There seems no better symbol of the beleaguered stock market that has confounded investors in the past six months than Charging Bull, the 7,100-pound bronze in Bowling Green Park near Wall Street—now fenced off to protect it from the Occupy Wall Street pro testers.

The third quarter of 2011 was unsettling to investors, bankers and E&P companies alike. With the Dow Jones Industrial Average rising 200 or 300 points one day, and reversing course a like amount the next, market watchers were rattled. The stock market was pounded thanks to the U.S. debt downgrade in August, worries about the euro zone financial crisis, and suspicions that the global economy will continue to slow down.

E&Ps are in good shape financially, but are focusing their portfolios, says Steve Daniel, global cohead of energy investment banking, Goldman Sachs.

“People are on pins and needles,” says one energy investment banker, although he remains personally optimistic—and extremely busy—in the oil and gas sector. “We could be looking at several years for Europe to get straightened out.”

“You’ve got to be wearing a flak jacket in this market environment,” says another.

On the plus side of the ledger, investors and financiers still like the oil and gas story. In the third quarter, the U.S. land rig count rose for the ninth consecutive quarter. The Baker Hughes and RigData tallies both rose about 6% on the back of continued good news in the Marcellus and Eagle Ford plays, and strong drilling activity in areas such as the liquids-rich Bakken, Permian and Midcontinent.

On the other side of the ledger? Natural gas prices have failed to rally given surging U.S. production, which is now up by 4.5- to 5 billion cubic feet a day over the prior year, according to government figures.

At press time, the Europeans appeared to have agreed on a financial rescue for Greece, the stock market rallied, and oil had climbed back to $95 per barrel—but the outlook seesawed daily. No wonder that New York and Houston investment bankers use the same word again and again: Uncertainty.

Barriers protect Charging Bull and the New York Stock Exchange from Occupy Wall Street protesters camped in Zuccotti Park.

Some now think the market will essentially just trade sideways until the presidential election next November, or at least until the Republican presidential nominee becomes clear in the early primaries just ahead.

“I hope energy is part of the debate,” says one banker. “We seem to just kind of steer from guardrail to guardrail on energy policy.”

Institutional investors are running out of ideas and trying to find the next opportunity, thinks Fadel Gheit, senior analyst and managing director at Oppenheimer & Co. “It’s getting harder… but the entire energy complex is attractive. They are cautious on natural gas, where they once loved the story, until gas prices crashed. They hated refining until recently. If you run an energy fund, there’s no place else to go, you have to be in energy. This industry is more efficient than ever before. You can drill faster and cheaper and extract more of the resource than ever before.”

And so, a note of optimism endures in the halls of Wall Street and Houston-based financial companies. After all, the E&P industry is undergoing a wonderful renaissance in rig efficiency that has led to oil and gas production increases in every major basin. These will transform not only the E&P companies themselves, but indeed, the economies of many states.

“It’s an interesting time to be talking about energy. The sector has never been more active. That’s partly because the bifurcation between North American gas and oil prices creates a need for companies to really focus on their portfolios,” says Steve Daniel, managing director and global co-head of energy investment banking for Goldman Sachs, based in Houston.

“North America is just so much more attractive today than it was five years ago. There’s so much to do here, and you can produce all the product you can…in a relatively stable environment,” notes Barclays’ Greg Pipkin, man- aging director in Houston and global head of oil and gas.

David Albert, top, and Rahul Culas, bottom, co-head the Carlyle Energy Mezzanine Opportunities Fund.

Crystal ball

Against this backdrop, what could 2012 look like? Most financiers think merger and acquisition activity will increase, driven by shale fever. “The longer debt and equity markets stay out of sync, the more M&A we’ll likely see,” says Daniel. “It is a tough general market environment, but the energy space is in strong shape financially.”

Goldman Sachs has had a busy 2011. It advised on more than $100 billion in transactions this year including the pending merger of El Paso Corp. with Kinder Morgan Inc. (and before that the spinoff of El Paso’s E&P business), the sale of Petrohawk Energy Corp. to BHP Billiton Ltd., the sale of Southern Union to Energy Transfer, the sale of Pride International to Ensco Plc, and Statoil’s acquisition of Brigham Exploration Co., to name a handful.

