Growth and exit exercise North Sea private equity minds
The UK and Norway upstream sectors have benefitted from a rush of private equity cash, but the key question is what next?
PE investment has boosted the coffers of more than a dozen firms active in UK and Norwegian waters over the past few years. The industry is now asking how the newcomers will add value and how they will exit.
On the first, those less convinced by the utility of PE investment on the Norwegian continental shelf (NCS) and UK continental shelf (UKCS) mutter darkly that the rationale is simply a bet on buying at a low oil price and selling high, and in the meantime sweating ageing assets. Defenders argue that, if PE had not provided the capital, it is unclear from where other sources of investment would have come.
One analyst describes trying to sell an upside story from manifestly ageing portfolios as "a bit of alchemy" and, before the recent oil price swoon, the value proposition of PE buyers in a sub-$50/bl environment selling their purchases in a $70/bl+ world as "unbelievable".
But, while some executives at PE-backed firms and at the PE companies themselves are prepared to admit privately that their peers include oil price speculating and asset sweating "bottom feeders", all offer assurances that their vehicle is not one of them and has significant growth potential through exploration, appraisal and development activities.
The success of AkerBP tempers some of this cynicism. The Oslo-listed joint venture between Norwegian services heavyweight Aker and the UK major has delivered growth from a portfolio of maturing assets, especially in the Alvheim area of the North Sea.
IPO is a “core” strategy for PE firms to exit their North Sea investments” - Aitken, Wood Mackenzie
"Clearly part of the PE rationale was to invest near the bottom of the oil price cycle and profit as this has recovered. But the involvement of some firms in exploration, appraisal and development activities, implies a willingness to continue investing even when prices had climbed substantially higher," says Dan Slater, oil and gas research director at London brokerage Arden. "Indeed, higher oil prices may end up justifying more investment, as long as PE firms can see a way of monetising returns on an acceptable timeframe.
"PE firms are looking to build oil companies where they can increase the value, and then sell and return cash to their underlying investors. A portfolio of older fields, into which a PE-backed firm has bought at lower oil prices and invested to prolong or even increase production plateau, should imply good returns on paper. But adding in upside potential from new discoveries and/or upcoming developments should open up any sale process to a wider group of buyers, beyond those that just want to pay for cash flows. It is reasonable to assume that this should increase returns overall, as long as new projects are chosen carefully and sufficiently progressed," Slater continues.
Another obvious value-add route for PE-backed firms is the M&A market, which was the initial genesis for several of them, snapping up portfolios shed by existing North Sea players either rationalising their portfolios or exiting the basin altogether.
Private capital has levered large production portfolios out of businesses where they were non-core and into leaner, dedicated organisations such as (the PE-backed) Chrysaor, Neptune Energy, Siccar Point Energy, Var Energi and the [non-PE-backed] Spirit Energy, said broker Stifel in a July note to customers. "We see these E&Ps investing more than their predecessor companies… [they] look set to have a real impact on the health of the UKCS and Norway over the longer term."
Point of departure: Norway may see its first IPO exit with Okea over the next 12 months
But, while the greater focus of the PE-backed firms compared to the majors, Japanese producers, European utilities and other sellers is a positive, the Stifel note remains concerned about the fragmentary nature of shareholdings, particularly on the UKCS. Consensus is that the discrete packages of assets firms have bought could be improved by further consolidation.
"The PE firms have been a strong source of new capital into the North Sea, in large part via the M&A market, and there's no reason to think this will not continue if they can find the right investments," says Slater. "Typically, I would expect this to continue being existing producing portfolios where they can realise upside, with any pre-production projects most likely acquired as part of wider transactions."
There is no shortage of potential targets, with Chevron looking to divest its UK Central North Sea portfolio and Total also touting a package of assets. UK chemicals firm Ineos, which has expanded rapidly into the upstream, has entered exclusive talks to buy US independent ConocoPhillips' North Sea assets. Analysts suggest that the reportedly high price Ineos was prepared for exclusivity reflects an expectation that it could face competition from other potential suitors, including PE-backed firms.
Consolidation among producers with PE investment is also possible. Zennor Petroleum CEO Martin Rowe says candidly that his firm could be a buyer of its peers, but also possibly an acquisition target for them.
“The PE firms have been a strong source of new capital into the North Sea, in large part via the M&A market” – Slater, Arden
PE investors and investees stress additional value beyond growth through the drill bit and the cheque book. Increased access to capital and greater scope to move quickly come through as strong themes in all the conversations across the following pages.
And there is a genuine sentiment that having PE as an informed, if demanding, investor, prepared to take a view across the lifecycle of its investment horizon is better than having to respond to the more short-term demands of the public markets. Relief about not having to manufacture a story to satisfy the quarterly results presentation cycle is palpable.
One source, speaking on condition of anonymity, was even more forthright, describing an AIM listing as "purgatory", where "one wrong move condemns you to a fate of always scrabbling around for £10mn here and £30mn there". The US E&P experience is much different, where PE is the default first option for management teams, not least because it offers the prospect of being financially more rewarding on a personal basis.
PE also offers the advantages of expertise, deep pockets and deep networks when it comes to recruiting, says the source. "We can go out and find the best explorationist out there and make him available as an extra pair of eyes." The calibre of board directors, both from the PE parent and independent directors, is also higher than an Aim-listed firm could attract, the source says.
When considering exits, it's worth remembering that PE investment in E&P firms in the North Sea and indeed globally is not a new phenomenon, and that the recent surge in investment is just the latest iteration of an observed trend. 3i, many of whose personnel are now involved with Blue Water Energy (BWE), invested in at least nine firms in the North Sea and Asia-Pacific region in the 2000s. Its exit strategies, split roughly 50:50 between industry sales and IPOs, may prove instructive as to how current PE investments may exit.
