Between them, Paul Favret and Paul Rady have dialed just about any type of E&P capital in the money Rolodex. Friends and family, mezzanine, joint venture, private equity, bank debt, public equity, public debt.

Favret worked for Amoco Corp. before joining privately funded Aspect Energy LLC, founding Aspect Abundant Shale LP and Ascend Geophysical LLC, and recently launching Source Energy Partners LP with some former Aspect Energy colleagues.

Rady, too, was with Amoco and was chief executive of Barrett Resources Corp. and Pennaco Energy Inc. before co-founding privately held Antero Resources Corp. in 2002 with Glen Warren and other former colleagues, many dating back to his Amoco days.

It’s good to have when you need it, but mezzanine capital is among their least favored types of funding—because of its high cost. Rady adds public equity to his short list of costly capital—and not just because of its literal drag on the profit-sharing pie. “Being public has a number of advantages, but it also comes with a certain time commitment, which can take away from creating value,” says Rady, Antero chairman and chief executive officer.

Favret, Source CEO, has tapped mezzanine capital in the past. “We’ve had to pull it in from time to time to accomplish certain projects and goals. It’s expensive and project returns might not be substantial enough to make it work.”

Rady and Warren, Antero president and chief financial officer, considered mezz funding when getting Pennaco off the ground in the late 1990s. The start-up was drilling coalbed-methane wells in the Powder River Basin in northeastern Wyoming while oil and gas prices were trending south. “The summer of 1998 was a difficult time for energy producers.”

He and Warren looked at many options, including project and mezzanine financing, but these looked very expensive and cumbersome. “Instead, to bootstrap ourselves, we sold an undivided 50% working interest in our project to (Michigan-based electric utility) CMS Energy.”

That gave Pennaco $28 million of cash. “It’s not a lot of capital these days but, when our wells cost $50,000 to $100,000, it allowed us to drill a lot of CBM. We drilled upwards of 1,400 wells in two years” With working capital to accelerate drilling, reserves began to move into the “proved” column, becoming collateral Pennaco was able to take to the bank and win a commercial line of credit. Its enterprise value grew to meet American Stock Exchange listing requirements, and Pennaco added public-equity capital to its mix.

It was sold in 2001 for approximately $500 million to Marathon Oil Co. Its CBM portfolio had grown to more than 400,000 net acres. Production was more than 50 million cubic feet of gas per day. Net proved reserves were some 200 billion cubic feet.

Another money source Rady has not used is “friends and family.” He’s looked at it in the past; however, “it can be expensive and more complicated capital,” he says.

Favret has used friends/family capital to join in one-off, quick ventures. He also owns an investment fund, Abundant Investments LLC. “Historically we’ve used this type of capital for small opportunities that require a very quick decision. Some investments have carried a 48-hour response deadline.”

Patient Money

For their current ventures, each is primarily employing private equity from well-recognized, formal providers. Rady says, “With a large amount of private equity, we can build value on a much larger scale—drill a lot of wells, and build up a large production profile and cash flow. With a smaller amount of capital, we would need to focus on projects with a smaller scope.”

Rady and Warren picked Warburg Pincus, Yorktown Energy Partners and Lehman Brothers Merchant Banking Group in 2003 to join in Denver-based, Barnett shale-focused Antero, which was sold to XTO Energy Inc. in 2005. They reloaded with the three capital sources with a $1-billion commitment in 2007 for deployment in the Arkoma, Piceance and Appalachian basins. After Lehman failed in 2008, a new private-equity group recapitalized it and renamed it Trilantic Capital Partners. “But we continue to work with the same people. They have been very supportive in turbulent times,” Rady says.

Warburg energy-investment chief and vice chairman Howard Newman had moved on to co-founding Pine Brook Road Partners with investors that include a Soros fund by then, but Rady stayed with Warburg in 2007. “We know and respect Howard, but we also have a good relationship with Peter Kagan and Jeffery Harris at Warburg, and enjoy working with them.”

Favret stuck with an existing relationship too, when forming Denver-based Source this spring. Favret had worked with Craig Jarchow, a Pine Brook managing director, while Jarchow was a director of First Reserve Corp., which was invested in Barnett- and Fayetteville-focused Aspect Abundant Shale.

“Having built a very successful enterprise together, I reached out to him again to partner on a resource-oriented company,” Favret says. “I knew I was going to go with Craig, so I didn’t consider any other investors.”

Private equity has proven to be patient money. “Pine Brook works closely with management teams to develop the business plan and continue to refine the strategy before executing on the plan,” Favret says. “And, they know the value of persistence, hard work and good fortune over the course of business cycles.”

Rady says his and Warren’s relationship with Warburg, Yorktown and Lehman began shortly after Pennaco was sold in 2001. “In 2002, we regrouped and started talking to private-equity providers. We felt comfortable with these firms in terms of our strategy of growing via the drillbit, the risk profile and the investment time horizon.”

