits, in its view, is limited. Alaska, too, has a small population of buyers, but Cleveland says there is plenty to do between the U.S. and Canada outside of these exceptions.

The time frame is typically the two-to-five-year private-equity horizon. Partly this is because SFC structures agreements to reward management based on internal rate of return, instead of return on investment.

"We aren't in the business of holding forever in the hope of increasing prices. We like to bring things to market, and some have occurred more quickly than two years," says Mitch Solich, referring to two partial monetizations. Though receptive to an initial public offering, the group's institutional investors prefer liquidity, and would be concerned about holding more stock than would be feasible to sell without drastically reducing the stock price.

“The opportunity for technology to impact the shales is only beginning,” says Jim Sledzik, partner and president of Energy Venture’s Houston office.

"Some management teams are compensated based on ROI, but when we started Fund I we thought IRR was better for us," says Cleveland. That means time is a part of the value calculation, so faster exits are more valuable. It is crucial that the opportunity not be solely dependent on an exit based on commodity prices, and SFC runs sensitivity cases to make sure investments can tolerate price volatility.

Cleveland says SFC adopted an oil bias several years before the shine had worn off dry gas, a move that has served it well.

"We are not ignoring gas deals, but I think it's difficult for us to do a dry-gas deal right now, because it is difficult to get a handle on the exit market for gas deals," he says. "You could be sitting on one five years from now." He thinks the gas price will turn at some point, and there will be a good time to invest in high-quality natural gas properties, but for SFC's private-equity model, the fit isn't there yet.

The firm expects to activate $596-million Fund II later this year, with potential to pull the trigger on the first deal in the third quarter.

Investment banking's view

Not all financiers are specifically raising funds to back oil and gas companies. Investment banks on the advisory side are also seeing plenty of deal flow, and they have a different point of view on today's market. Generally, the strategic advice being delivered has changed over the past few years, coinciding with private-equity funds returning to the market.

As its name indicates, investment bank Petro Capital Securities LLC, Dallas, is solely focused on raising capital and providing advisory services to E&P, midstream and oilfield services companies. The Petro Capital Group, of which Petro Capital Securities is a part, began in 2002 targeting early-stage principal investments in energy companies. In response to the market upheaval in 2008, Petro Capital Group saw an opportunity to grow Petro Capital Securities as a stand-alone investment-banking practice, but it needed a capable leader to head this initiative.

Enter Marvin Webb, an experienced investment banker in Bear Stearns' natural resources group, who came aboard to build the franchise following the sale of Bear Stearns to JP Morgan in the summer of 2008.

"At first I entertained the idea of joining another big organization, but upon reflection, what interested me most was working with growth-oriented companies that might not catch the eye of bigger organizations," he says. "I sought a smaller, more agile platform to service these clients. This was my chance to do just that."

Since Webb joined as managing director, Petro Capital Securities has raised capital for start-ups and established companies and provided M&A and strategic advisory services.

"In late 2008 and 2009, a primary focus of the firm was advising clients on strategic alternatives to help keep their companies together or hold positions, as opposed to growth," says Webb. While fundraising in 2007 and first-half 2008 had been fevered, in the latter half of 2008 and 2009, capital sat on the sidelines.

Petro Capital Securities managing director Marvin Webb

The firm brings a well-rounded approach, as its senior principals have backgrounds in petroleum engineering, land, finance and private-capital investment. For example, prior to his tenure at Bear Stearns, Webb was a petroleum engineer for Burlington Resources and Phillips Petroleum.

Another member of the Petro Capital Securities team, director John Calce, previously worked on assembling and syndicating drilling deals in the Barnett shale, East Texas and the Midcontinent. He built a deep network of land professionals in the process, a unique advantage for clients. Says David LaLonde, associate and third member of the leadership team, "Often, our clients and investment firms ask us to help them enter or grow existing positions in highly coveted resource plays. With our land connections, we can drum up proprietary acreage deals others can't access. Not many investment banks can source transactions of this type." His experience includes principal investing at The Sterling Group and investment banking at Bear Stearns.

Beyond deal access, Petro Capital Securities provides its clients an understanding of current market conditions and educates them on the capital-raising process.

"Oftentimes, people who are expert at finding and developing oil and gas do not possess much experience in dealing with institutional capital sources," says Calce. "A key aspect of our capital-raise process is to not just close the deal, but also find the right terms and capital partner for our client."

Although 2008 and early 2009 brought challenges, the firm's growth and expanded knowledge base and capabilities quickly bore fruit. "While there was still uncertainty as to whether we had reached a trough in commodity prices, we began to see a shift in the last quarter of 2009. Investors returned to the market and began to focus on value-oriented deals," says Webb.

This shift was evident when Petro Capital Securities completed a series of transactions for Eagle Energy Co. of Oklahoma, a start-up led by industry veteran Steve Antry. The investment bank helped negotiate an acquisition in the Midcontinent and secured a $100-million equity commitment and $150-million credit facility to close the deal and provide growth capital. This opportunity was not only a tipping point for the firm, but also an indication of capital returning from the sidelines. (For more on Eagle Energy, see "Mississippi Lime," Oil and Gas Investor, April 2011.)

Petro Capital Securities, Director John Calce

Petro Capital Securities followed up those transactions with a series of capital placements and advisory assignments in 2010. It sourced a $200-million private-equity commitment for Liberty Resources LLC to acquire and develop Bakken shale assets. Liberty is led by a highly credentialed management team with significant operation and completion-design expertise. Shortly after placing the equity commitment, Petro Capital Securities, through its land contacts, procured a $27-million acreage acquisition for Liberty that offset its existing assets.

In March 2011, the firm advised BlackBrush Oil & Gas LP and TexStar Midstream Services LP, which sought funding to expand E&P and midstream assets in South Texas, including the Eagle Ford shale. Petro Capital Securities was able to source a $220-million equity commitment and $200-million senior debt facility.

"The BlackBrush transaction was well received by the marketplace. We encountered great interest from both equity and debt providers, resulting in numerous financing alternatives for our client," LaLonde says.

Petro Capital Securities currently sees many opportunities to acquire and develop acreage adjacent to existing producing properties. Webb estimates that the majority of the firm's prospective financing transactions today are focused on sourcing capital for development projects for which the acreage has already been leased. He says more capital is returning to big acreage buys, with a caveat that most investors will require such positions to be located in the core area of a play.

Petro Capital Securities, associate David LaLonde

Webb believes capital markets will remain highly active, with ample capital and many providers becoming more aggressive about putting dollars to work. For investors with flexible capital to deploy, he says, creative deals and financing structures can be done. Investors are willing to be more aggressive in oil-heavy plays like those in West Texas, the Eagle Ford, and the Bakken shale.

While the shale plays continue to garner much of the popular interest, the firm believes that 2011 and 2012 will be highlighted by the application of modern horizontal and completion technology to develop/redevelop conventional reservoirs.

Webb suggests that although the E&P and midstream sectors have been hot, oilfield services also hold promise, as the industry faces equipment and human-capital constraints. He thinks oilfield service providers will face capital demands, because many are operating at the limit of their equipment's capacity. They will have to build or buy equipment, and the firm is starting to see an influx of service-oriented transaction opportunities.