With the momentum of the ESG and energy transition movements building, private equity investors are pouring more capital into renewables, forcing E&Ps to rethink their strategies in order to compete.

“You've got to give them something that truly is a differentiator,” said Chuck Yates, a member of Cottonwood Venture Partners advisory board, during the NAPE Global Business Conference. “You have to show that you’ve made money. There are no more equity line of commitments, you’ve got to have the asset on lockdown.”

Speaking on a panel discussion titled “Private Equity 2021: Feast or Famine,” Yates and other industry veterans discussed the morale of private equity investors and what the shift toward ESG-focused investing means for oil and gas producers, including the growing importance of proven assets and detailed carbon-neutral goals.

Yates, a former managing partner at Kanye Anderson Capital Advisors, said the days of firms allocating 10% to 12% of their funds for energy deals are long gone. Oil and gas producers will have to compete with every other investment vehicle like leveraged buyouts (LBO) and venture capital. “Those things are all on fire and doing really well,” he noted

In today’s energy landscape, he said it is important to present an established team with a polished business strategy because firms want to be able to “scrub down everything about getting into business with you.”

“You almost have to have it totally buttoned up today to be able to get money because money is really scarce,” he said.

The COVID-19 crisis certainly accelerated the transition to ESG-focused funds, but investors’ appetite for energy began diminishing well before the pandemic.

According to Bloomberg, Preqin Pro found conventional energy funds dropped from $46.7 billion in 2015 to $8.3 billion last year. However, in that five-year period renewable funds grew from $21.4 billion to peaking at $52.2 billion in 2020. Further, roughly 47% of investors plan to significantly increase their ESG investments over the next two to three years, according to EY’s 2021 Global Private Equity survey.

Increasingly, ESG policies are driving LP decisions about commitments. With fewer LP dollars available for fundraising, E&Ps negotiating power is non-existent, according to Yates.

“Just sign whatever they put in front of you as quickly as possible before they change their mind,” he said.

“It's literally a day to day relative type scenario,” he continued. “Whoever goes out to raise money truly won’t know [the available capital] until they put the puck on the ice. We used to be able to say, ‘we're going to go raise a billion and a half’…those days are all gone.”

Historically, market distress signaled an opportunity for private equity investors to chase deals. As the oil and gas sector struggled to survive fluctuations in price, investors would swoop in hoping to acquire lucrative portfolios. This current downturn, however, has significantly decimated energy funds.

“There are institutions today that are saying that they will not invest in hydrocarbons anymore and it just feels realer than it ever has,” he said. “It truly is a tidal wave that is going to hit us so it is something that we have to take serious.”

In five years, Yates forecasts all money-centered banks will exit the energy sector in full pursuit of greener assets. Even as companies improve their ESG efforts, he said investors will prefer the attractive returns from longer-term, more sustainable investment strategies.

“I think that will happen,” he said “and I don't think it's just one or two of them: it’ll be wholesale—no more oil and gas.”

So far this year, the majority of the ESG funds outperformed the S&P 500, according to a recent report published by S&P Global Market Intelligence. The data showed that 16 out of 27 ESG exchange-traded funds outperformed the S&P 500 between an 11% to 29.3% margin.

The top two performers Ariel Fund and Ariel Appreciation Fund, both managed by Ariel Investments LLC, saw a 29.3% and 25.1% price change, respectively, year-to-date. Parnassus Investments' Parnassus Endeavor Fund had the third-best performance with a 23.6% price increase.

“I’m just worried with the ESG tidal wave,” he said. “Clearly as an industry we’ve had a red problem in terms of losing money, but we have a real green problem.”

With ESG on track to become more than just a trend, companies have to be diligent about adopting ESG principles in their portfolios or risk losing out on the scarce capital that is available.

“On ESG, our industry was late to address it,” he said.

However, oil and gas companies are now starting to embrace ESG wholeheartedly with legitimate ESG-detailed slides in our deck, he said.

“Calculating, quantifying and addressing it in your presentations to go raise that private equity is important now,” he said. “They like to see that now because they get calls from their LPs about it. They don’t want to be the equity behind a company that is getting the wrong type of attention.”

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