Private Equity: Transition & ‘Tweeners’

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Arguably, energy has been in transition for thousands of years, said Justin Stolte, a partner in the Houston office of Latham & Watkins LLP and global chair of its energy and infrastructure group.

It’s the whiplash pace of change that newly challenges the energy industry and those who finance it, he said at Hart Energy’s Energy Transition Capital Conference.

There is little difference in the fundamentals of private equity investments regardless of whether profits are driven by pure economics or environmental aspirations.

Much of the energy transition-focused funds are managed by professionals who have built their careers around oil and gas investment. Hydrocarbons are legacy fuels, while many clean technologies have yet to mature.

NGP Energy Capital partner James Wallis said that, regardless of how individual private equity funds answer the public mandate, energy investments must be grounded in the reality.

“The world is also demanding clean, cheap, affordable, abundant energy,” he said. “But we have to keep the economy moving at the same time that we’re trying to transition the primary energy supply.”

“We’re taking a pretty pragmatic approach to the whole energy transition discussion.” —Joe Bob Edwards, White Deer

As such, NGP’s management maintains an “all of the above” investment strategy. Its large, traditional oil and gas portfolio remains active and profitable, but there is tremendous opportunity in the transition space, he said.

Longtime oil and gas private equity investor White Deer continues to invest across the upstream oil and gas, midstream and services sectors. In 12 years, the firm has raised $2.7 billion, said Joe Bob Edwards, managing partner.

“We’re taking a pretty pragmatic approach to the whole energy transition discussion,” he said.

White Deer is structured to manage the uncomfortable realities ahead in which demand remains in place for hydrocarbons. But society is confronted by the growing call for a rapid adoption of new forms of power production, renewable fuels and grid hardening.

“It’s really the intersection of both that we’re focused on,” he said, adding that the firm does not want to take on venture capital risk in the process.

Rather, he said, White Deer’s clientele may best be described as “tweener” companies: traditional energy supply chain participants with exposure to emerging energy transition trends.

“We had to dig pretty deep to kind of find that specific opportunity,” Edwards said.

“It’s the companies that have a really good base business that understand project delivery, hitting a budget, responding to customer demands for product quality and service, but also have exposure to increasing, positive energy transition trends.”

Diversified portfolio

EnCap Investments LP has a smorgasbord of offerings that include a 30-year-old upstream private equity business and a midstream unit that started about 12 years ago. A dedicated energy transition fund came to life two years ago.

And while this phase of the energy transition may be relatively new, EnCap’s Kellie Metcalf has been immersed in the renewables space for 20 years.

Much of the rhetoric around renewables questions its profitability without the assistance of government subsidies, but “it is a growing space,” said Metcalf, managing partner, energy transition.

“A bit counter to what [others] say, there are definitely investment opportunities that can make money. We have significant positive returns in the energy transition space.”

A different outcome could be most likely at a fund in which the investment professionals are focused on investing in transition exclusively, she said.

Faster than expected

GreenFront Energy Partners co-founders Robert Birdsey, Adam Hahn and Whit Wall were key players in BB&T’s energy i-banking group when a trend began to emerge in which end users began to openly prefer cleaner energy.

The trio formed GreenFront with a singular focus on alternative energy, including solar, wind, storage, renewable natural gas (RNG), carbon capture and clean technology. But their background in oil and gas gives them a broad perspective on resources.

“I certainly have a lot of appreciation for the coexistence that needs to take place,” Birdsey said.

User demand followed user preference, setting the scene for sociopolitical structures to evolve and adapt to accommodate the public, he said.

That gave rise to government intervention that would enable growth within the transition, including the U.S.’ 45Q renewable credits and, in California, low carbon fuel standard (LCFS) credits.

“A lot of investors are interested in traditional energy or oil and gas investors who are coming into the transition space.” —Kellie Metcalf, EnCap Investments LP

Success via subsidy is showing the possibilities of cleaner energy, and mature capital is going to flow in that direction, Birdsey said.

“We’re starting to see many new technologies become competitive very, very quickly. It has happened first with wind, most recently with solar, and it is happening now with battery storage.

“I think it will also happen with carbon capture and RNG. Once you take that into consideration, I would argue that the transition will probably take place more quickly than what has been seen in history.”

$4T/year—or more

EnCap’s transition fund reviewed 170 opportunities in 2021, and the returns are staying in place, Metcalf said. “There is a lot of money coming into the space.

“A lot of investors are interested in traditional energy or oil and gas investors who are coming into the transition space,” she said. “We’re at the beginning of a huge incline in the slope of what we’re going to look at in investment in transition.”

Projections are that $4 trillion a year globally will be spent on transition, but Metcalf suspects the real numbers could go higher.

“It’s critical that such investments are managed from a fund perspective by people who understand the business,” Metcalf said, agreeing with Birdsey that moving from oil and gas into solar, wind and battery storage would be a stretch.

But carbon capture and sequestration (CCS) has space for both types of investors. “We’re also doing CCS and renewable gasoline.

“Those are things that oil and gas professionals have experience with, and we’ll transition well to that,” she said. “It’s a competitive market, but I think there are still a lot of opportunities.”

‘Up in flames’

Billions of dollars went up in flames roughly 15 years ago as sudden demand emerged for clean tech investment, Edwards said. “Many of those were venture capital bets parading as growth equity investments.

“We’re trying to learn from the industry’s history of making those sorts of bad decisions and applying that through the lens of what we think we do best.”

White Deer’s portfolio includes some service companies that will benefit from that intersection, which currently joins rising activity levels in the North American market and increasing ESG pressures.

“There are some things in energy transition that don’t make a ton of sense for oil and gas professionals to start pursuing.” —Robert Birdsey, GreenFront Energy Partners

One portfolio firm is relying on its legacy technology to actually capture methane that would otherwise be vented or flared. The process keeps the methane greenhouse gases out of the atmosphere, and the company can commoditize methane’s Btu content.

“That’s one example of something that’s benefiting from both trends at the moment,” Edwards said.

Consider CCS & RNG

Given the entirety of the energy market landscape today, Birdsey said higher commodity prices are basically signaling that all of the capital withdrawn from traditional sectors will come home to roost.

“On the transition side, the world’s really just getting started,” he said. “There’s trillions of dollars that are needed to be invested over the next few decades. But it needs to be done very responsibly.”

While there are intersections to exploit, some parts of the energy transition would be a tight fit for oil and gas investors. “There are some things in energy transition that don’t make a ton of sense for oil and gas professionals to start pursuing,” Birdsey said.

“When I started in 2006, frankly, I admit we kind of scoffed at solar and wind. Now those are the two cheapest forms of energy production that we know of at scale.”

While that opportunity for traditional oil and gas professions has passed, there are other options, he added. “Carbon capture and RNG are ripe for oil and gas professionals.”

CCS relies on some work that oil and gas has been doing for years: geology, reservoir engineering and transport. Oilfield service and midstream companies are beginning to see that there is real money in CCS and how to further efficiencies to drive down costs.

“It just kind of plays to the strengths of oil and gas. I mean, there is the capture component of that value chain, which is kind of new.

“There are plenty of companies who have capture equipment and understand that technology like Koch Industries and Mitsubishi. But everything else is right up oil and gas’ alley,” he said.

CCS is still in its earliest stages, Birdsey added. “You can do two months of intensive study and get up to the top of the learning curve in carbon capture. But you’ll realize when you’re at the top of that learning curve, you’re still in just the first or second inning of what is a very embryonic industry.”