Although growing up in Dallas, Ken Hersh knew little about the energy business. He enrolled in political science at Princeton University. But he took a job at Morgan Stanley post-graduation before enrolling in Stanford University—where he chose to get an MBA.
While at Stanford, he won a summer internship with McKinsey & Co. in its Dallas office, using the comp airfare from San Francisco to also visit with the late Fort Worth-based Richard Rainwater, the investor for the Bass family who by 1986 had formed his own firm.
Rainwater didn’t have a summer job for Hersh but hired him for freelance work. The job was to analyze potential natural gas investment opportunities in response to a new McKinsey report. The report had concluded that prices were about to skyrocket.
Hersh joined Rainwater’s office in early 1989 while still a student, as part of the newly formed oil and gas private equity firm Natural Gas Partners (NGP) with David Albin, John Foster and Gamble Baldwin.
Early on, NGP created an investment methodology that has become the standard way capital is allocated to the sector.
“I was 25 years old,” Hersh said. Today, NGP is older than Hersh was when the firm was established. “We built something from scratch into a firm that has invested tens of billions of dollars.”
In a planned succession, Hersh handed leadership to another generation of NGP team members in 2016 and began a new chapter: CEO of the George W. Bush Presidential Center.
His memoir, “The Fastest Tortoise: Winning in Industries I Knew Nothing About,” will be published March 28. The Oil and Gas Investor team had a page-turning preview in January, poring over thrilling tales of investments that turned out well—and a couple that didn’t—as NGP grew into one of the largest and most successful energy private equity firms.
Among deals that went well was the restructuring of the late T. Boone Pickens’ Mesa Inc., resulting a year later in Mesa’s merger with longtime Permian Basin wildcatter Parker & Parsley Petroleum Co.
The new leadership: Scott Sheffield. The new company: today’s $52 billion market cap Pioneer Natural Resources Co.
NGP was also there for the early days of Energy Transfer LP. Founders Ray Davis and Kelcy Warren were looking to buy a South Texas midstream gas asset. NGP invested $37 million in 2002. In 2008, upon distributing the last of the equity to NGP’s investors, the return totaled $1.3 billion.
It was extra helpful to compensate for an investment that went bust in the midst of the late 1990s’ financial crisis. While doing the deal, a green light had turned yellow, but NGP moved forward, stepping outside its typical investment parameters.
The lesson: yellow lights don’t turn green.
Nissa Darbonne: Your first experience in the oil and gas business was at Morgan Stanley. You were put on the team that was trying to help Texaco Inc. figure out how to pay $12 billion to Pennzoil Co. for getting in the middle of the Pennzoil-Getty Oil deal. Did that result in a distaste for stepping into other companies’ deals?
Ken Hersh: I never wanted to operate in the gray areas. Richard Rainwater used to always say, “Don’t go near the foul line.” For example, we didn’t ever want to drill near Yellowstone. We wanted our companies to operate in places where they were welcomed. There was enough to do in the fairways with people who were quality people we trusted. You just didn’t need to go that far afield. We had plenty to do down the middle.
ND: There was a time at NGP when action could have been brought against a bank but you chose not to. Is it best to avoid being litigious?
KH: I’m not going to say we were just going to be a pushover. You’re referring to our Sunoma Energy Corp. transaction in 1998. In that case, we had to make a decision as to whether we should attempt to work out a restructuring or go to war with the bank that chose not to fund under the agreement we each had signed. At the time, the banker was very honest and said, “You can go that [court] route, but it will drag on for years, and I will [need to] disengage.” We discussed our options. In that case, the whole economy was in a really bad place. And our industry was worse. Oil had gone from $20 to $9. Long-Term Capital Management had threatened a global financial crisis. Russia was defaulting on its debt. There was real fear of contagion. Banks had to hoard their liquidity. So they made a decision not to fund.
Had we been consumed by that deal, we may not have done the half-dozen other great deals at that same time. So the key thing was not losing our confidence in our business plan. We clearly learned some valuable lessons. But the same [external forces] that were causing that company to get hurt were creating great opportunities [for us] elsewhere. We had a whole fund and teams were buying assets and planning for the upturn. By not being consumed [by that one deal], we were able to play offense elsewhere.
ND: In another deal, the numbers were simply untruthful. What did you take away from that?