"I would have thought it is IPO or trade sale," says Slater. "The companies being built generally have a solid, cash generative production base, but often with new projects to provide a degree of upside. This could all be attractive to institutions, at the right price. Otherwise trade sales are always a possibility, and we would see the region as attractive to peers looking for a position in an established operating environment with good access to services and offtake demand."
While interviewees were keen to stress that industry buyers would likely re-emerge in time, as they have done throughout the North Sea's history, there is sentiment that IPO may be a more popular route for current PE investments to exit. This is not a universal truth, with the UK's BWE and Blackstone-backed Siccar Point, based on its relatively smaller size and higher growth potential, seen as a standout candidate for a strategic sale.
"IPO is a 'core' strategy for PE firms to exit their North Sea investments", says Grieg Aitken, director of M&A research at consultancy Wood Mackenzie. But he warns that flotation will be "very sensitive to the equity market and oil and gas prices".
"Historically some companies would get more involved in exploration and look to catch the eye of someone else to which to sell. There is more ambition this time to build companies of scale and put them onto public markets. If you do build a business of scale in this energy cycle, who would come to acquire you? There are not as many in the market for taking out a big scale player as there would have been a few years ago. IPO has to be the way," says Aitken.
Relief about not having to manufacture a story to satisfy the quarterly results presentation cycle is palpable
But there is a significant challenge, particularly for those looking for a London listing. Tullow is the only listed independent E&P player of any size on the London markets, whereas a slew of listings could add another $15-20bn of market capitalisation, which would completely change the market dynamics, said analysts.
The larger IPOs would likely break into the FTSE250, meaning they would need to be bought by investors in index products. But sentiment is that these generalist investors are not natural fans of E&P, with its exposure more to the oil price, which they do not necessarily well understand, than wider macro-economic trends, and may baulk at the index going from 2-3pc E&P exposure to 5-10pc. Thus, there may be a natural limit to how many of the PE-backed firms can go public.
The strongest value proposition should go first, and hopefully it will go well, says one analyst. But if there is a queue of firms ready to IPO and the best proposition is not well received by the market, then that would represent a problem. The analyst stresses that the oil price will make a huge difference, but also cautions that firms need to set realistic valuations and recognise the reality that at least some are companies with declining asset bases.
The potential limit to the capital appetite for multiple IPOs also poses a risk to orderly sequencing and initial success stories. Rather than waiting for the best prospect to go first and pave the way, some weaker candidates may be tempted to go early for fear of missing out entirely if capital reserves are exhausted by the early movers.
The Norwegian investment picture is different, with independents AkerBP and Lundin already listed and both with market capitalisations around the $15mn mark. Norway may see the first IPO, with Okea, backed by PE firm Seacrest Capital and Thai oil refiner Bangchak, announcing in September that it planned an Oslo listing within the next 12 months.
"Success, or lack of it" for Okea "could shape future investor sentiment for more E&P opportunities", says Neivan Boroujerdi, senior research analyst with Wood Mackenzie. AkerBP's successful listing, in the face of some initial scepticism, provides a potential blueprint for one of the more circuitous PE-backed journeys of recent years. Norwegian PE house HitecVision was an investor alongside 3i in Revus Energy and Noreco, which both IPO'd in the '00s, as well as in Spring Energy, which it sold to Tullow, only for the company's management to return it to the PE world as Pandion Energy, backed by Kerogen Capital. HitecVision launched Core Energy in 2010, Spike Exploration, which purchased assets from Bridge Energy, in 2012, and Pure E&P, which took over Rocksource, in 2014. In 2016, it merged the three firms into a single entity as Point Resources, and this year announced that it will merge Point with Eni's Norwegian assets to create Var, in which it will hold a c.30pc stake with the Italian major holding the remainder.
AkerBP's private/major hybrid provides a precedent that such an ownership structure can go public, although analysts caution that, in Norway, a firm looking to list needs a story for investors about its development pipeline. The need to have a vehicle into which to recycle profits to avoid punitive 78pc tax rates is a paramount structural issue and, while Point scooped assets from ExxonMobil prior its Eni tie-up, the feeling is that it still light on the development side and may need to add to the portfolio before any listing.
HitecVision also has UKCS interest through Verus Petroleum and another NCS firm called Cape Omega. While the latter's stated initial premise was an IOR/EOR in late-life assets focus, it has now expanded its mission statement to encompass development of proximate assets, reinforcing the impression that a solely asset sweating focus is deeply unfashionable.
One PE-backed firm where there is greater clarity on a potential exit route is Hurricane Energy, which is focused on UKCS fractured basement reservoirs and where its PE investor, Kerogen, came on board when it was already Aim-listed.
"To me, this seemed like a bit of a special situation, with Kerogen's funding-amongst others-giving Hurricane the ability to execute its 2016 drilling programme and drive the company forward," says Arden's Slater. "Without it, Hurricane could have struggled, and this was probably part of the reason the raise was done at the level it was, which may also have helped Kerogen get comfortable with the risk. In addition, Kerogen got two board seats, giving it significant influence—more in the manner of a standard PE investment. Holding the listed equity gives a defined exit route, particularly as the company has grown. It has been a very successful investment for Kerogen," he continues.
Hurricane has also struck a recent deal with another private North Sea operator Spirit, which is backed not by PE but by UK utility Centrica and German midstream firm Bayerngas. Spirit in September paid almost $400mn for a 50pc farm-in to Hurricane's Greater Warwick area, in a move that analysts say is further evidence of private firms striving for value through growth. Paying so much to Hurricane is risky, but it reflects an appetite for a growth story, says one. "If [Hurricane] works, and it is an if at this moment, it becomes attractive to pretty much anyone in the space."