With the leveraged buyout business all but shut down for the past three years, Kohlberg Kravis Roberts is looking to the oil and gas industry for its next big score. The buyout firm, whose shares will begin trading on the New York Stock Exchange (NYX) on July 15, is targeting the ocean of natural gas that lies under parts of Appalachia and Texas in formations of shale rock. KKR is expanding its presence in shale, launching a new business with two industry veterans: David Rockecharlie, who is co-head of the energy group at Jefferies & Co., and Claire Farley, an adviser to Jefferies. The firm is also raising a $1 billion fund dedicated to making oil and gas investments.
Gas trapped between rocks and coal beds will account for 64 percent of total U.S. gas production by 2020, up from 42 percent in 2007, according to analysts. The exploration companies that own most of the nation's shale prospects don't have the estimated $500 billion they'll need to develop them.
"The promise of shale and what it means to domestic oil and gas production is significant, but the cost to get there is very significant too," says Marc S. Lipschultz, global head of KKR's energy and infrastructure business. "That is going to present opportunities for firms that have the right level of expertise and commitment." KKR began focusing on the exploration business in 2008, when natural gas prices soared. "During the energy bubble, we started questioning where the world was going and how we could participate when pricing got rational again," Lipschultz says.
When prices came down amid the global economic slump, KKR went to work. Last year it paid about $350 million for a minority stake of East Resources, earning a quick profit of more than $1 billion when Royal Dutch Shell (RDSA) bought most of the company's assets 11 months later. In June, KKR signed a deal with Hilcorp Energy, a closely held exploration and production company based in Houston, to develop the Eagle Ford formation southeast of San Antonio.
"We're going to see a lot more private equity flow into this space," says Ralph Eads, chairman of energy investment banking at Jefferies. "There's huge demand for capital, and that capital's not all going to come from the public capital markets." (JEF) KKR already has competition from big oil companies. Buyers have struck 11 U.S. shale gas deals worth $17.9 billion this year.
Environmentalists have raised concerns about the impact of drilling for shale gas. And KKR's move into the field is an unconventional bet for a private equity firm that traditionally targets mature businesses with steady cash flows to use to finance takeovers. "Only time will tell whether these deals are good values," says Ellen K. Hannan, an analyst at brokerage Weeden & Co. "It is impossible to know until the fields are developed and the price of natural gas rises. If it doesn't, the companies better drill a lot of wells."
The bottom line: Shale gas companies represent a departure from the typical buyout model. Payoffs will depend on the direction of gas prices.