It’s one story of how private equity can put people to work. When Bruce Northcutt and his colleagues at Copano Energy LLC sold the company to pipeline titan Kinder Morgan Inc. last year for $5 billion, he didn’t intend to get right back to business.

But as word of the deal spread throughout the industry, investors looking to capitalize on the strength of Northcutt and his partners Jim Wade and Bryan Neskora approached the trio. Business opportunities abounded, and they weighed the pitches. In October, Northcutt and his team committed to create Navitas Midstream Partners with Warburg Pincus’ $500 million private equity infusion.

Having been the private equity backer of Targa Resources Inc. and others, Warburg had a solid track record of building companies—not just one-off assets, Northcutt said.

“That’s our direction for Navitas,” he told Midstream Business. “We’re in it for the long term. I think that’s what producers want now.”

What’s more, Warburg’s more than $37 billion in assets under management demonstrated that the firm has the size to make a difference at a fledgling company.

“We felt like we could put a significant amount of capital to work and they had a lot of capital strength behind them, and they’ve been doing it a long time,” Northcutt said.

What clenched the pairing: Warburg had exited its investment in Targa, which gave the Navitas team the assurance they wouldn’t be one among many midstream assets vying for attention.

“There were a lot of other folks who were backing multiple midstream teams, and we felt like that might put them in a position to pick or choose winners and losers for the capital they had put to work across multiple teams across multiple basins,” Northcutt said. “We wanted a bigger purview. We didn’t want to be cornered into one simple basin, and we didn’t want to be in competition with another Warburg-backed midstream company in the areas in which we operated.”

Follow the oil money

Private equity is chasing crude oil and natural gas recovered from unconventional resource plays in North America, from the deals it takes to get the resources out of the ground to the transactions that move hydrocarbons to market.

“The large-scale infrastructure buildout associated with the explosion in unconventional resource development is such a game changer that historic paradigms for midstream funding no longer apply,” said Jeffries LLC’s Peter Bowden, global head of midstream energy investment banking, in the recent article “Investment in Midstream Infrastructure Rises” for Midstream Business’ sister publication, Midstream Monitor.

IHS Global Inc. noted in its January report on oil and gas transportation and infrastructure that for the last 30 years, infrastructure in the domestic energy business was predicated on the notion that the U.S. would have a dwindling supply of hydrocarbons and consequently, more imports. But advances in unconventional drilling have upended those assumptions.

The nation instead is poised to lead the world in production capacity growth, having added almost 1.2 million barrels per day (MMbbl/d) since 2012. The U.S. is also the largest natural gas producer with 65 billion cubic feet per day (Bcf/d).

IHS suggested that capital spending in midstream and downstream infrastructure has grown by 60% from $56.3 billion in 2010 to $89.6 billion in 2013. IHS estimated that between 2014 and 2025, cumulative spending on oil and gas infrastructure would reach $890 billion. As much as 60% of that figure will be focused on crude oil and natural gas gathering systems and direct production support facilities, according to the report.

A higher-than-expected scenario in which production soars 20% above estimates would put transportation and storage infrastructure investment at a whopping $1.15 trillion during the 2013 to 2025 period.

Beyond the buildout

What’s more, the study found that although investment declines after the buildout, investment after 2025 remains at least $60 billion.

“This is an indication of continuing investment at fairly steady levels beyond 2025,” the report said.

And investors are responding to those numbers. In May, EnCap Flatrock Midstream closed its largest fund to date when its Fund III closed at a hard cap of $3 billion. Founded in 2008, EnCap Flatrock Midstream has more than $5 billion in total assets under management.

Bill Waldrip, one of three managing partners at the firm, told Midstream Business that, in dollars, 90% of the capital from EnCap Flatrock’s second fund returned for Fund III. He went on to explain that 75% of the new capital in Fund III came from limited partners that participate in EnCap Investments’ upstream platform but had not invested in midstream until EnCap Flatrock Midstream Fund III.

