What LPs Want in Today’s Energy Funds

Even without the oil price correction, the shape of private equity energy fundraising has been shifting. Jeff Eaton of Eaton Partners explains what LPs are looking for in energy funds today, and why GPs differentiating themselves is important.

All of the recent buzz over swings in oil prices has overshadowed the state of capital raising for energy-focused private equity funds. But fundraising marches on amid a changed landscape with new potential opportunities, says Jeff Eaton, a partner in the Houston office of fund placement and advisory firm Eaton Partners.

Even before the drop in oil prices, the energy market was already changing as far as its relationship with private equity. Everyone in the PE world had assumed that it was relatively easy to raise an energy fund, Eaton says, and as a result, more and more people entered the market to do just that.

“It was becoming somewhat of a crowded market, with a lot of potential managers jumping into certain sectors like exploration and production in a big way,” he adds. “LPs had committed a lot of money to the space over the last few years and, even before the oil price correction, they had begun to slow down their pace of commitments.”

The drastic oil price sell-off has given investors a reason to slow down. Eaton points out that “investors are spending more time trying to determine how best to invest in the new environment,” and with those LPs giving pause, it leads to an environment where fundraising is more difficult. Eaton says that among the PE oil and gas players in Houston, some think that there could be a protracted environment of lower oil prices creating greater opportunities for investors.

“I do see smart LPs attracted to the space,” he says. “There’s an interest in trying to get in at attractive valuations. In the long run, it’s probably healthy and a good opportunity for investors to get into energy if they haven’t already gotten in.” Eaton adds that he’s seen success fundraising for specialized strategies in the energy space, including for deep water drilling in the Gulf of Mexico, oilfield services, and power suppliers. Certain debt-focused strategies are also getting attention.

While there are opportunities for both established and emerging investors in energy, there are challenges beyond just commodity prices that people should be aware of, Eaton says. One issue is that LPs have a lot of unfunded commitments, where the fund manager hasn’t invested nearly as much as some investors thought they would. “That puts a drag on the portfolio performance and gives the LP pause about making further commitments,” he explains. Part of the issue is that, as the size of the funds grew, GPs overall had more capital to invest. The other dynamic occurring is that some owners of energy assets have been reluctant to sell at lower prices, but with the recent moves in the overall equity and commodity markets, and the potential that the banks will start to put pressure on companies, that could change quickly.

Despite all of the perceived challenges, there are still energy funds in the market successfully raising capital, says Eaton, including those from a number of established firms, and debt-focused funds trying to raise money. The number of funds in the market is part of the reason that fundraising has become more difficult, and Eaton says that differentiation is more important than ever to successfully raise an energy fund.

“Performance is first and foremost on people’s minds,” he says. “There’s track record and strategy differentiation—[providing] something an LP doesn’t have exposure to. There’s size—we’ve seen a lot of interest in funds doing smaller deals. LPs see them as less competitive, and they feel they can make more impact on a smaller company.”

Other things, such as the longevity of the GP’s team, remain important. And Eaton points out that a GP assuming success just because they’re raising an energy-focused fund is no longer a reality. “You really have to compel an LP to believe that your strategy is truly unique.”