Indeed, thanks to historically low interest rates and robust capital markets in first-half 2011, most E&P balance sheets are in good shape. Profitable oil and natural gas liquids have offset lukewarm natural gas income. Much of the M&A activity already seen has not been driven by distress, but rather, is propelled by enthusiastic large-cap E&Ps or foreign oil companies seeking a ticket to North America’s multistage-horizontal-frac party.

On the corporate finance side, at least 15 to 20 initial public offerings are poised to either file, or having filed already, to jump on an exchange as soon as the market window opens.

Many are going to be upstream master limited partnerships (MLPs). The valuations of most existing upstream MLPs are nearly double that of their C-Corp counterparts, even though the two may hold similar types of assets.

Private-equity providers are bullish as well. “Demand continues to be robust. People like the energy sector and continue to seek exposure to it. They still see it as an inflation hedge,” notes David Albert, portfolio manager and cohead of Carlyle Energy Mezzanine Opportunities Fund. An initial close of the fund was achieved in December 2010 and two E&P deals have been funded so far.

“Both deals closed in under a month. Speed is so critical in this business,” adds Rahul Culas, co-head of the fund. “Whenever there is a period of change and incredible excitement about an area, such as with shale plays and fracing, a lot of private capital flows there. That gives us a more attractive opportunity to back conventional players. At $80 oil, a lot of conventional plays make sense.”

Capital is ready to be deployed in increments of $20- to $100 million or more. Carlyle’s sweet spot is funding E&Ps to make acquisitions or develop their proved undeveloped reserves (PUDs)—no pure acreage deals here—although the broad mandate includes upstream, midstream, refineries and power generation in North America.

Carlyle has ended its long-time energy investing partnership with private-equity provider Riverstone Holdings LLC. (Although they will continue to co-manage six existing funds, they will no longer jointly raise additional capital.) Meanwhile, its parent, The Carlyle Group, has filed to go public.

Challenges and opportunities

Even if investors buy the idea that the global economy will just bump along and U.S. energy demand will be flat, there are still plenty of opportunities to be had in energy, says Tim Day, managing director with private-equity provider First Reserve Corp.

Top, Tim Day, managing director with First Reserve Corp., and Greg Pipkin, global head of oil and gas banking for Barclays, are busy looking at energy deals.

“It’s a challenge to stay ahead of the curve though. Just think: four or five years ago, there were no real unconventional plays to speak of. Then, the plays that were most interesting two years ago are no longer as interesting, and new plays have come to the fore like the Utica. As an E&P company, you have to ask yourself, are you going to try to get in a play early, or be the second or third company in, or get into a contrarian play that no one else is pursuing yet?”

There is no one right answer, Day says, but E&P companies need to have the right people and the dollars with which to succeed.

First Reserve is there on that score. Its most recent private-equity fund, closed in 2009, raised $8.9 billion, with a good portion of that still to be committed to new energy deals. Overall it has $20 billion under management in energy, investing in everything from solar, refineries and offshore facilities to a recent stake in Amromco, the leading independent oil and gas producer in Romania.

In May 2011, it entered the midstream space, closing First Reserve Energy Infrastructure Fund LP with over $1.2 billion. This October, it contributed $100 million to a 50-50 joint venture with John Mork’s Energy Corp. of America, for a Marcellus shale gathering system.

Indeed, all the shale plays are receiving lots of attention up and down Wall Street, whether they are connected to equity raises, monetizations or mergers. Gassy deals command a different type of attention—and financing structures—than do oil deals, thanks to the commodity-price disparities.

“These shale plays are truly revolutionary and there’s a lot of work to be done domestically and internationally,” says Rome Arnold, echoing the thoughts of most bankers. With 26 years of oil and gas banking behind him, he is the new managing director and head of energy I-banking for New York’s Dahlman Rose & Co. It is building a new oil and gas team to enhance the full resource chain. It already focuses on everything from shipping to mining, metals and coal.

“We think the underlying fundamentals of energy are still good, but the market’s been on hold and it’s hard to know how much longer this will go on,” Arnold says. “The larger companies have done debt deals, sold assets or done JVs and are in a good position. I think smaller companies that have to watch their capital budgets quite carefully may be on hold for financings.”

Dahlman Rose will focus on those smaller companies and private ones as well, although it also co-managed several equity transactions for Energy XXI this past year. For Arnold, the opportunity is in working with smaller companies that need to go public, do an acquisition or find other financing alternatives. The sweet spot is those with market caps of $50- to $500 million, primarily U.S.-based. “We have great placement capabilities so we can do whatever they need,” he says.