“We had really strong interest in the market for this fund raise,” Waldrip said. “Many were limited partners who have a long and successful history of investing in the upstream side of the business with EnCap Investments but hadn’t yet come into our midstream funds. They expressed interest in Fund III, did their due diligence and invested in midstream this time.”

A lot of opportunity still exists in the midstream space because there is a great deal of demand for infrastructure across the continent. For example, EnCap Flatrock recently increased its commitment to Tall Oak Midstream LLC from $100 million to $400 million to begin construction of its CNOW System: 250 miles of natural gas gathering pipeline and a 75 million cubic feet per day (MMcf/d) cryogenic processing plant in Oklahoma.

Midstream attraction

“The midstream sector is an incredibly attractive investment space right now,” Waldrip said. “There’s a convergence going on between the opportunity in the space, its maturation and the acceptance of the midstream private equity model. Those vectors are coming together, and that’s what’s generating a lot of the excitement.”

Oil and gas producers are also finding that working with private equity-backed teams like the midstream teams in EnCap Flatrock’s portfolio demonstrate significant value, especially in the buildout of greenfield assets to accommodate production growth, Waldrip said. Equity-backed teams can move quickly to deploy capital and execute a buildout that is tailored to meet customer needs, he said.

“Part of our growth story continues to involve experienced industry veterans who see stepping out and being part of their own team as a very viable career path. It’s more and more accepted in the business world, and there is more opportunity for funds like ours to back senior people like this who have a lot of midstream experience, are aligned with our approach and have an entrepreneurial mind set,” he added.

Power to the people

Rather than start with an interest in a particular area, many private equity firms like EnCap Flatrock look specifically at talent when they contemplate where to invest.

“It all starts with the people. We focus our efforts on finding the right teams to partner with and the opportunity sets that will take those teams to the appropriate places. We work with those teams to make sure that we all agree on the best places to invest midstream dollars, and then we provide capital and the expertise that comes from having spent many, many years in the midstream business. But for us, it all starts with backing the right management team and then pursuing opportunities in a partnership with those teams,” Waldrip said. “If we make sound decisions in picking the right teams, it makes the rest of our lives a lot easier. Fortunately, we’ve been able to attract very high-quality teams.”

Warburg Pincus, a global private equity firm focused on growth investing, also adheres to the people-first model of midstream investing, as energy group managing director In Seon Hwang told Midstream Business.

In developing the Navitas project, Warburg followed the model it used with Targa Resources—a deal that began with an investment in 2003. Warburg declined to comment on performance, but public information shows the private equity firm invested $400 million and netted $1.8 billion almost a decade later.

“When we started thinking about investing with the midstream sector, we took the approach that Warburg Pincus generally takes with making investments, which is to focus on exceptional management teams who have a strong track record in the sector, and both operating and growth experience,” Hwang explained.


The Ramsey processing plant in Reeves County, Texas, has total cryogenic processing capacity of about 300 million cubic feet per day. Source: Nuevo Midstream

In the early 2000s, much of the midstream industry was evolving, he said, which provided an attractive opportunity for the firm to form a new company and acquire midstream assets. But in addition to looking for growth opportunities, the firm didn’t want to buy assets simply because they had a low valuation, he said. Rather, Warburg also wanted to invest organically in a business it could help to grow over time.

During the course of two years, Warburg’s energy team met with about 30 midstream management teams to learn the sector and find partners with aligned interest, “people who we could trust to make the right decisions, help navigate and lead us through the sector,” he said.

Then and now

That’s how Warburg came to meet Rene Joyce, Joe Bob Perkins and Roy Johnson, now the leadership at Targa Resources. At the time, the three were known as the team that founded Tejas Gas Corp. before selling it to Shell Oil Co. in 1997 for $1.45 billion in cash.

During the course of 2004 and 2005, Warburg provided capital for the newly formed Targa Resources to acquire assets from the major oil companies and power and utility companies. Hwang said the real opportunity for Targa came in 2005, when Dynegy offered its midstream business for sale as part of its restructuring. Targa scooped up the gas gathering and processing assets, plus fractionation, storage and distribution facilities for almost $2.5 billion.

