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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Private Equity Senses Market Bottom, Pouring Money Into Texas Shale

Texas Oil Patch

In a sign of just how competitive the rebounding energy market could become, private equity firms are jumping into the rebounding Texas market. As retail investors weigh the right time to jump back into the energy market, it looks increasingly like the large institutional players are already ready to bet on the permanence of the rebound.

For example, Blackstone recently announced an agreement to invest $1.5 billion in two separate drilling deals in West Texas. Moreover, the firm also agreed to commit another $500 million in funding to a group that is buying 16,000 acres in another area of the Permian Basin.

Other investors jumping into the oil fields in recent weeks include Wilbur Ross, EIG Global Energy Partners, and Apollo Global. Parsley Energy CEO Bryan Sheffield put it best when he said "There’s this one corner of the world, the Permian Basin, where investors will keep financing you to keep on acquiring”. Parsley has sold stock to buy land five times since 2014 (including a sale last week). Parsley is not the only firm behaving opportunistically though - PDC Energy shot higher last week after it inked an agreement to buy Permian field assets from a New York investment firm for $1.5 billion.

The private equity money from Blackstone and others is crucial to the resurgence of drilling in unconventional areas. Blackstone’s funding for the deals came from an $8 billion pool raised early last year, but had mostly been unused until recently.

The funding from private equity and institutional investors is particularly important because oil firms themselves are binging on debt. Consider the oil majors for instance; Exxon, Chevron, BP, and Shell hold a combined $184 billion in debt at present – more than double the 2014 level. While low levels of interest rates and ample demand for bonds has kept costs low and debt burdens manageable, that situation may only be temporary. Exxon and the other majors will likely spend a decade or more getting themselves back to normal debt levels, and if interest rates move higher, firms that need to refinance their debt for any reason could find that they face unpleasant choices. Related: The Biggest Wildcard For Oil Prices Right Now

In fact, the oil majors may face hard choices even sooner than that. During the first half of 2016, oil majors looking to fund new production investments, debt payments, and dividends had a cash shortfall of $40 billion. In theory, 2017 will be better – but only if prices continue rising rapidly. If oil markets fall back, the oil majors will either be forced to raise more cash through debt or else decide what matters the least: dividends or funding new production investment (presumably bond payments would be the most sacrosanct given the consequences of defaulting on debt).

Last year, the oil majors spent more than 100 percent of profits on dividends, and this year the problem is worse. From April to June, Exxon spent $3.1 billion on dividends while earning net income of $1.7B.

Oil majors are not alone in this quandary of course – in fact they are in far better shape than most of the smaller unconventional players. All of this brings us back to why private equity and institutional investors like Wilbur Ross are so excited about the sector. Sage investors buy when blood is running in the streets, and right now the streets are looking pretty crimson. Retail investors can’t get the same kind of advantaged deals that Blackstone and Apollo can get of course – by the can buy stock in the private equity firms themselves. In the current environment, that opportunity is worth considering.

By Michael McDonald of Oilprice.com

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