Kerogen investments go full-cycle
Kerogen's vehicles grow from their appraisal and development core focus
Appraisal and development are the key value areas for Zennor Petroleum and Pandion Energy—two producers owned by oil and gas-focused private equity (PE) firm Kerogen Capital—as well as the driving logic for the company to invest in AIM-listed Hurricane Energy. But now its investments are moving full-cycle, from exploration all the way through to production.
Kerogen's managing partner and co-founder Jason Cheng spoke recently to Petroleum Economist editor-in-chief Peter Ramsay.
PR: Should PE investment be seen in a positive light for the Norwegian continental shelf (NCS) and UK continental shelf (UKCS) investment?
JC: Perception of PE is sometimes skewed and there is a lack of understanding what it actually is. It does have a different model to the more traditional financing in the industry, but having that different model is valuable in the current market. It's bringing new investment and a value-orientated focus into the sector, which is overall a good thing for the UKCS and NCS.
PR: What has brought PE in general, and Kerogen specifically, back into North Sea E&P?
JC: Our focus is on growth. We are investing in new plays, new discoveries, adding value through the drill bit and taking projects up the development value chain to sanction and production.
Three key things attracted us to the UKCS in particular. The price of assets had fallen dramatically from where they were in the $100+/bl environment compared to a $60/bl world. On taxation, the UK government had reduced taxes to encourage investment in the sector. And cost deflation was the final factor—you can get more done for your dollar in the current environment. We are expecting that the lower prices in the services sector will come under some upward pressure, but thus far we are pleasantly surprised at what sort of rates are still available. Aside from cyclical cost deflation, the industry has been successful in achieving cost savings via structural changes in its operations during the downturn, and is now turning to further cost savings via the use of technology. We believe the potential cost savings will be significant, and digitalisation of our assets is one of the key initiatives here at Kerogen.
PR: What are the advantages for Kerogen in having three separate vehicles in the basin, rather than a single investment with a wider focus?
JC: They are three very different investments with three different areas of focus and expertise. Each has a different history behind it and a specific logic. Hurricane is a specialist in the fractured basement sector and it does not really compete or overlap with the other two. Zennor and Pandion are more similar in their buy and build strategies, and both have grown from a focus on appraisal and development to now full-cycle firms from exploration all the way through to production. However, they operate in different geographies, and there is variation in doing business in the UK and Norway in terms of licensing regimes and infrastructure and each team has a different history and way of doing business. Our job is to provide the investment and support to allow three management teams to each deliver value.
PR: For Zennor and Pandion, what are the major ways to add value?
JC: At the core of both companies' value creation strategy is appraisal drilling and development. We aim to add resources and reserves through the drill bit. On development, it is about execution and bringing projects to sanction. We want to add to the portfolio, and M&A is a part of that, but also licensing rounds and farm-ins. Both have been involved in M&A previously, mainly bolt-on acquisitions close to their core hubs. Once you have anchor assets, you unlock a lot of synergies by building around your hubs.
PR: Does the fact that Pandion's management are returning to a PE-owned world of which they have previous experience offer some advantages?
JC: I think it does, not just specifically to Pandion, Norway generally is more familiar with the PE model. The reference point for those not previously involved in a PE investment can be different, so that familiarity does help. Having an investor that is actively involved in the strategy and the deployment of capital is different to passive investors. The direct involvement of the shareholder in a private company changes the speed at which you can do things, at which you can adapt the strategy and at which you can make decisions. Having a management team at Pandion that has been in that environment before reduces the risk of lack of clarity in the relationship between management and investor.
PR: The Hurricane investment is slightly different to most other North Sea PR deals in that you invested post IPO. Does that make any significant impact on approach compared to Zennor/Pandion?
JC: The structure and governance are obviously very different between a public and a private firm. But, at its essence, we as a business are focused on partnering with firms with a great management team and great assets. The approach is the same for any company, private-held or listed—how can we support the management and unlock the value in the assets? If the right components are in place, as a value-oriented investor we can make a deal work, regardless of structure. Hurricane was basically right in our sweet spot of appraisal and development, so we felt very comfortable making the investment.
PR: What are the options and timescales for exit for PE generally and Kerogen in particular?
JC: A PE fund typically has a 10-year life cycle, although that could stretch for an additional one or two years. That is pretty much true for most PE funds. That timeframe allows you to invest through a full business cycle and offers a long-term perspective and stability. But you really look to create value in a three to five-year timeframe, although some things can always be shorter and some slightly longer. You have wells to drill, projects to sanction and projects to take to first oil, and it's going to take that three to five-year period to get those things done.
In terms of exit, you really have to look at how the M&A cycle is developing at any point, but that 10-year lifetime of the investment does give you some flexibility to manage the cycle risk.
The portfolios for Zennor and Pandion are both focused on building a material asset base at the lower end of the cost curve/ low breakeven costs, with young assets that have a lot of growth, upside and limited near-term decommissioning exposures. We are confident therefore that at exit we should have an attractive asset base which should appeal to various types of buyers, be they financial investors or strategic investors, or someone looking for a boost in growth for their portfolio. Obviously, M&A is not the only exit option, we evaluate all potential monetisation routes and our evaluation will be subject to market conditions.
PR: Does Energean's IPO offer any indication that this is likely preferred exit from Zennor/Pandion?
JC: We have no a priori view, it is very much asset specific. At Energean, there was an attractive business and the IPO success really speaks to the quality of the business and team. Even in a challenging market that has seen few successful IPOs, if you have a great business, then you can make it work. Energean's IPO was a successful example, being the largest IPO on the LSE in the oil and gas E&P sector since 1H 201