“We were taking advantage of a market dislocation at the time,” Hwang said. “There were unique circumstances that allowed the Targa team to identify and capture high-quality, cash-flowing stable businesses at attractive valuations.”

Warburg also believed its deep bench of professionals who understood E&P and especially basin economics—positioned the private equity firm well for entering the midstream space.

“When we purchased the Dynegy midstream assets, one of their key gathering areas was in North Texas right in the Barnett, and this was in 2005—the dawn of the impact of unconventional drilling in shale gas—so we were able to be aggressive in that bid because one of our portfolio companies, Antero Resources, was one of the pioneers of the Barnett,” Hwang explained.

“They were one of the larger producers applying horizontal drilling and multistage fracking within the Barnett,” he added. “We had made that investment, and we were already looking to exit in 2005, so we clearly understood their upside potential in the expansion of the Barnett. That degree of understanding basin-wide geology, producer economics, supply and growth potential— we believe allows us to be more astute midstream investors.”

Organic growth

Warburg entered the Targa investment believing in organic growth, Hwang said, and it’s a philosophy that’s paid off.

“We didn’t go in just because we could buy something for a low valuation—don’t get me wrong, that’s an important entry point—but within the course of our decade-long ownership within Targa, [the company] spent billions of dollars on organic infrastructure projects. So whether it’s expanding fractionation capacity at Mont Belvieu [Texas], export capacity out of Galena Park [Texas], processing facilities at Cedar Bayou [Texas], processing within North Texas and the Permian, the management team there did a wonderful job of focusing on the customer, looking for market opportunities, obtaining long-term contracts, underpinning billions of dollars of investment and growing the employment base to support our customers,” he said. “We continue to see opportunities to invest, which is a reason why we held on as long as we did. We believe in being long-term investors.”

To be sure, there are similarities between the foundations of Targa and Navitas. But a key difference is that the market had challenges a decade ago that don’t exist today, he added.


Nuevo Midstream completed the processing capacity expansion at its Ramsey plant in the Delaware Basin in 2014. Source: Nuevo Midstream

And those opportunities aren’t available without taking greater risks, Hwang said.

“We believe the opportunity today is to be much more organic, much more growth-oriented, and this is really where Bruce Northcutt, Bryan Neskora and Jim Wade distinguished themselves at Copano,” he said.

The Navitas deal

In June, Warburg Pincus announced its $500 million backing of the former Copano Energy LLC’s top executives to form Navitas Midstream Partners. John Rowan, an energy principal at Warburg, said the opportunity to invest in a wellrounded and complete executive team was attractive.

“It’s the team that, at Copano, executed on both acquisitions and very large-scale greenfield development successfully, and it’s rare to find that in a team. Each one of these individuals as executives, could have been backed independently to run their own company, and we were lucky enough to get all three of them as a team,” Rowan said. “With their executive experience in running a public company, strong commercial orientation and operations experience, we really feel like we’ve got a great team here to capture what is the current market opportunity.”

Northcutt said it’s fair to say that as early as September last year—a few months after the deal with Kinder Morgan closed in May—the team was beginning to think about what opportunities may be ahead.

“As a result, we didn’t sit on our hands for long, and we began developing a list of projects that we wanted to work on,” he said. “Warburg has a tremendous amount of information on the upstream side. They’ve got energy investments in the Lower 48 and also in Canada, and they’ve been very good about showing us business opportunities that they’re aware of through their upstream investments, and I think that’s been beneficial.”

Northcutt said he wants to keep Navitas’ intentions for particular plays close to the vest until the plans are more mature. Part of Warburg’s appeal is the firm’s willingness to give Navitas a broad playing field.

“I think it’ll be areas where our team has experience,” Northcutt said. “We’ve played in a lot of the traditional plays onshore and also working in a lot of the shale plays. We have a pretty wide spectrum now that we have to pick from.”


Wells in the rapidly developing Delaware Basin have been strong performers, keeping Nuevo Midstream's Ramsey plant near Orla, Texas, busy. Source: Nuevo Midstream

Greenfield projects

Acquisitions—expensive in the current market—would be considered on an opportunistic basis, he said, but for now, the focus has been an organic, greenfield construction perspective.