Corporate clarity

Another trend dealmakers are watching is what Vean Gregg, Houston-based sector head for the oil and gas group at J.P. Morgan Securities calls “corporate clarity events.” By that, he means companies separating into two entities to become upstream and downstream pure plays.

Vean Gregg of J.P. Morgan Securities thinks more MLPs will come to market in 2012.

Marathon Oil Corp., Williams, El Paso and ConocoPhillips have each decided to separate their upstream and downstream operations into two companies. He and other observers think this theme will continue into 2012, with companies electing to potentially sell, spin off, pursue IPO carve-outs, or seek joint ventures to achieve more transparent valuations for their assets.

“This is the time that large-caps and integrateds do have an advantage. They have cash and access to markets. An E&P company can ‘deficit-spend’ for a while. But at some point, it has to issue high yield or equity to fund the deficit, consolidate—or slow down. Of course, the market will recalibrate your valuation if you do that for too long.”

J.P. Morgan has some big assignments on its plate, such as advising ConocoPhillips and Williams on their corporate separations. It has had an active year raising capital at historically attractive rates as well. It led Range Resources Corp.’ s $500-million senior subordinated notes offering in May and Newfield Exploration Co.’s $750-million senior notes deal in September—both issued with 5.75% yields—among several other deals that achieved extremely low yields relative to the issuers’ credit ratings.

It advised and provided committed financing for Superior Energy’s recently announced merger with Complete Production Services, advised Broad Oak on its sale to Laredo Petroleum, and advised Legend Natural Gas on its acquisition of Range Resources’ entire Bar-nett shale portfolio.

Marc Garfinkle, top, and Jason Selch, are portfolio managers for Helios Energy Fund.

Corporate separations remain intriguing and will no doubt lead to a lot of asset packages trading hands, as well as E&P start-ups by former large-cap executives. Although historically integration was touted as a smart corporate structure, it has not served most large companies that well, argues Oppenheimer’s Gheit. “It has passed its useful life, if you will. It isn’t hurting them, but it isn’t helping them either. When you run out of ways to reinvigorate the stock, you invent a new way. Investors want a pure play and to pick a la carte. They are looking for predictable growth and a moderate return.”

Many of the senior bankers on the oil and gas team at Barclays, which includes legacy Lehman Brothers professionals, have been together for about 15 years, and being backed by one of the largest global entities, they are primed to do all kinds of deals. At present Bar-clays is handling nearly $60 billion of deals, from representing BHP Billiton Ltd. in its purchase of Petrohawk Energy Corp., to Marathon Oil Corp.’s buy of Hilcorp Resources’ Eagle Ford assets. It was joint book-runner with Goldman Sachs on EOG Resources’ $1.4-billion equity offering earlier this year—the equity offering was the first for EOG since it went public more than a decade ago.

One could argue that EOG didn’t need to raise that much money, but its success speaks for the reputation of the firm, and a well-stocked balance sheet is always prudent.

Barclays’ largest recent commitment is to Kinder Morgan Inc. in its pending acquisition of El Paso Corp. It has advanced to KMI a cash commitment of up to $13.3 billion “to lend comfort to the El Paso side that this deal will indeed close,” says Pipkin.

M&A trends

The economics of some shale plays may not be meeting expectations, as oilfield service costs are trending higher; some of the shales have not performed as well as they might due to low gas prices. This will drive all kinds of deals.

So too will opportunities in the shales that are as hot as an NFL kicker who can go through the uprights from 50 yards out. Case in point: the day we spoke with some analysts and bankers for this story, Statoil had just announced its intent to make a $4.4-billion purchase of Brigham Exploration Co. and thus, launch its first foray into operating in a shale rather than being a non-op partner. Most sources see more of this kind of deal coming, viewing it as a natural progression. Things have changed, and changed dramatically, when companies like ExxonMobil, BP and Shell pour billions into shale-related deals.

“Now, the parents are learning computer tricks from the children,” Gheit says. Once the large companies grasp the relevant technology, they will add their own strengths to the shale plays, in terms of financial stability, robust research and project management, he says.

“The interesting dilemma is this,” says Gregg. “At what point do you need to combine an opportunity-rich company with shale acreage, yet which is capital-constrained, with a much larger company, in terms of having the financial flexibility to develop the asset with sheer industrial scale?”

