They say the night is never darkest than in the middle of it, and with commodity prices’ plunge in recent months, some investors say we’ve made it to the midnight hour.

“We just have yet to find out how long and how dark this night will be,” Ben Davis, a partner at Energy Spectrum Capital in Dallas told Midstream Business. “But as an industry, we have made it through many down cycles in the past, and we’ll make it through this one.”

Indeed, private equity may light the way. Information from Preqin Ltd., a New York-based company that tracks alternative assets, indicates there is currently $90.1 billion in available dry powder—capital raised, but yet to be invested—for energy-focused private equity funds. Specifically for energy-focused infrastructure funds, about $20.2 billion is on the table.

“Investors are still looking to commit significant levels of capital to the asset class, but managers must make a compelling investment case to attract capital,” said Preqin’s chief of real assets products, Andrew Moylan. “Investors are becoming far more sophisticated in how they invest in infrastructure, with many increasingly targeting direct investments or co-investments. While fundraising is likely to be strong in 2015, we expect that capital will continue to be concentrated into a smaller number of funds.”

Falling prices

Dozens of infrastructure funds have been raised each year for the last several years. By the end of February, only two had started to raise capital, suggesting a slowdown.

Moylan explained that although the number of infrastructure funds reaching a final close was lower in 2014 than in previous years, the dollars being committed to the class remain strong.

“Funds that closed last year raised more on average than in any year, with the majority closing above their fundraising targets, reflecting continued strong investor demand for infrastructure,” he said.

Nevertheless, the demand for infrastructure faded to some degree with distressed commodity prices.

Davis said midstream investors realize that they should focus on the plays that are going to work at $50 oil.

“That’s a pretty easy conclusion to make now, but we’re fortunate that we’ve been thinking about that for the last several years—certainly since oil got to such lofty levels,” he said. “We’ve been doing this for 20 years now and we’ve learned from our mistakes. We have learned that we need to continue to be disciplined and focus on plays that work when oil is at $50 or $60 and partner with producers who could withstand the price down cycle.”

Davis explained that there are two types of investment opportunities that Energy Spectrum is seeking in the current environment: acquisitions and new-build projects.

In acquisition opportunities, prices have gone down as commodity prices have plunged.

Dropping transaction values

“For acquisitions, transaction values generally should go down in this commodity price environment because most operating assets are probably worth less. So the question may be whether we are going to be paying more or less as a percentage of what something is worth at that moment,” Davis said.

‘There’s a negotiation of terms that the producer goes through with its midstream suitors to try to get the best deal possible, but I think at the end of the day, they’re picking a midstream partner not just based on the economic terms, but on who they think is going to do the best job for them as their partner,” he added.

But plunging prices have done more than cast a shadow over a few balance sheets. Oil at $50 per barrel (bbl) may mean there are fewer opportunities, and more concentrated competition, for private equity in the market.

“Is that $50 per bbl a good enough price to keep enough producers drilling and enough rigs running to maintain a supply level that would lead the market to keep oil at $50? If it will, then we’re going to be at $50 oil for a long time because we’ve found balance, but the market rarely seems to do that,” Davis said. “How many times can you remember that we’ve maintained some steady commodity price for a multiyear period of time? It just doesn’t seem like we can find that equilibrium. It’s a pendulum, and we may swing right through that equilibrium point, and then swing back through it, but the pendulum never seems to come to rest in a perfectly vertical position at the point of equilibrium.”

Specialty shops

Boutique private equity firms have been accumulating capital at a steady pace in the last decade for deployment in the energy industry. Although there was some pause during 2009, when the nation was teetering in a recession, in more recent years specialist firms are being joined by generalists with even larger pools of capital investment.

So as the upstream takes a beating from commodity prices, what’s a well-established firm to do with all that cash on hand?

Several are sticking with energy, and even more are veering toward the middle. Enormous generalist funds, such as Warburg Pincus and Kohlberg Kravis Roberts, are increasingly investing billions throughout the supply chain—despite the dramatic dip in commodity prices. The Blackstone Group, for example, announced at the end of February a $9 billion energy fund.