“There is still a lot of competition,” he said. “We see many other midstream teams around us, but I think our experience, our relationships and our experience with producers give us certainly somewhat of an advantage in stepping out with Navitas.”

As Northcutt explained, private equity is filling a need in infrastructure funding that’s become critical in recent years.

“There is a certain amount of replumbing of the gas gathering infrastructure in the United States because of the resource plays. I think part of the reason that midstream companies have been teaming up with the E&P companies is that a lot of the E&P companies, certainly the smaller ones, are trying to preserve their capital dollars and direct those toward drilling rather than toward midstream infrastructure,” he said. “Also, for the smaller firms, I think they would like to have their people, their time and their money working on drilling wells as opposed to building surface pipes.”

And all of this surging activity presents opportunity that private equity players seek, John England, vice chairman and oil and gas leader at Deloitte LLP in Houston, told Midstream Business.

“They like the overall macroeconomics around midstream. Upstream has grown dramatically over the last number of years and now midstream is really trying to catch up. There is significant need for midstream infrastructure,” he explained.

“The private equity folks see that as well. I think quite often they see the best opportunities either in making acquisitions in new basins that they can grow their presence in or in getting involved with construction of new facilities,” England added.

Need for speed

One thing that makes private equity an attractive option for companies that need capital is that the transactions typically allow a company to move faster on an opportunity, England said.

“The private equity firms often are willing to take some risk on those transactions,” he added. “It would be difficult to go to the public markets all the time for these—particularly when you’re in more of a startup mode—private equity is a very efficient means of accessing capital.”

In addition, he said, private equity also often brings with it some experience with the financial markets. Combining with management teams who know the operational side of the business means private equity firms are often able to find the long-term financing strategies.

Although there’s a lot of money in the space, there aren’t a lot of deals being done, England said. Rather, investors actively weigh options showing the most movement.

“I expect there to be activity there,” he said. “I expect deals to start getting done, but I’ve been expecting that for a while. I do think there’s a lot of private equity money looking to do deals in the midstream, and I think there’s a lot of need, so eventually, the parties will come together, and we’re going to see some deal flow in the latter half of 2014.”

England said that for many midstream players, there is so much organic growth occurring at good rates of return that traditional use of private capital is gradual.

“For the private equity folks, I do think they’re interested in doing deals, and I continue to believe the parties will meet at some point and deals will get done,” he added. “It’s just going a little slower than I expected.”

In the pipeline

At EnCap Flatrock, the partnership found such interest in the Fund III that it has committed to at least two more energy infrastructure funds.

Waldrip, an engineer by training, formed Flatrock Energy Advisors in 2000, and took on partner Dennis Jaggi in 2001. Billy Lemmons joined the firm as a partner in 2002. Prior to forming Flatrock, Waldrip, Jaggi and Lemmons had worked together at Dehli Pipeline Corp. Jaggi and Lemmons are also registered professional engineers.

“Since 2000, when Bill formed Flatrock Energy Advisors, we’ve been involved in the midstream advisory business, looking at potential investments by an MLP or by our client into the midstream space,” Dennis Jaggi, managing partner with EnCap Flatrock, told Midstream Business. We performed evaluation and due diligence work for them, and we created the economic models. It’s very similar to private equity. We evaluate opportunities and look at how we can create value for our investors and our management teams.”

During Flatrock’s beginnings, a lot of assets were changing hands through acquisitions, which generally occurs during a period of rising prices.

“That made it seem like every deal became a good deal, so it was a pretty fun time,” Jaggi said.

Then, in 2008, Waldrip, Jaggi and Lemmons partnered with EnCap Investments to manage EnCap’s midstream private equity funds and agreed to close their advisory practice. Out of the gate, the team’s first fund raised nearly $800 million. The second fund reached $1.75 billion.

What kick-started private equity in midstream, Waldrip said, was the development of shale plays and unconventional oil and gas. Industry veterans could see that new infrastructure would be critical to handling production from these new resource plays for decades to come.