Antero leased ranch property in the core of the Barnett play in 2003, worked it, added acreage and flipped the package in two years for more than $1 billion in cash and XTO Energy Inc. stock. “We made a good return for investors and management, so we were all were ready to ante up again as we grew our Arkoma and Piceance projects in 2007,” Rady says.

In the past year, Rady and Warren brought $525 million of public bonds into the Antero capitalization mix at 9.375%, paying off bank debt with the proceeds. “We did our high-yield deal to term out our bank debt. It improved our liquidity and reduced our vulnerability to a lower bank price deck,” Rady says.

He likes the current capitalization mix the most. “Barrett was a public company. Pennaco was public. Antero has used private equity, bank debt and, now, public bonds. It has worked well.”

Risk/Reward Profiles

For Rady and Favret’s business plans, their private-equity partners are also especially suited to their risk/reward appetite. Both Warburg and Pine Brook have records of funding higher-risk/higher-reward, exploration-oriented start-up E&Ps, while some private-equity providers will look at only exploitation start-up strategies.

Favret says private equity that will fund exploration in this capital-markets environment is cleverly “jumping off the sidelines” and taking advantage of good investment stories. Pine Brook—in particular, co-founder Newman—has a “long and successful track record of investing private equity in exploration strategies,” Favret notes. While at Warburg, Newman led investments in Newfield Exploration Co. that was built upon Gulf of Mexico exploration, Kosmos Energy LLC and its wildcat success offshore West Africa, Rady’s first Antero, and Gulf-focused Spinnaker Exploration Inc.

At Pine Brook, Newman partnered with principals from Spinnaker and Newfield to form Common Resources LLC, which sold its Haynesville/Bossier assets in May for $805 million. It had been formed in only 2007.

Source was formed just this April and expects to start spending on an asset portfolio in the first quarter of 2011. In June, it joined Vancouver-based Realm Energy International Corp. in the 161,000-acre Llawa and 180,000-acre Wegrow concessions in Poland for 50%. Neighbors include Talisman Energy Inc., Marathon, ConocoPhillips and ExxonMobil.

Favret warns against working with very short-term-return-focused investors. “There are some less experienced and less patient private-equity investors who throw in the towel at the first sign of trouble. Most of us in this business know how cyclical it is with pricing, how resource plays evolve, and the learning curve of the team,” he says.

“It takes a substantial amount of time to optimize returns. And, these resource plays require more patience to stay in the game and win, and hopefully enjoy some technological improvements with time. Long-term-focused private equity will wait through the cycles for an attractive exit multiple to be achieved.”

Rady notes that start-up management should be mindful of applying talent to the appropriate tasks. “Very talented people who are excellent in technical and company-building roles can get pulled away into administrative, regulatory, compliance and other roles. This can take them away from their very best skillset,” he says.

And Rady and Favret suggest, dial the right capital.

Sidebar: Marcellus Expansion

Reloaded in 2007 with a focus on the Arkoma and Piceance basins, Denver-based Antero Resources Corp. added acreage prospective for Marcellus shale gas in 2008 in a deal with integrated energy company Dominion that pushed through the September 2008 capital-markets crisis.

Chairman and chief executive Paul Rady and team picked up 114,259 acres in southwestern Pennsylvania and northern West Virginia for $347 million. Company-wide production is now more than 130 million cubic feet of gas equivalent per day. Antero holds more than 120,000 net acres in the Marcellus, 80,000 in the Woodford shale play, 6,000 in the Fayetteville and 66,000 in the Piceance. Proved reserves are more than 1.5 trillion cubic feet of gas equivalent.

After selling Antero's Barnett portfolio in 2005, "we looked at what would become the next great oil and gas plays. We saw the Marcellus as having great potential, as did many others. We started looking for the right opportunity to get in." Drilling began in the summer of 2009.

The nascent play is ripe for Antero-type engineering, he adds. "We've been able to pioneer a lot of technology in previous assets and we're using them now in the Marcellus. We were the first to do simultaneous fracs in the Barnett, one of the leaders in microseismic technology, and we've been drilling some of the longest laterals in the gas industry in the Marcellus."

Rady flipped Pennaco Energy Inc.'s Rockies coalbed-methane assets for $500 million in cash in three years, and Antero's Barnett package for more than $1 billion in two years. Antero's Barnett properties are now owned by ExxonMobil, which bought XTO Energy Inc. in June. Pennaco's properties were sold to Marathon Oil Co. Rady says large-company interest in the Antero team's portfolios is a testament to asset quality.

"We took XTO stock (as part of the Barnett sale) because we believed in the assets we built and in XTO's ability to run with them. The properties were producing 60 million cubic feet per day when we sold them. They're producing at least 10 times that much now, so these were quality properties in the Barnett that have a lot of potential."

In the Marcellus, Antero again sits on prime real estate. Rady admits he gets calls to sell. "People do touch base now and again."