“The Bakken is ripe for further consolidation,” he says. “There is enough large-company interest and there are enough small companies with ‘chunky’ positions that need capital. We expect the Bakken to undergo significantly more consolidation in the next 12 to 24 months. A lot depends on access to capital, which could be affected by market turbulence.”

Gregg thinks the Eagle Ford is in an earlier stage with players “still separating the tenderloin from the skirt steak.”

At GE Energy Financial Services, managing director John Schaeffer, top, and global leader of the natural resources group, Jim Burgoyne think there's plenty of private equity and debt deals ahead.

Barclays’ Pipkin thinks we might see a slowdown in shale JVs in 2012. “There are too many negative forces against unconventional JVs for many more to happen in North America.” But on the other hand, Pipkin thinks, the national oil companies involved will indeed figure out how to buy a U.S. company, or bring in their own expertise. “The Statoil transaction shows you they want to own, operate and not be passive.” Gas prices

Natural gas prices remain a big dilemma for everyone, with E&Ps and financiers marveling at the surge in U.S. production, yet at the same time, bemoaning what that has done to the Nymex strip and well economics.

“I have a dimmer view than most. I think gas prices are going to stay flat, like a cardiac arrest, for awhile,” says Gheit of Oppenheimer. “I think they will be under pressure for a couple more years, and this will change policy in Washington—eventually.”

Gheit says he’s given up predicting oil prices, “other than for amusement at cocktail parties,” because they are not driven by supply and demand as much as by unforeseen factors such as the Arab Spring, speculation and other externalities.

With low-priced, yet plentiful natural gas, talk grows of exporting it in the form of LNG. Might an alternative be to develop long-term gas sales contracts with domestic end-users instead? Barclays’ Pipkin says those discussions break down as producers want to get paid more than the forward curve currently indicates, and end-users would rather buy gas on a spot basis and take their chances.

“It seems to me we should be developing markets here in this country, and we could if we had support from our politicians. I do think global petrochemical companies are studying this already,” he says. “There is a timing mismatch. A gas-to-liquids plant takes five to seven years to build, so trying to lock up gas supply today, when you’re not operating until five years later, is tough. What are gas and liquids prices going to be in five years?”

J.P. Morgan’s Gregg thinks the national oil companies (NOCs) will remain interested in North American resource plays “for the rest of our lifetimes” and as production increases, gas exports from the U.S. are a real possibility. That in effect globalizes the gas market.

IPOs ahead?

While most declare the current IPO market to be cold as ice, there’s no telling when the window of opportunity will open, or for how long. Once it does open, many upstream companies are ready to go. Some private-equity players are ready to monetize some of their E&P clients.

J.P. Morgan’s Gregg thinks most of the companies that have filed to go public will be patient but opportunistic, given recent market volatility. The firm was involved as a book-running manager on all three oilfield service company IPOs completed this year, and is working with three more currently filed with the SEC.

On the upstream side, the firm is also leading a longtime client, Randy Foutch’s Laredo Petroleum LLC, on its proposed $450-million IPO, now going through the SEC registration process. In the meantime, Tulsa-based Laredo recently closed on a $200-million add-on to its $350-million debut bond offering that it closed earlier this year.

“IPOs for C-Corps that choose to go ahead may come to market with a bigger discount if markets stay choppy,” he says. “But companies are not going to force it. I think some may wait until the new year. I think MLP investors are a lot more resilient though,” Gregg says.

On balance, he says he is constructive on 2012, somewhere between neutral and positive. As soon as the markets come back, “we hope to see a lot of equity issuance and IPOs. If markets stay a bit wobbly, more high-yield issues or debt will come to the fore, as well as further M&A transactions.”

True, investors still like the idea of a yield-oriented security. Barclays’ Pipkin also foresees more MLPs coming to market in 2012. “When Wall Street recovers, the first wave of issuance will be yield entities and that will be followed by the C-Corps. As we sit here today, we hope there is an economic recovery and that equity valuations have rebounded to a higher level than we see today.”

Observers anticipate the high-yield market will recover back to its record-low yields, even though it’s traded down lately. More royalty trust vehicles will also come to market. When other investments are paying next to nothing, the smart money migrates to riskier assets or hard assets like oil and gas. Anything yield-oriented looks attractive. Then too, investors see some Wall Street mavens predicting WTI oil will recover to $100 per barrel and higher in 2012 and 2013 as the world economy picks up steam.

