As much as anxieties arise in the U.S. over whether there is sufficient government funding of Social Security programs, similar concerns are less apparent in Canada. One reason is the track record of the Canada Pension Plan Investment Board (CPPIB), which not only has C$328 billion in assets as of Sept. 30, 2017, but also projects sustainability of funding pension benefits for the next 75 years.
The CPPIB’s sole focus is investing the assets of the Canada Pension Plan (CPP), and its mandate is straightforward: “to invest the fund assets to maximize returns without undue risk of loss.” It operates at arm’s length from federal and provincial governments. It was established in 1997, four years after benefits paid out by the CPP started exceeding contributions and investment income.
The strong financial position of the CPPIB, coupled with its expertise in energy investments, offers unusual latitude for candidates seeking private-equity (PE) backing. While investments must meet tests of balancing risk and reward, the sheer size of fund assets means individual investments can be as large as $1 billion or more. Moreover, there is no prescribed upper limit to a portfolio of PE investments.
Investor took a closer look at the growing role of the CPPIB in making PE investments in the energy sector in Canada, the U.S. and international markets. Providing insights from Toronto and New York, respectively, were Avik Dey, managing director and head of natural resources at CPPIB, and Michael Hill, managing director, natural resources, who leads the U.S. and international activities. (The CPPIB has eight global offices serving markets in five continents.)
Prior to joining CPPIB, Dey was president and CEO of Remvest Energy Partners LLC in Houston. Previously, he was co-founder and CFO of Remora Energy. He has been active in the global energy sector since 1999 with roles across the industry, private equity and investment banking. Prior to joining CPPIB in 2016, Hill spent 25 years in investment banking, including, most recently, as head of M&A and corporate finance for Nomura Securities.
Investor You’ve recently provided equity commitments to a number of U.S. players in the energy sector, including two based in Colorado. What are the circumstances behind the increase in activity?
Dey The natural resources effort at CPPIB started in early 2015, when we formally created an independent investment group focused exclusively on the sector. Prior transactions consisted mainly of co-sponsorship transactions, partnering with general partners, mostly here in Canada. From early 2015, we’ve grown to 22 investment professionals. Our mandate allows us to invest with partners and to do sole-led transactions. We invest across a spectrum of upstream oil and gas, midstream, power and renewables, as well as metals and mining.
Investor How readily are you able to put capital to work?
Hill We’ve seen pretty dramatic growth in our program since its inception. We’ve seen the portfolio effectively grow from about C$1.4 billion to a total amount of capital that is deployed or committed of over C$6 billion. One thing you’ll note is that our strategy is in part focused on deploying larger amounts of capital in a smaller number of transactions.
Dey Yes, our minimum check size is $500 million of equity, and, more typically, we’re looking to deploy up to $1 billion per investment opportunity. In terms of expected returns, I would say it’s commensurate with what you would expect out of a typical private-equity program. We have the ability to evaluate the risk-return profile of each of the individual investments and understand how each fits in within the context of not just our portfolio in natural resources, but also within the larger overall fund.
Investor For some PE sponsors, there may be a fund duration set at, say, seven years. How are you different?
Hill We don’t operate in a conventional PE fund structure. A typical PE fund may have a seven-year maturity, at which point it would expire, and its limited partners would then expect the return of their capital. We operate inside the larger, C$328 billion capital pool. That’s one of the reasons why we don’t have the requirement to monetize within a specific timeframe. It gives us the flexibility to hold assets for a very long time, if that is what’s appropriate.
Dey I can’t emphasize enough the fact that we’re not underwriting specifically to a seven-year bullet exit. We have the opportunity to invest through the cycles and commonly do so. Holding an asset over the life cycle of that asset doesn’t scare us. One of our key comparative advantages is the ability to provide follow-on capital to our existing portfolio companies, since we’re a long-term investor and not beholden to duration limits.
Hill We really have an ability to continue supporting portfolio companies that we acquire. If we find the right opportunities, it’s consistent for us to put more capital into the companies to continue support of a drilling program or to make an acquisition. And we’re able to fund them at scale. In that regard, we are differentiated from a lot of the PE sponsors who talk about their ability to provide further funding, but sometimes find it becomes more complicated when operating within typical fund structures.
Investor What are examples of going beyond a typical seven-year fund structure?
Dey If you look at our investment in Wolf Midstream Inc. in Canada, we were able to work with Devon Energy (Corp.) and acquire its 50% interest in the Access Pipeline. We were able to enter into a 25-year offtake agreement with them based on our ability to offer long-term capital and because they were comfortable in dedicating their acreage to us for an initial 25-year term. That ability to commit long-term capital and a spirit of partnership lend especially well to the energy-infrastructure space.
