PetroCap Raises Second Fund in Changed Market

One of the most notable things about PetroCap Partners’ second fundraise wasn’t that the targeted amount was double that of its first, but the environment in which the capital was raised.

The fundraising market was very different with PetroCap Partners II, which had its final close in January after hitting its hard cap at $350M. PetroCap’s first fund, Falcon E&P Opportunities Fund, LP, was in the market in 2009 to 2010, in the depths of the financial crisis and recession. “It was a much different fundraising environment,” PetroCap’s managing director Alec Neville says of that first fundraise, which closed at $163M in 2011. “Endowments and a whole segment of the LP base weren’t really investing.”

The latest fund from the Dallas-based firm will invest in onshore basins, with a target of $20M to $70M per project. The firm is looking to partner with operating teams to develop projects in the U.S. exploration and production market.

PetroCap Partners II is targeting between eight and 12 investments, each in the range of $30M to $50M. “There aren’t that many capital providers focusing on the smaller end of the market,” Neville says, adding that it’s overlooked. “But it’s the end of the market we’ve always been in—small E&P land.”

Fund II is a mirror image of Fund I as far as how the capital will be invested. And there are investment opportunities to be had in the smaller end of the E&P market that the firm plays in.

“The pipeline is probably fuller than it’s ever been,” Neville says. “It’s going to be pushing hard to get deals done.”

After oil prices dropped, some had the view that a V-shaped recovery would take place, which then permeated deal terms with sellers asking for prices that didn’t fit into PetroCap’s view. However, in the past month Neville says he’s gotten the sense that the view is changing, and it presents some opportunities as those with liquidity or balance sheet problems can sell non-core assets. “Sellers with debt issues will sell at today’s price; they don’t like the price, but it’s better than foreclosure,” he adds.

The average age of the investment committee at PetroCap means that they’ve previously been through cycles such as the current one. “It’s not our first rodeo,” Neville says. “We view it as an opportunity. We lived through the ’86 price collapse, and don’t think we’re living through another 1986.”

One element of the current PE market for energy gives Neville and his colleagues pause: the enormous amount of dry powder out there. There is more than $50B of PE dry powder, he says, and the amount needed for the entire North American energy industry for 2015 is estimated at $100B. “Our fear is it’s going to result in people bidding prices up to unrealistic levels. Some may just go chasing yields and deals.”

PetroCap does have some advantages in the energy market. They don’t compete with the multi-billion-dollar PE energy funds, and also invest differently. The firm invests directly in the projects they’re funding by owning a working interest, which is a very technical, operations-focused differentiator. The end result is that the structure of PetroCap’s deals is much simpler than “regular” private equity transactions in that the firm’s partners sign a joint operating agreement and a short side letter. “The people we want to partner with don’t have a law firm on retainer,” Neville says. “They’re great technical people, great operating people.”

While there is a lot of dry powder waiting to be invested in the energy market, Neville is confident that PetroCap will be able to find opportunities to use both the capital from its second fund, and expertise.

“There are going to be a lot of assets changing hands over the next months, which is a good thing for us,” he says.