“Looking at regions like Appalachia or West Texas or developments in North Dakota with the Bakken … the shale production was so different from what the legacy infrastructure could handle that people who were very tightly tied into the industry could see very early on that there would be a tremendous need for infrastructure going forward,” Waldrip explained.

Foreign markets

A rush of funds into the midstream can’t come too soon.

Wood Mackenzie estimated in a June report that by 2020, North American oil production growth will outpace that of the Middle East by four barrels to one. The research group said in June that North American gas production will double to 1,000 million tons of oil equivalent by 2030. In less than five years, North America will have overtaken the gas output of Russia and the Caspian Sea to become the world’s largest gas-producing region by 2030.

All of which will add up to North America becoming energy independent with energy exports exceeding imports, Wood Mackenzie predicted.

“The renaissance of North American gas and oil production is the critical supply-side trend affecting global energy markets in the long term,” wrote Paul McConnell, principal analyst of Wood Mackenzie’s global trends service. “Energy production has undergone an abrupt reversal, which will make the region a net exporter of energy before the 2020s and will redefine global energy markets as it provides a robust and stable energy supply. It will also facilitate the global rebalancing of energy demand toward Asia, providing increased supply in a period of long-term demand growth, as well as reshaping commodity trading patterns across the world.”

Equitable models

J. Denmon Sigler, a partner in the Houston law office of Winston & Strawn LLP, told Midstream Business that historically midstream companies have had a variety of vehicles with which to obtain capital, not the least of which is the MLP model.

“What we’ve seen now is a lot of private equity companies look for a relatively short-term return on their capital, and we’re seeing a real need for infrastructure, which means that in the current environment, it’s possible to obtain transportation agreements and supply agreements and other contracts to back up the investment, so it’s less speculative,” she explained. “You know that within a three-to-seven-year time horizon there’s the possibility of getting all of your capital back and your investments realized.”

In the current environment in which producers are desperate to get their products to market, there is plenty of opportunity for midstream private equity investment. However, Sigler added, “I think once the required infrastructure is in place, you’ll see this slow down.”

Bowden at Jeffries said private capital in the midstream is on the rise. Last year was a high watermark for MLPs in terms of capital raised, but the $75 billion in total investment still wasn’t enough.

“Even if this pace were to continue unabated through all cycles in the capital markets, and even if 100% of this capital was used to fund gathering and processing infrastructure, it would still fall short of our future estimated annual funding requirement of $80 billion to $90 billion,” Bowden said.

He said that the re-plumbing of North America will take years, if not decades.

“If you look at the total capital that’s being targeted toward unconventional shale development, and then you impute from that the total cost of the related infrastructure, it is enormous in size and decades long in tenor,” he said during a recent interview. “I believe private capital is going to become increasingly important in the midstream sector. And I don’t see that trend changing any time soon.”

Midstream in the main lane

By the middle of 2014, billions in private equity had been raised specifically to build out the infrastructure needed in the midstream sector.

In April, Energy Capital Partners raised $5 billion for power generation, gas pipelines and energy service. And two months later, First Reserve, a large global private equity and infrastructure investment firm focused on energy, closed its second energy infrastructure fund at $2.5 billion. The firm now has more than $4 billion dedicated to investing in energy infrastructure.

At Warburg, Hwang explained that midstream has caught the attention of private equity mostly based on several very successful deals, including the Targa Resources transaction.

Warburg is different among private equity firms, he said, because Warburg tends to do more early stage, startup growth investing, but deployment of large-scale capital could take up to a decade from the start of a venture through the ultimate exit.

“You’re writing small checks upfront to get the team started and the large checks for the development or acquisition that may not happen until years two, three, four and five,” he said. “So you need to have vision, a long-term perspective, be patient and grow and build for the long term.”


The hub of North America's gas liquids infrastructure is the Mont Belvieu complex east of Houston. Private equity has financed numerous recent expansions of the sprawling midstream asset. Source: Targa Resources

Quick moves

Hwang said that generally speaking, private equity firms approach midstream investing in two ways: They like to buy something cheap and sell it quickly, or they build a small system on the back of contracts and future potential growth, still seeking a quick exit.