KH: I don’t want to use “untruthful.” I’m not saying that they were fraudulent. Auditors audit the information that they’re handed. Behind that, in the files, there are many assumptions. As we know, assumptions can be wildly optimistic. So our lesson from that was to be leery of what you read in public financials. Always do your due diligence.
ND: That McKinsey report which formed the basis for NGP’s founding … How much confidence did you have after that in prognostications by those who don’t have skin in the game?
KH: The report definitively predicted a sharp rise in natural gas prices. That was our thesis: We were going to buy [gas] low and sell high. That turned out to be essentially wrong. Prices went down for about seven straight years. The lesson there was that reality sometimes gets in the way of great theory.
ND: What have you found to be the best use of investment banking firms?
KH: Bankers were bringing us information that they gleaned from annual reports and quarterly reports that were 90 days or six months or a year old. I said, “Wait a minute. I’m going to these meetings and depositing more information than I’m getting.” I concluded that we should not be relying on the Street for primary information when we have so many portfolio companies spread across the industry.
What the Street is good at is how capital markets distill the information. How are M&A markets functioning? So, we said we should use the banking community as corporate finance and M&A advisors but not as deal sources. Our best deal sourcing is ourselves. We built our firm around getting out to oil towns. There’s Houston and Dallas. But there’s Tulsa and Oklahoma City, and Midland and Shreveport. We fanned out as a team. We kind of got ahead of the curve that way.
ND: NGP Global Adaptation Partners. You pitched the climate-response fund in 2010 and it failed to launch. Too soon?
KH: Today it would be in vogue. Being in the energy business, I knew all the numbers. The world’s population was going from 7 billion to 9 billion. Two billion more people were going to want to enjoy middle-class consumption. It didn’t matter whether you believed the climate models. The planet was changing.
But mankind has adapted to changing climates long before there were fossil fuels. We need to look forward and say, “If the planet’s changing, why are we spending all of our time and money focused on preventing change that’s going to be inevitable? We’re not going to get to the year 2100 if we don’t focus on getting to 2030.” So the way to get to 2030 is to protect our populations. When you have countries that no longer can support agriculture, populations move and the machetes come out. That is not a good condition. Looking at the numbers [in the aughts], I said, “This is inevitable.”
ND: Your position is that we needed to adapt.
KH: If you’re in the oil business, you’re looking at geology that says this area and that area were underwater for millions and millions of years. And now they’re not. These mountains are this many years old. They weren’t there before.
My point is, we had an ice age before we were burning fossil fuels, and the ice age went away. The planet warmed without any CO2 from man. The narrative needed—and still needs—to change to adaptation. I liken it to saying, “If we’re all on a boat that is taking on water, would the people on the boat vote to repair the boat or start a 50-year research project on new boating materials that don’t leak?” The world is doing the latter when we need to do both.
The world has spent more than $2 trillion in the last 15 years on renewable energies. And fossil fuels have gone from 82% of global energy demand to 84%. Emissions have gone up and the Paris Accord allowed emissions to increase.
ND: Tell us more about that.
KH: We’ve spent the last 20 years trying to get 196 countries to agree on a plan that we heralded in 2015 in Paris as “We did it.” No, we didn’t. We came up with an outline and everybody was to submit their goals and not a single country has met its goal. In fact, the Paris Accord allowed China to increase its emissions from 10 billion tons of CO2 to 15 billion. Well, that incremental 5 billion tons is the equivalent of 100% of [the] United States. We’ve taken our emissions from about 9 billion down to 5 [billion] because of the shale-gas revolution.
Well, if the Paris Accord was rewritten and it said, “We’re going to allow the introduction of an entire United States to the world’s CO2,” people would’ve gone bananas. But that’s effectively what they did. So the Paris Accord was a nice thing to have, but getting 196 countries together is meaningless. The top five emitters emit 70% of the world’s CO2; we don’t need 196 countries. We could have just had a G2 [Group of Two] or G3. Instead, the world went ahead and spent $2 trillion and has almost nothing to show. As a planet, we’re not doing a great job. We need to be spending more money and time focusing on adaptation.
ND: So the fund never came to fruition.
KH: The adaptation crowd back in the day was lumped with the climate deniers; they were pushed aside. I tried to be ahead. I was getting feedback from the market. But when it was time for people to commit, they basically said, “We’re not ready.”
