Politics Over Returns? Private Equity’s Renewables, Hydrocarbon Challenge

Quantum Capital and EnCap Investments are making it through their latest fundraising efforts to bring in billions of dollars for energy development.

However, the private equity firms—both of which invest in oil and gas as well as power and renewable energy—said the task has been challenging.

“It was probably one of the harder fundraises that we’ve done in our 27 years,” Garry Tanner, partner for Houston-based Quantum Capital, said Oct. 1 during an annual energy summit co-hosted by Rice University’s Baker Institute for Public Policy and the Baker Botts law firm.

In the last 10 years, the Houston-based firm has raised more than $10 billion across multiple products and typically has a re-up rate in the 95% to 98% range, Tanner said. But that rate was “dramatically less” with its latest fund, having lost many European and so-called “blue state” investors.

Why? “It was basically ‘you may be our best performing private investment, but we can’t invest in you because you do oil and gas,’” Tanner said, adding that people are still attracted to the energy space because it’s one of the lowest multiples in the S&P. “The supply demand balance is actually pretty constructive for long term oil and gas prices. So, we saw a lot of red states kind of pile in and a lot of family offices that we didn’t expect.”

Private equity has been a clean energy investment leader amid the continued global drive to lower carbon emissions. While some funds and investors have shifted away from fossil fuels, others have stepped in to capture profits, given growing—albeit at a slower pace—oil and gas demand.

Like Quantum, EnCap Investments, which has about $40 billion under its management, has seen a similar experience, according to Gary Petersen, founder of EnCap Investments. The firm, which recently closed a $5 billion fund, said it had 90 university endowments as investors. However, about 65 of them wouldn’t return due to EnCap’s oil and gas investments. He added that some Asian sovereign funds also have declined at the advice of their U.S.-based consultants.

“It’s really become a political issue more than it is a return issue,” Petersen said.

So, EnCap turned to family offices and “red states” with its most recent fund, he said. “It hadn’t been an easy fundraise, but we finally got it done,” Petersen said.

Getting ‘cleaner’

While investments in lower-carbon technologies and renewables is helping to reduce global greenhouse gas emissions, cutting off oil and gas investment could prove detrimental for developing countries. Balancing energy security, affordability and reducing emissions remains a delicate balancing act for investors.

Tanner acknowledged what he called a dual challenge: addressing energy poverty and climate change.

“The World Health Organization estimates about 4 million people a year [are] dying from using wood and dung and cooking indoors. That’s a real problem that people don’t think about,” he said. “On the flip side, you have climate change, which is real, and we acknowledge that. So how do you provide all the energy that the world needs, and is growing, to lift the human condition while reducing emissions?”

“We spend quite a bit of time talking about responsibly-sourced hydrocarbons. I think not only is it the right thing to do, it can be really good business.”

That also means spending time on reducing flaring and leaks, he added.

Petersen flashed back to the 1970s, recalling lunchtimes with martinis and Rolex-clad wildcatters who could care less about the environment. The industry is cleaning itself up now, he said.

“It’s a very sensitive issue, and we all recognize that,” Petersen said. “I think in the future … you’re going to see more and more oil production, but the oil is going to be cleaner. There’ll be more carbon capture. You’ll have the same thing with natural gas. It’s going to be cleaner and cleaner and cleaner in the form of producing hydrocarbons.”

Restricting oil and gas production in the U.S. and Canada, where there is a focus on lowering emissions, may not be in the world’s best interest, according to panelists.

“The bad news is the world demands the same amount whether we produce it here or we produce it in a country that doesn’t like us too much. We do it a lot cleaner and a lot safer and a lot more socially responsible,” Tanner said.

As global emission rise and billions remain in energy poverty, “we’re not doing a very good job addressing the dual challenge,” he said.

A ‘broader approach’

Climate Investment, an independently managed decarbonization investor fund founded by members of the Oil and Gas Climate Initiative, looks at investments with CO₂ emissions in mind.

“That is beyond the energy sector. So, thinking about the built environment, heavy-emitting industries in steel, cement, coal. The common language that we can use is CO₂ emissions,” said Patrick Yip, managing director, head of growth equity.

He spoke about partnering with other firms to develop common vernacular and methods to standardize the calculation of CO₂ emissions.

“We took one step back and said we want to be better citizens, reduce hydrocarbon emissions. But if we look at CO₂, if we can offset CO₂ from a building, from building materials, in the supply chain—to us that is just as valuable,” Yip said. “I think taking that broader approach, we can achieve traditional private equity returns but also have that real CO₂ impact.”

Technologies also exist to monetize wasted natural gas streams while reducing methane emissions as well, he added, referring to flaring.

“We’re going to back these technologies that can really solve these methane issues. … As a climate-focused investor, we are moving toward that ability to now back those existing commercialized solutions,” he said.

Shawn Cumberland, managing partner with EnCap Energy Transition, also addressed the search for great investor returns.

“There’s a lot of competition for investing in renewable space. You’re trying to find the outsized opportunity,” he said. For EnCap Energy Transition, which is part of EnCap Investments, that includes battery storage in Texas.

“We backed two big players that had actually kind of changed the way the battery landscape was looked at, and we exited those—one to a monolithic, big fund manager, BlackRock, and one to the big European utilities, Engie,” Cumberland said. “That gave us the ability to actually raise Fund II, and we just closed Fund II in March, $1.5 billion. We’re out now deploying that into different portfolio companies.”

He later explained that EnCap Energy Transition is more focused on infrastructure.

“It’s not just core buying. We actually do have to create value,” he said, adding the firm has to court a number of international limited partnerships.

In Europe, divergent investment trends are also evident, like the red and blue states in the U.S.

Investing in gas turbines may not be welcomed in Europe, even if “we view it as important for the energy transition,” Cumberland said. That can be difficult to explain to someone set on decarbonization, he said.

 “So that’s a challenge for us right now, but we’re still seeing a lot of interest for what we do. The harder part is for us to try to describe to them that we’re going to continue to get outsized returns. That’s the bigger one right now.”