“We think this is a unique opportunity with the Navitas team,” he said. “They know how to run and build largescale systems for the long term, and they’re paired with a private equity firm that has exactly that same long-term, growth-oriented, large-scale vision.”

Rowan added that with the right management team and a patient financial partner, private equity-backed groups can develop projects that have large, upfront capital needs but don’t produce immediate cash flow. Longer-term development projects that require a couple of years between conceptual design, engineering, construction—where there’s a clear need and a lot of capital that needs to be deployed over time—presents a unique opportunity for private equity to invest, he said.

“With Navitas, we’ve been focused on projects that are long-term and companybuilding,” Hwang said. “That’s the ideal situation for private equity-backed teams.”

Cliff Vrielink, a partner in the energy mergers and acquisitions and private equity practice in the Houston office of Sidley Austin LLP, told Midstream Business the backing of private equity is especially effective when a company is looking to be a first mover in a hot play. He explained that one client sought private equity for a deal in the Bakken before the play took off.

“They got in there early and said, ‘We think the oil and gas industry is going to do really well here, and we want to build out this gathering system and be a first mover,’” he said. “That’s not a story you can sell to the public markets very well because there is so much risk and so much is unknown about it.”

Upstream knowledge

A fund that has deep upstream knowledge can study a play and be confident the resources exist, even though the deal could initially cost significantly more than will be returned.

“But if we do it, then in three years, you can then take that entity with the cash flows and either sell it to an MLP, or take it public, and lo and behold, the public markets will pay more for that asset than our cost base,” Vrielink said. “So it’s a great opportunity for a fund, and an example of where the funds really are the right answer of how to develop it.”

Taking on a management team and creating a new company is a strategy that’s been around for a while now, Vrielink said, and consequently, the economics aren’t as lucrative. As a result, some funds are getting more aggressive and taking on more development risk, he said.

“Some are building out processing plants or building out different kinds of infrastructure projects that have just a little more risk, more uncertainty around it, they may not have as many contracts around it, and some of themare thinking, ‘If we take on more risk and can progress as far enough, it will pay off,’” he said.

The bottom line, Vrielink added, is that there remains significant need for infrastructure and plenty of energyfocused funds whose mandate is to invest in the sector.

“You will continue to see those that are particularly savvy and really understand the business continue to do well, and I’m sure there will be some that will just chase every deal and overpay, and will have to re-evaluate their strategy at some point,” he said.

In fact, there is so much money chasing the deals that Vrielink said it’s placed some funds in a scramble to find the right people to lead the projects.

“I almost wonder whether that is indicative that maybe there is a little too much capital chasing deals,” he said. “The fact that there’s somebody not from the space who thinks they can do deals and is trying to find people to execute the deals almost makes me feel like it’s becoming a little bit frothy on the funding side.”


It starts here, it goes there: A pumpjack frames the Delaware Basin's Ramsey plant. Source: Nuevo Midstream

Filling the gap

Waldrip said that as upstream activity continues to surge in the “Big Three” plays—the Marcellus/Utica, the Bakken and the Permian, and elsewhere like the Eagle Ford, the Midcontinent and the Niobrara—midstream spending will also be in an upswing.

“We think private equity will fill a good piece of that. Our analysis shows private equity might be filling as much as 20% of that investment need,” Waldrip said. “While it’s significant, it’s surely not dominating the dollars going into midstream infrastructure in those plays, but it would not surprise me to see private equity continue to grow and play an even bigger role in the business.”

In fact, for every $1 spent on the upstream side, there is a corresponding 15 cents to 30 cents that must be spent on midstream infrastructure, depending on the play and how much additional infrastructure is needed, Jaggi said.

“We talk about the upstream business domestically being a $160 billion per year space, and we think that entails $30 billion to $40 billion on the midstream side as far as annual domestic spend,” he said.

Groundwork in Canada

During 2013, the U.S. and Canada accounted for 75% of all midstream transactions, Deloitte said.

