That’s not to say conventional energy investments by private equity funds will die out. Fossil fuels will remain a vital cog in the world’s economy for decades to come. KKR & Co. in early June announced plans to build a shale-oil acquisition vehicle with the $5.7 billion combination of two little-known explorers. The combined entity will vacuum up over-leveraged and stranded shale oil assets, Bloomberg reported. And U.S. crude prices are doing better this year, with oil closing above $75 last week for the first time since 2018.
Adding to that, one energy-focused manager said it’s hard to put money to work to generate private equity-like returns in renewables, with some projects still lacking the scale an investor might be looking for. Go back about a decade and renewables proved a poor bet, with U.S. and European solar panel manufacturers in particular collapsing amid a flood of cheap Chinese imports. The high-profile failures left a stigma around renewables, another manager said, whereas others thought the projects were too costly or dependent on government subsidies.
Still, older renewable-focused energy funds have managed to outperform conventional energy, though the performance advantage looks to have reduced over time, according to data compiled by Preqin. For instance, the median net internal rate of return for conventional energy funds that started investing in 2010 was a loss of 5.6% since inception through March 2021, while renewable-focused funds from the same period gained 8%. For the 2018 vintage of these funds, the most recent meaningful data available, the median gains since inception were 13% and 8%, respectively.
“Renewable-focused funds closed early in the period between 2010 and 2018 were able to significantly outperform conventional energy-focused funds,” said Lowery. “This suggests that it may have become harder to deliver outperformance as the asset class has grown in both popularity and size, and returns appear to be converging.”
Private equity remains a significant investor in the energy sector, completing $261 billion of deals since 2017, around 20% of total transactions, according to data compiled by Bloomberg. U.S. renewable energy investments by private equity firms topped $23 billion in 2020, the largest annual amount to date, according to the American Investment Council.
Unlike a mutual fund owner, who typically holds a tiny percentage in hundreds of publicly listed stocks, a buyout fund can drive change through control over management and board appointees. That’s important because with capital usually locked up for a decade both managers and investors need to consider how regulation and environmental changes will crimp operating profits and impact the value of any asset over that time.
The fear of being stuck holding an unsellable asset is one reason some managers won’t touch anything that doesn’t meet ESG metrics. “One of the critical questions we have is who will buy this business in five years’ time,” said Philippe Poletti, head of the buyout team at private-equity firm Ardian. “If we don’t find strategic players who could be interested in buying it, we will not do a deal.”
That’s just one of the lessons learned from back-to-back oil busts. “Energy companies have lost a lot of money, they’ve been very poor stewards of capital,” said Wil VanLoh, founder and chief executive officer of Houston-based Quantum Energy Partners.
Quantum is raising a new fund that will dedicate as much as 30% of its investments to the energy transition and decarbonization, according to a person with knowledge of the matter.
VanLoh declined to comment on the firm’s fundraise but said that many investors have “soured” on the fossil fuel space not just out of concern for the future, but also because of its checkered past. “Quite frankly,” he said, “they left it.”
This article was provided by Bloomberg News.