As Private Equity Funds Shrink, Strategies Shift to Mirror Publics

DALLAS — While public E&Ps’ capital discipline is well known, private equity firms have transformed their strategy to meet the changes the oil and gas industry has faced in recent years—and those moves have some parallels with public E&Ps’ current financial prudence.

Speaking at the Oct. 2 Energy Capital Conference, Billy Quinn, managing partner of the Dallas private equity firm Pearl Energy, talked of selling assets when there is not a staggering profit to be made, but when “the market is good enough.”

Brooks Despot, a director at EnCap Investments LP, said his firm’s current practice is “building companies for the long-term” instead of flipping portfolio companies after just a few years of ownership—rewriting the script from the heady days of the shale boom.

Even though public E&Ps are flush with some of their most abundant free cash flows ever, investor demands have pushed them into an era of capital discipline. Private equity’s new discipline comes from the opposite source—they are on the side of the industry short on cash and experiencing difficulties raising capital.

“We find ourselves in this place where there is, relative to recent history, the lowest amount of available, callable or liquid private equity available in the space—generally less than $10 billion,” Frost Cochran, managing director and founding partner of Post Oak Energy Capital, said during the panel discussion. “The industry is smaller, and there are fewer management teams. There are fewer of us as private equity firms engaged in the space, there are fewer commercial banks. The whole industry has shrunk.”

The lack of capital has attracted new partners in the form of family offices, some from overseas.

“They tend to be a little bit more entrepreneurial and opportunistic,” Quinn said.

Frost added that family offices “are here now because they see there’s a window, but they’re entrepreneurial and when your valuations get high, we may not see them.”

Evan Smith, senior vice president of Stephens Inc., said people are wrong to think family offices are passive investors with “dumb money” that lack expertise.

“In reality, a lot of those family offices have hired people from private equity, and a lot of them look more and more like private equity firms, and the type of deals they’re doing,” he said.

In the smaller environment with less capital, private equity is maneuvering to benefit from what the larger companies are doing.

“Our companies that we are invested in are currently almost exclusively in full development mode. [It’s] a very different story than the public side because we’re not looking at distributions or stock buybacks—a complete recycling of cash flow,” Cochran said. “The drill bit is where we see the opportunity to gain some edge while some of the public companies are captive to their dividend and stock buyback strategy.”

Despot said public companies are shedding noncore assets that EnCap is “eager to evaluate and hopefully acquire.”

Panelists described their approach to energy as “commodity agnostic,” while Frost described natural gas as an “ESG asset.”