PE Money Seeking Oil and Gas

 | Feb 18, 2014 | 4:00 PM EST
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Over the years, I have learned to pay close attention to the sectors where private equity is spending money.

When private equity money starts to move into a sector that has performed poorly, you can be quite confident that the end is in sight and these assets are going to be revalued higher over the next several years. When more than one firm shows up, it is reasonable to assume that a whole bunch of formerly smart people got stupid at the same time. They may be early and we could see some continue downward pressure for a period of time, but odds are very high that in the timeframe of private equity firms of 5-7 years, these assets and sectors will be selling at much higher prices.

Following private equity money helped lead me to the shipping sector in late 2012 when no one wanted to tough these stocks. To say that worked out well would be something of an understatement, so far. In 2013 the increased private equity attention to the mining industry led to another one and so far that investment is working pretty well. Now I am seeing renewed private equity interest in the oil and gas industry, particularly the North American sector that has seen asset prices decline in the face of a slow economy and glut of natural gas.

A recent survey of oil-and-gas-related PE fund executives found that almost half of them were currently looking to invest in North American oil and gas deals and 77% of them said they expected private equity interest in the space to accelerate this year. Last year, $27 billion in capital went to the 26 natural resources funds that closed in 2013. That's a lot of money coming into the sector and although I would not expect an immediate rally, it would seem clear that some smart people are expecting much higher asset prices in North American oil and gas assets.

The bigger names in private equity are getting involved now. TPG Partners just raised $1.25 billion for energy investments in its first energy-dedicated find. Kohlberg Kravis and Roberts (KKR) just opened an energy-related office in Canada and said it expects to invest between $500 million and several billion dollars in energy-related companies over the next five years. In 2012 Blackstone opened the $2.5 billion Blackstone Energy Partners fund to make controlling investments within the energy and natural resources sector. There is a lot of smart long-term money moving into the sector and long-term investors should take notice.

Private equity firms are not the only ones sharpening their pencils in the energy patch either. With the economy still relatively weak, the best way for energy-related firms to grown in the near term and better position themselves for the future sis to buy smaller oil and gas firms, especially those related to the shale fields. Last year a total of 182 deals worth $115.9 billion were announced. The pace accelerated as the year came to close and 51 deals with a total value of $54 billion were announced in the final three months of the year. About half of those were in shale-related companies.

I have no idea which companies the private equity of strategic buyers will target over the next several years. I do know that there buying will, over time, cause many oil and gas assets in North America to revalue at higher levels. I am also fairly confident that the economy will eventually recover fully in spite of the politicians' best efforts to prevent it and oil and gas demand will increase over time. Natural gas demand will increase over the next decade as we begin to recognize as the best path to energy independence and eventually we will also have a more robust natural gas export market.

Knowing that there will be increased buying interest in energy-related assets makes me feel pretty good about my energy holdings in the sector. Stocks like Swift Energy (SFY), WPX Energy (WPX) and Penn West Petroleum (PWE) still trade at large discounts from the book value of the assets. As conditions in oil and gas improve and private equity and strategic buyers mark up the value of oil and gas assets these stocks have the potential for spectacular 5-7-year returns.

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