Longtime energy fund manager Bill Weidner has studied the phenomenon of private equity’s interest in hydrocarbons for years.

Risk and predictability

“The midstream business model, because of the demand for capital in new, productive areas and the demand for transportation in new productive areas—along with the general perception of the investment community that there is a little bit less risk and more predictability in the midstream space and maybe higher multiples—has certainly gained in popularity as an investment style,” he told Midstream Business.

Weidner said that following the declining interest rate environment following the 2008 credit wreck and stock market crash, there was a move among institutional investors toward larger bond allocations to avoid volatility.

“I think a big factor driving this really materialized in the 2009 to 2010 time frame when investors wanted both safety and return at the same time by that method. That was very important. Unconventional resource opportunities showed there was a chance to have attractive returns at scale, and I think scale is the operative word,” he explained. “Back in the day, a $40 million or $50 million investment with a 2-to-1 return on investment was OK. But if all of a sudden, it’s a few billion dollars with the same return metrics, then it starts to attract some meaningful amounts of money.”

Even with prices shifting, there remains a lot of private capital bottled up and earmarked for energy.

“Therefore, there’s a lot that seek to take advantage of this environment. I think as long as this environment is deemed to be temporary, finding more ways to take advantage will be difficult. In this business, everybody knows you want to buy low and sell high, and that’s true for both buyers and sellers and therefore isn’t necessarily all that easy,” Weidner said.

A pivot point

Weidner noted that megafirm Kohlberg Kravis Roberts’ investment in Samson Resources had been marked to 5 cents on the dollar.

“Does that mean some of these larger generalist funds that came into the space with larger allocations are having those kinds of hits to returns, and is that going to impact their appetite going forward? I think that remains to be seen. It could be a hiccup for somebody like that, or it could be a pivot point,” he said.

Whether a private equity deal goes forward depends on more than just price, however.

“It’s the fit of the personalities and their modus operandi, the investor vs. the portfolio company. There’s no one answer. I think it’s how the two parties mesh together. There are certain investors who are probably great for one management team and probably awful for another. It just depends,” he said. “Everybody’s money is green and everybody claims they add all sorts of value. The extent to which that is true I think is pretty hard to tell oftentimes.”

Ranking the enablers

All of which can make it tough to tell who’s the biggest or the best when trying to put private equity firms in some kind of order.

Until last year, Weidner had his own index of private equity firms. But the task of obtaining information that is, by nature, private, is more challenging each year.

“The willingness of people to participate in the survey seems to be inversely correlated with the amount of money out there that’s available. The more money there is in the sector; the more active and bigger everybody is, the more they don’t want to be bothered with this sort of private information gathering,” he said, adding, “I think also there’s growing concern with securities regulation so to the extent a money managing firm is in capital-raising mode they don’t want to say anything publicly and therefore they won’t.”

What’s more, it’s become more difficult to divine the energy specialists’ investments from more random ones, he said.

“There has been this huge influx of generalist private equity firms that do lots more than just invest in energy. They may invest in fast food restaurant chains or radio station franchises or what have you, but they also have an allocation for energy that waxes and wanes. And therefore what I was finding was that the index was becoming less reflective of reality. It was a marker, a measuring point, but it was not as conclusive as something like the Dow Jones industrial average of 30 stocks,” he said.

The PEI 300

Indeed, the PEI 300—Private Equity International’s ranking of the “300 biggest private equity groups on the planet”—lists the top five firms from among the super-sized generalist funds: The Carlyle Group, Kohlberg Kravis Roberts, The Blackstone Group, Apollo Global Management and TPG. Each has a presence in the energy industry and the midstream sector, but their wider influence in the field is difficult to judge.

The top three energy infrastructure raises in private equity last year were carried out by boutique groups: Energy Capital Partners raised almost $6 billion, Energy & Mineral Group closed a $4.08 billion fund and EnCap Flatrock Midstream raised $3 billion.

By the end of January, there were 144 infrastructure funds in various stages of raising capital. But it may be the energy specialists who keep the path lit if the generalists decide $50 oil isn’t worth it.

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