And, you know, one of my expressions is “feed the ducks while they’re quacking.” So I moved on. I can only lay out the investment thesis and ask people to be forward thinking. But when push comes to shove, if it doesn’t look like it’s going to generate a return the next two or three years, they don’t want to talk about it.
So I just chalked that up to “lessons learned.”
ND: Do you agree with Greta Thunberg?
KH: I wouldn’t comment on her specifically. I would just say that I am not a denier. The planet is changing. The planet has always changed. If you believe in the models, the one thing we don’t have is time.
ND: What’s next?
KH: We need to be working on leapfrog technologies. I love the fact that we’re working on fusion.
Natural gas should be a massive bridge, and let’s get rid of coal and replace it with gas. That’ll buy us two decades or more.
Nuclear power…France is sitting pretty with a strong nuclear grid and low emissions. There can be a safe nuclear power industry in this world. But we’ve decided nuclear is dirty. I think nuclear power is a big winner of this realization that the energy transition is not going to be easy or quick. You see Japan is going back to nuclear power.
Unfortunately, the world needs to see the building burning. I was talking fire prevention in 2010.
ND: NGP did still create the nonprofit Global Adaptation Institute.
KH: We did. We ran it independently for a handful of years. We’ve merged it into the Environmental Change Initiative at the University of Notre Dame. They’re doing good work on promoting adaptation.
So it’s found a home. And hopefully there’s some intellectual contribution the institute plays.
ND: Hydrogen wasn’t on your short list.
KH: I will leave that one alone.
ND: It isn’t among your personal investments?
ND: Would there be any place outside the U.S. that you do feel comfortable with investing in oil and gas? Would you do British shale?
KH: No, I wouldn’t. You’re just at the whim of whatever political power lets you live. The cycle times in the business have gotten shorter with shales, but the project times aren’t any shorter. The well will last a decade. So that’s a 12-year time interval, at least.
If you’re in an area that’s not developed, especially if it’s gas, you have to have oilfield services, gathering systems and processing ready. You have to have the downstream ready as well. And all of this before you drill your first well.
You’ve done a decade of front-end work. Then that drilling rig stands up and the neighbors say, “What the hell’s this?”
ND: Sounds like Colorado.
KH: That’s true everywhere. In Colorado, in parts of Wyoming, in parts of the Northeast. I mean, New York state doesn’t have a fracking industry; Pennsylvania does. New York chooses to import natural gas. It doesn’t mean they don’t have any natural gas there. They have plenty of gas in the ground.
It’s very frustrating, but it’s just a reality of our industry. So to go someplace where you could be switched off on a dime [by the government] is really problematic. The business is hard enough. Colorado has been a place that might switch on and off over a decade. Parts of Colorado have become inhospitable that used to be hospitable. That’s hard enough.
As we built NGP, we just said, “Let’s go where we’re wanted.”
ND: What else?
KH: I’m not a geologist. I’m not a geophysicist. I’m not a petroleum engineer. What I really loved about the energy industry is that I was able to make an impact in a business I knew nothing about by just diving in, meeting people and listening.
You don’t have to be a geologist or geophysicist to have a good conversation about energy. For a generalist, I did okay.
Repotting the plant
Nissa Darbonne: You write about “repotting the plant” in business and in one’s personal life. You and your family moved to London in 2008, while NGP was building its network of potential investors overseas. You didn’t get a car; you walked and used public transit and cabs. Tell us about repotting the plant.
Ken Hersh: One of my adages is “be uncomfortable.” I thought it would be a great experience to take my family out of our Dallas comfort zone and repot ourselves in another country. Professionally, it was like starting over with meeting new people and learning new ideas.
My family really was brought together by experiencing city living.
ND: Retiring to lead the Bush Presidential Center is another example.
KH: Moving from the NGP world to the Bush Center, I was now running a nonprofit. I didn’t have big bonuses or equity points to give out. It’s a completely different incentive structure. Figuring out how to motivate people in that environment has been very exciting.
ND: How’s it going?
KH: I feel 20 years younger when I go to the office at the Bush Center. There’s a cadre of young, motivated, mission-driven people who want to change the world. I could start a company with this group and be wildly successful.
But they wouldn’t come. “Why would I make a widget? I want to change the world.”
And I get to help them!
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