Driven largely by oil sands, the total Canadian crude oil production is expected to almost double between 2013 and 2030, according to projections by the Canadian Association of Petroleum Producers. About 1.7 MMbbl/d in additional crude oil supply is expected from western Canada alone by 2020.

The report also said that pipeline projects are being developed in Canada’s east, west and south sides to access new markets.

“The growing supply of crude oil from western Canada is filling the existing pipeline capacity and protracted timelines for regulatory approvals combined with other uncertainties have affected the evolution of the transportation network,” the report said. “Other forms of transport, such as railways, barges and tankers are quickly becoming additional means to distribute increasing volumes to markets throughout the U.S., eastern Canada and offshore.”

Jaggi said Canada presents a lot of opportunity to private equity investors.

“Right now, we’re intrigued by Canada,” he said. “The resource playsup there are very promising, and they’re very advantageous economically. We’re trying to get involved in Canada’s developing midstream sector.”

Winston Strawn law partner Sigler said energy reforms south of the U.S. border may also present opportunity for private equity in the midstream space.

“I anticipate that Mexico will be another hot area following the passage and implementation of energy reform laws in Mexico,” she said, adding that the reforms are expected to spark increasing development of upstream and refining resources.

Warburg, which already has a significant presence in Canada, where it’s one of the largest players in the nation’s E&P space, is also looking for opportunities to invest in Mexico, but mostly on the upstream side, Hwang said.

International opportunities

“As the U.S. has gotten more competitive, one of the real opportunities that we see is international,” he said.

“Energy has become a more popular area for private equity. If you look over the last 10, 15 years, it has been one of the few growth areas in the North American economy, and it has yielded good returns for investors. We believe in the fundamentals of investing in energy behind exceptional teams in the E&P side, midstream, power and services sectors, and we continue to find differentiated opportunities with the teams who share our vision, and that vision of long-term, fundamental, growth-oriented investing.”

What’s more, Hwang said there are several factors at work to drive private equity into international midstream.

“The increase in U.S. and Canadian crude production, the changing refinery dynamics, the Panama Canal opening up, Mexico reforms, new E&P plays and growth potential out of Latin America and Africa,” he said. “These will change the way crude and refined products are refined, stored and transported globally, and we believe all of that will create new opportunities for investment.”

Deon Daugherty can be reached at ddaugherty@hartenergy.com or 713-260-1065.

Fixed Is In Favor

Midstream players and other energy firms have stepped up to the new-issue market.

By Chris Sheehan, Senior Financial Analyst

Energy continues to find favor in fixed-income markets, where the recent low interest rate policies of the Federal Reserve—coupled with near-record low credit spreads—foreshadow what could be another very robust year of issuance by the oil and gas sector.

Despite earlier fears of rising rates as the Fed “tapers” its bond purchase program, the interest rate environment has remained attractive, with the 10-year U.S. Treasury note yielding around 2.5% early in the third quarter. This puts the 10-year rate in the lowest fifth percentile over the past 15 years, while credit spreads are at the lowest level since the financial crisis, according to Barclays data.

Issuers have not been slow to take advantage of the low interest rates. The new-issue market has seen a broad range of companies—including midstream players, major oil companies, independent E&P companies and others—step up to the plate. Notably, even ExxonMobil is reported to have placed a $5.5 billion issue, marking its return to the market after a 21-year hiatus.

Market participants noted exceptionally strong issuance in this year’s first quarter by the investment-grade oil and gas sector. Through March, issuance by North American and international companies came to $21 billion, with a further $15 billion placed by emerging market issuers. Across all economic sectors, new issuance was also unusually high, outweighing first-quarter redemptions by a ratio of more than 1.5-to-1, according to Barclays research.

But issuance by the oil and gas sector extends much more widely than just to investment-grade issuers. And in large part, this reflects investors’ growing understanding of individual basins in resource plays, as well as their comfort with the sector as a “safe haven with yield,” said Greg Hall, who heads up natural resources debt capital markets at Barclays.

