North America’s energy-focused private equity firms just saw a five-year low in fund closings and the lowest amount of total capital raised for energy investment since early 2016.
During the 2014-2016 period of low oil prices, many energy-focused funds raised billions of U.S. dollars, aiming to invest the money in energy assets at bargain prices.
But as oil prices increased from 2017 onwards, there have been few bargains left and asset valuations have increased. Add to this a mixed bag of investor returns over the past few years amid volatile prices, and energy-focused private equity funds had their worst quarterly performance in years in terms of capital raised and funds successfully closed.
In the first quarter of 2019, private equity firms in North America closed four funds with a total capital of just US$1.4 billion, compared to a dozen funds closed with as much as US$4.8 billion raised in the first quarter of 2018, according to data from alternative assets data provider Preqin, cited by Bloomberg.
Between 2014 and 2016, private equity firms—led by large companies including First Reserve, Warburg Pincus, and Riverstone Holdings—raised a total of US$132 billion in energy-focused funds, according to Preqin data. In 2018, contrary to initial expectations, private equity in natural resources investments jumped, Preqin said earlier this year. Fundraising by unlisted funds for investment in natural resources – oil and gas, timberland, farmland, water, and mining – set a fresh record in 2018. Energy-focused funds accounted for almost all of last year’s activity as 77 funds raised US$89 billion, with the vast majority of these funds targeting North American oil and gas plays, according to Preqin data from January.
Preqin’s investor outlook for alternative assets in H1 2019 found that “the natural resources industry has suffered from poor performance in recent years and investors are understandably disappointed with the returns they have received.”
However, high absolute returns are not the primary motivation for investors to commit capital to natural resources. The top reason for 66 percent of investors is portfolio diversification, while 39 percent cite a low correlation to other asset classes. High absolute returns were named by just 28 percent of investors in Preqin’s survey conducted in November 2018.
Due to the commodity markets volatility and the slump in oil prices at the end of 2018, many of surveyed investors feel that performance may dip even further in 2019. Nearly a quarter of investors, or 24 percent, believe that their natural resources investments will perform worse over the next 12 months, compared with just 6 percent of those surveyed at the end of 2017, Preqin’s outlook showed.
In terms of natural resources investment living up to expectations, 29 percent of investors felt at the end of 2018 that their investments fell short of expectations, up from 21 percent who were disappointed with returns at end-2017, but nowhere near the disappointed 62 percent of investors in 2015 and 54 percent in 2016, according to Preqin’s surveys between 2015 and 2018.
The biggest challenges to returns generation in natural resources going forward are asset valuations, cited by 45 percent of investors, followed by commodity market volatility and the geopolitical landscape, with each of those two getting 31 percent of investors’ votes.
For this year, energy will continue to dominate the investor commitments, with 86 percent of investors feeling that energy-focused funds will offer the most attractive opportunities.
According to Preqin, two-thirds of investors—or 67 percent—believe that the U.S. currently offers the best investment opportunities in natural resources, and is “likely a result of the continuing expansion of the oil & gas industry in the country due to technological advancement and more stable or even reduced drilling/extraction costs.”