Staying Calm Amid Oil Price Volatility

Consumers viewed the plunging oil prices of recent weeks as good news, cheered by the prospect of paying less to fill their vehicle’s gas tank. However, some private equity investors in the oil and gas sector reacted with a different emotion: panic.

Jeff Eaton, a partner at placement agent Eaton Partners did not panic, and is urging other investors, both GPs and LPs not to. He remains bullish on fundraising, despite the volatility of commodity prices.

“Allocations to the asset class have been increasing for several years,” he says. “I don’t see that trend changing. More experienced energy-investing LPs have increased their allocations to the space, while other LPs are just establishing allocations. The LPs are playing catch-up and need to put a substantial amount of capital to work.”

The panic about oil prices began in September and October when the price-per-barrel of the Louisiana Light Sweet blend of oil fell below the price of Brent crude oil—used as a global benchmark—by an increasingly wider margin. Because of the uptick in oil production in the U.S., there is a glut of oil flowing into Gulf Coast refineries, driving prices down.

“It’s the most profound move down in prices for several years,” Eaton says. “Obviously, energy is a cyclical business. Investors learn to embrace the cycle. You have to be in it for the long run.”

Eaton Partners closed three energy funds in 2014 on behalf of GP clients, with a fourth on track to close later in the year. Despite the strong energy fundraising market, Eaton says that “it’s still not easy” and that the majority who try to raise money in the sector fail.

Although recent volatility “has likely given some investors pause,” with the possibility of fundraising slowing down a bit, Eaton also says that the situation creates opportunities. Private equity investors shouldn’t be scared by the price volatility because the amount of capital needed to sustain current levels of investment, on top of additional growth, is “significant,” he says. “If the public capital markets or large integrated oil companies pull back as a result of the volatility, that just increases the need for private investment.”

“A number of GPs have also done a good job exiting in the last couple of months, and a lot of this money has already been distributed,” Eaton says. “Distributions lead to LPs having capital to reinvest back into the sector.”

Other side effects of oil’s price volatility include a change in the exit environment for upstream investments, he says. His firm and others are looking intently at the rest of the year to see if exits in the sector actually happen. If the volatility continues, the pricing of some deals could carry into 2015, and there also might be an impact on the timing of some general partners’ fundraising, including potentially delaying the launch of a fund by a quarter or two.

Is energy fundraising for the remainder of 2014 doubt? Eaton says no.

“People were getting nervous, and the current price volatility happened pretty quickly, but prices have largely stabilized in a range at which activity levels should remain high,” he says. “A lot of people feel like, if anything, there was a correction” and companies are still profitable. One impact could be that firms decide to delay exiting portfolio companies. As buyers look to pay a lower price amid the fear and volatility in the market, the sellers may think they should wait.

“I don’t think it derailed anything,” Eaton says of the situation. “I wouldn’t say LPs are sitting here looking at next year, saying ‘We’re doomed.’ I just think it might delay things a little bit.”

The volatility may also have an upside: raising the potential for mergers and acquisitions of distressed or stressed companies, or entering the sector at lower valuations. “It whets the appetite for people who have cash on the sidelines to put to work,” he says.