Investors understand plays

“Investors are very bullish on the oil and gas industry at the moment. This is an industry where a lot of investors feel they understand what is going on in the Bakken, Eagle Ford and Marcellus, among others,” Hall told Midstream Business. “They view oil and gas as a safe place to invest. You’re talking about buying bonds backed by cash flows from hard assets in the ground, and that has an appeal to a lot of people.”

The fact that energy issuance offers investors a chance to buy nonfinancial paper—in relatively short supply compared to financial issuance—also works in the sector’s favor.

“There hasn’t been as much nonfinancial paper as investors would like to buy,” explained Hall. “As a result, investors will pay a slight premium. And that is one reason why we’re back to credit spreads that are close to pre-crisis tights. Investors feel like they can get their arms around oil and gas plays, and they have a high degree of confidence that the debt will be repaid.”

While interest rates were expected to trend upward as the Fed began its program of tapering, rates have been slow to move higher. Hall cited weather-related temporary weakness in the economy as well as a flight to safety due to geopolitical factors, notably in the Ukraine, as factors tending to hold rates down in the first part of the year.

In addition, Hall noted the “strong technical backdrop in the new issue market,” where a significant amount of bonds are due to mature in the first half of 2014 across the entire investment-grade market. “This means investors are receiving a lot of cash, and they are incented to quickly redeploy this capital in the new issue market.”

This partly explains why interest rates remained acquiescent in the first quarter—and why investment-grade issuance across all economic sectors hit a record level of $292 billion.

“Because you had so much debt maturing in the first quarter—a lot of it five-year paper issued post-crisis in the first quarter of 2009—you had an incredible technical backdrop of money flowing into the coffers of investors,” recalled Hall. “That, coupled with a weak economic backdrop and the concern over the Ukraine, added up to almost a perfect storm and continued to hold coupons down.”

However, low interest rates are not expected to last for long. Barclays anticipates an “upward drift” in rates as the tapering program approaches completion in October and predicts the Fed will likely begin tightening around the middle of 2015. Barclays’ rate forecast is for the yield on the 10-year U.S. Treasury note to rise to 3.4% by the end of 2014.

Who has turned to the debt markets to lock in low rates of late?

Midstream borrowers

In the first quarter, the midstream sector saw significant new supply, with about $10 billion in issuance, as MLPs met refinancing needs and planned for heavy capital expenditures on infrastructure projects. At $10 billion at the end of the first quarter, the midstream accounted for just under half of energy investment grade issuance.

Among the larger deals by MLPs were those by Enterprise Product Partners ($2 billion), Kinder Morgan Energy Partners ($1.5 billion) and EnLink Midstream Partners, which combined the assets of CrossTex Energy with substantially all the U.S. midstream assets of Devon Energy, placing a $1.2 billion inaugural investment-grade issue.

Hall described Enterprise and Kinder Morgan as “bellwether issuers” that perceived rates to be lower than anticipated and, with fixed income markets “wide open,” chose to come to market.

Also coming to market in the first quarter were several major international oil companies. Notable were issues by Total, Petrobras and Pemex.

With oil and gas investmentgrade issuance in the first quarter already running at twice prior-year levels, how will the balance of the year unfold?

Looking ahead

Hall allows for a possible slackening from the current “breakneck pace” resulting from issuers’ desire to act pre-emptively ahead of potentially rising rates and widening spreads.

“We expect issuance for the remainder of 2014 to be robust, as the debt market is likely to remain attractive. But, to some extent, we’ve probably seen some frontloading in terms of 2014 issuance.”

Hall identified two “wild cards” that could influence the course of events in coming months: potential merger and acquisition activity and, additionally, shareholder activism.

“We’ve certainly seen a pickup in M&A [mergers and acquisition] activity,” said Hall. “There’s a high expectation out there that there will be some consolidation—especially in the midstream—much of which would be financed with long-term debt.”

As for shareholder activism, the trend “continues to encourage companies in terms of shareholder-friendly activities, which include corporate decisions to return cash to shareholders, either through share repurchases or increased dividends.”

Chris Sheehan can be reached at csheehan@hartenergy.com or 303-800-4702.

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