Investors Who See ‘Froth’ in Market Go All In for Oil

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Cash is King for Shale Producers

Cash is King for Shale Producers

Joseph Gladbach and his fellow bankers at Jefferies Group field three to five calls a day from investors eager to park their millions in energy stocks or bonds in the worst down cycle in 30 years.

They’re no dummies, Gladbach says. One of the biggest mysteries of the oil market crash is why the money hasn’t dried up. The collapse in crude prices was supposed to devastate companies and spook investors after wiping more than $200 billion off the balance sheets of U.S. and Canadian producers. It didn’t.

As industry luminaries gather at the IHS CeraWeek Energy Conference in Houston this week to ponder the implications of $50-a-barrel crude, the money keeps piling into oil, with hedge funds, buyout firms and asset managers rushing to claim a spot at the table.

“There is just so much money,” said Gladbach, who noted that more than $100 billion has been raised and set aside for energy investments by the likes of Blackstone Group LP and Carlyle Group LP.

Many of the investors are newcomers to the industry, drawn by the hope of turning a quick profit on market fluctuations. Some are seeking a haven from inflated assets in other industries, or positioning themselves to take over distressed companies, according to interviews with more than a dozen investors and bankers that have helped energy companies raise money this year.

High Interest

The structure of many debt offerings has put new investors near the front of the line should any of the companies fail. These new investors may be able to take over assets that could increase significantly in value in a recovery. And in the meantime, the loan pays off on higher-than-average interest.

Private equity and hedge fund groups with long experience in energy see the downturn as an ideal time to buy in cheap to strong assets and management teams.

“It’s a natural place for investors to evaluate, where there has been a clear correction in a world where other assets are fairly to fully priced,” said Eric Scheyer, head of the energy group at hedge fund Magnetar Capital, who oversees a team that manages more than $4 billion.

EIG Global Energy Partners spent $3.6 billion on energy companies in a six-week shopping spree earlier this year, including a $1 billion deal with Breitburn Energy Partners LP in March.

“It’s been a very active period,” said Bill Sonneborn, president and chief executive officer of the Washington-based private equity firm. “They all relate to similar themes, which is the energy sector under fire.”

Preferred Equity

EIG stepped in to help Breitburn repay a loan after its bank tightened credit limits. As part of the arrangement, EIG bought $650 million in bonds that pay 9.25 percent interest and $350 million of preferred equity that gave EIG an 18 percent voting stake in the oil producer and a seat on the board.

By comparison, the $500 million of senior unsecured notes of larger producer EOG Resources Inc. that mature in 2025 pay 3.15 percent.

EIG hedged its bet by demanding convertible preferred equity instead of Breitburn’s common stock. The preferred equity acts more like a bond in that it pays 8 percent interest, gives EIG a minority interest in the company and puts EIG ahead of common shareholders if the company goes bust and needs to be liquidated. It also gives EIG the option to convert it into common equity later if the stock price recovers.

Being Selective

U.S. and Canadian explorers sold about $12 billion in stock in the first three months of the year, in the sector’s busiest quarter for equity sales in eight years, according to data from Credit Suisse Group AG. Whiting Petroleum Corp., Encana Corp. and Noble Energy Inc. raised about $1 billion each selling shares in February and March.

The flood of funding from capital markets may prolong the downturn by propping up distressed producers and allowing them to keep pumping, according to Bloomberg Intelligence.

Magnetar has invested in several of the energy equity offerings, but also has been selective about its deals, Scheyer said. Not all turn out well. Encana, which issued more than $1.1 billion in stock, saw shares fall 7.6 percent in the week after the March 4 offering, and they didn’t rise above the offer price for about a month. Emerald Oil Inc., which drills in North Dakota’s Bakken shale formation, has fallen 46 percent from its $1.12 additional offering price on Feb. 5.

Buyers of the $1 billion secondary Whiting Petroleum Corp. shares sold March 23 have fared better. The stock was up about 17 percent as of Friday from the $30 offering price, according to data compiled by Bloomberg.

Scheyer looks for companies with solid executives and growth potential that are responding to the downturn by cutting spending and cleaning up their balance sheets. Magnetar chose not to buy shares in several companies that were selling equity to plug short-term cash flow holes, he said.

Longterm Bets

About 10 percent of the demand for energy shares is coming from retail investors looking to flip stock through online brokers, according to the bankers and investors. That’s dwarfed by about 50 percent that are making a longer term bet on the only asset class in the U.S. offering bargains.

“Interest rates are so low, a lot of people are skeptical of froth in the broader market, and energy is one area that has seen a major correction,” said Tim Beranek, an energy portfolio manager who helps oversee about $11 billion for Denver-based Cambiar Investors LLC. “Everyone is trying to find a bottom in one of the only places where that’s possible.”

So far this year, energy is paying off. Shares of oil and natural gas producers, which fell almost 50 percent along with crude prices last year, have significantly outperformed the broader market in 2015, rising about 14 percent.

Nice Returns

That’s almost 10 times the return of the Standard & Poor’s 500 Index. New shares issued this year by North American producers have risen an average of 16 percent from their offering prices, according to data compiled by Bloomberg.

The amount of money pouring into the sector is among factors that has bolstered the valuations of producers. On average, the larger companies are trading as if oil was selling for about $74 a barrel rather than $50, according to an April 16 report by RBC Capital Markets.

“People are looking out a year to a year and a half and they’re seeing a recovery, and we’re starting to see that reflected in markets,” Scott Key, CEO of IHS Inc., said Monday in an interview at CeraWeek. “After the correction, this is a long-term growth play. We will be struggling for decades to come up with enough supply to keep up with demand.”

Even so, Blackstone Group is among a number of private equity firms that set out to pour money into energy, but has stayed on the sidelines as public markets filled the void so far this year.

Oil companies have been “able to go out and raise a lot of debt and, in some cases, equity, publicly at values that we wouldn’t touch,” President Tony James said in an April 16 conference call with reporters. “There’s still a lot of optimism oil prices are going to bounce back, and sellers are sort of biding their time in the hopes that they don’t have to face the music.”

Laredo Success

The interest level is unprecedented, Tim Perry, head of the Americas oil and gas investment banking practice at Credit Suisse, said at a recent conference. Take, for example, the shares sold March 2 by Laredo Petroleum Inc., a producer that specializes in drilling in the Permian Basin in West Texas.

The company initially sold $650 million in stock -- almost half its market capitalization -- in two hours without any advanced marketing, said Perry, whose firm worked for Laredo in the deal. Historically, an issuance of that magnitude would have been advertised to investors two to three days ahead of time, he said. Laredo has risen 32 percent in the six weeks since the offering.

“The markets are absolutely wide open,” Perry said. Investors who are buying may not be energy specialists, but they’re “very sophisticated,” he said. “Generalist investors do not have many good alternatives because everything is so expensive.”

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