Meanwhile, every bit of geopolitical news gives the stock market the jitters.

Investing

Jitters or not, institutional investors and portfolio managers still buy into the energy story. Helios Advisors LLC manages two funds that invest in energy, with about $650 million under management. It launched Helios Energy Fund in 2010, a long-short hedge fund that invests in the securities of small and midcap E&Ps, oil services, midstream and power. That fund is accompanied by Sunbeam Opportunities Fund, launched in 2003 and focused on commodity industries such as gold, silver and copper as well as oil and gas.

Partner and Sunbeam portfolio manager Lawrence A. Heller says he likes to think of crude oil as a currency because it is freely convertible into any other (paper) currency in the world. He likens Saudi Arabia to a central banker, but one that is more disciplined than most central bankers lately.

“I’m a WTI guy, not a Brent guy,” he says. “On the other hand, these crude-based economies have to finance their entire civilization on a barrel of oil. Prices are up all over the world. Look at inflation trends and it is very pronounced. I don’t think the Saudis can deal with an oil price much lower than where it is today. Inflation affects Saudi Arabia; they have to import almost everything.”

Helios Energy Fund, managed by Jason Selch and Marc Garfinkle, likes equities such as Apache Corp., Whiting Petroleum, Oasis Petroleum, SandRidge Energy, Equal Energy Ltd., Subsea 7 and Vantage Drilling.

“We really like Hess,” says Selch. “They get 5% of their EBITDA (earnings before interest, taxes and depreciation) from refining and marketing and the rest is from E&P, yet they are being valued like they’re an R&M company. In fact, they have the No. 1 or 2 positions in the Bakken, Utica and Eagle Ford.”

Look closer and you’ll find that Selch’s investing theme is to track companies that are applying new shale technologies to tight-oil plays. “Famed investor Ralph Wanger always told me, ‘Invest in companies downstream from new technologies,’” says Selch, who for 11 years managed energy investments for Columbia Wanger Asset Management, and later, for legendary Chicago billionaire Sam Zell.

Says Selch: “Technology makes opportunities that are valuable to the early adopters, and in the shales, that is mainly the small-caps and midcaps, not the majors.”

The folks at GE Energy Financial Services remain active across the oil and gas spectrum, and currently have about $4 billion invested in upstream and midstream assets.

food vendors and public art vie for attention on Avenue of the Americas.

It has more than 20 partnerships on the upstream equity side, many of which are repeat clients. “There’s no shortage of capital targeting the upstream and midstream sectors,” notes managing director John Schaeffer. “But most of that capital targets larger companies and larger deals. We have a partnership model geared to the smaller producers. There is no shortage of growth opportunities for us there.”

Recently, in addition to equity-based partnerships, GE has begun to provide debt to some smaller companies, to step into the gap between pure conforming senior bank debt and equity, Schaeffer explains. GE Energy Financial Services provides a one-stop “uni-tranche” loan, that is, a debt product that combines attributes of the mezzanine or second-lien loan and senior debt. An example is its facility provided to Knox Energy of Columbus, Ohio, enabling the latter to pursue additional development drilling. “We moved out on the technical curve,” he says.

“There is plenty of room for investors like us to acquire or partner with companies,” says Jim Burgoyne, managing director and global leader of GE Energy Financial Services’ natural resources group.

“We are leveraging our experience to expand our product offerings into the North Sea and across the midstream sector. In the North Sea we’ve provided development financing, for example, to Sterling Resources. We recently closed our first oil terminal deal, and have a robust pipeline in the midstream space. Further, in midstream, we’ll look at independent gathering systems the smaller companies are building, as opposed to going head to head with the large MLPs. The big MLPs will provide the exit opportunities later on.”

Then too, shale-rich companies that are capital-constrained are candidates to form partnerships with the GE unit. Alternatively, GE Energy Financial Services can assist those companies by acquiring assets from them in partnership with a third company. For example, it recently formed a partnership with Marlin Energy LLC as the general partner, to acquire assets from a larger E&P company that faced drilling obligations and needed to boost liquidity. This allowed Marlin access to a high-quality set of conventional assets.

Despite market volatility, or perhaps because of it, producers and midstream companies of all sizes remain hungry for growth capital. Combine that fact with the surge in shale development, and investors’ love for the one industry that seems to be thriving right now—oil and gas—and you have a potent recipe for continued deal-making of all kinds in 2012.