Hill We really believe we can be the partner of choice in a lot of these longer-term situations.
Investor Is there a profile of an ideal investment?
Dey We’re not looking to chase deals; we’re looking to build a relationship. The guiding force behind our origination strategy is a spirit of partnership. We’re looking to establish long-term relationships with leading operating companies and management teams, recognizing we don’t need to do a deal today or tomorrow. But, if we build that trust and build those relationships, when interesting opportunities arise, we’ll be their first call. For us, active origination means building an active dialog with those leading companies. That’s really where we’re focused as an organization.
Investor Do you lean more toward oil than gas or unconventional vs. conventional?
Dey We do conventional; we do unconventional. We don’t look at it through a specific lens that says that we’ve got to go apply horizontal drilling at an increasing rate to be able to execute a very specific business plan and exit in a certain number of years. And we don’t have a strong view as to whether it should be oil or whether it should be gas.
Hill What we’re really focused on is identifying high-quality upstream assets that typically have attractive cost structures and, then, making sure we have very high-quality management teams or operating arrangements that allow us to effectively manage those assets and ultimately earn a return. We believe those high-quality assets with lower cost structures are more resilient to commodity cycles and provide us with more flexibility going forward.
Dey We have to underwrite an investment thesis that includes how we expect an investment to perform, and ultimately how we expect to realize an investment over time. What distinguishes our capital is that we have the flexibility to pursue a multi-pronged strategy—whether it’s to sell, to IPO or ultimately to harvest through maturity. And that in itself gives us a key comparative advantage as we look for opportunities to underwrite investments. When you’re going in the front door with the expectation that you could hold it through maturity, you take a different approach.
Our recent transaction to acquire the Corrib gas field is a good example. We’re acquiring a gas field offshore Ireland from (Royal Dutch) Shell (Plc). It’s a conventional reservoir, supplying a significant amount of gas to the domestic market. It illustrates our financial flexibility and ability to partner with industry players.
Hill The concept of partnership is very much engrained in our culture, and it extends not just to a financial partnership, but also to operating and strategic partnerships. In the Corrib transaction, we’re acquiring an operatorship stake, so we partnered with Vermillion Energy Inc., an existing participant who has a real knowledge of the field and the gas market.
Under the transaction, we’ll take most of the financial interest in Shell’s stake, and Vermillion will become the operator of the field. Our ability to come together with a really qualified operator was a distinguishing factor in our ability to secure the asset. Our ability to bring a bidding group together that included our substantial and flexible financial capital with Vermillion’s operating capability and its knowledge of the play made us a very competitive counterparty for Shell and the Irish government.
Investor Back in North America, your transactions include two in Colorado. Can you provide some color as to how they unfolded?
Dey Through an affiliate, CPPIB Credit Investments Inc., we’ve committed to deploy $596 million with LongPoint Minerals LLC over a two- to three-year period. Based in Denver, LongPoint Minerals is led by CEO George Solich and is focused on acquiring oil and gas mineral and royalty interests in three key basins: the Anadarko, Permian and Denver-Julesburg. (See the September issue of Oil and Gas Investor.)
When you have an opportunity to partner with George Solich, you take it. He’s created a tremendous amount of value for his investors over a long career. When he approached our organization to partner on a royalty structure, it was an opportunity that we were honored to be able to participate in. By owning royalty interests, we are able to participate in production revenues without the burden of associated capital or operating costs.
In addition, Crestone Peak Resources (LLC), a 95%-owned subsidiary of CPPIB, acquired 100% of the assets that were held by Encana Corp. in the Denver-Julesburg Basin. What we acquired was 51,000 net acres with production of over 20,000 barrels of oil equivalent per day. The transaction price, net to CPPIB, was $528 million. We have appointed a new CEO, Tony Buchanan, who is incredibly experienced in the basin, and he’s built out a great management and operating team.
This was a transaction that was completely in line with our strategy. It was an opportunity to acquire a high-quality asset that had been underinvested, since it wasn’t considered a core asset for Encana. The Crestone management has a high-quality operating team that has built a business over the years. After closing the acquisition, we have the opportunity to provide development capital and build the business over time.
What attracted us was that all the acreage was HBP at the time, and we were able to take a balanced view as to how to ultimately develop the assets. We look forward to building out Crestone in the region. There are significant opportunities to consolidate and optimize the basin, and we expect to be a significant player in that.
Investor That sounds like you see lots of consolidation opportunities ahead. Whether it’s in the D-J or another basin, you could be writing some very substantial checks, given the sheer size of the assets the CPPIB has under management. How big could those checks be, and what could they collectively total?
Dey We do not have a predetermined limit on an individual check size or on an aggregate portfolio.
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