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AUSTIN, Texas ̶ The money is astonishing: Some $16 billion flowed into the U.S. energy sector in the first quarter of 2015, two-thirds in high-yield issuances and one-third in equity raises. This money is on the hunt for opportunities, predicated on the theory that low commodity prices will deliver great bargains to the market.
However, as of yet, the hoped-for bargains are not widely appearing. “We think the worst of the downturn is yet to come,” said Carl Tricoli, managing partner and co-president of Houston-based Denham Capital. Tricoli spoke in early April at Hart Energy’s Energy Capital Conference. He participated in a panel discussion on private capital in energy.
“We’re not seeing a lot of bargains yet,” he said. That’s because in the recent round of borrowing base redeterminations, companies benefited from aggressive 2014 drilling programs. The flush of drilling increased booked reserves, and this helped offset the lower commodity prices. “If the price environment doesn’t change as we move into 2016, we will have much more difficult borrowing base redeterminations. That’s when we’re going see more of a target-rich environment,” he added.
Panelist Doug Swanson, managing partner, EnCap Investments, agreed. “We do think that the longer this downturn is protracted, the better the opportunities will be.” Nonetheless, Houston-based EnCap has already uncovered a couple of unique opportunities this year, investing $1 billion. (One was mineral acquisition and one was a marketing transaction in which EnCap backed a team that was familiar with an area and had strong operational expertise.)
The view of the institutional investor community is similar. “Overall, when examined on a price-to-marginal-cost perspective, many commodity prices today are below marginal costs,” said Austin-based panelist Mark Warner, senior managing director, natural resources and emerging markets investments, University of Texas. “We see the whole world going through a reset. It’s not just energy. It’s occurring across the commodity markets. What we are going through is not necessarily going to be over quickly or easily.”
The entrepreneurial portion of the energy industry has historically been pretty good at adjusting to cycles, said Warner. “We’re seeing that adjustment right now. It’s dynamic and there’s volatility in equity markets both from an issuance and a trading perspective. On the private side, the opportunity set is beginning to present itself, but our sense is we’re very early into that stage.”
And when opportunities come, they will not last long. Even with an amazing depth of available capital that is poised to capture distressed opportunities, those opportunities will be engulfed when they come to market.
“Capital structure is key today,” said Swanson. “Our companies have very little debt, so they’re able to be patient and wait for the right opportunities─whether that’s beginning to drill again aggressively or make acquisitions.”
In the meantime, EnCap’s portfolio companies are reexamining their strategies and portfolios, and also taking a pause to let service costs come back in line with the low commodity price environment. Said Swanson, “They’re looking to making bolt-on acquisitions and at diversifying their asset bases, but to date, the opportunities are somewhat limited.”
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