University of Texas Roundtable on The Role of Private Equity in the Financing and Restructuring of Oil and Gas Companies

Abstract

In this second of two University of Texas roundtables, four highly successful veterans of the U.S. energy industry, with considerable experience running both public and private companies, discuss recent developments in this rapidly evolving industry. Among the most remarkable—and a major focus of this discussion—is the dramatic expansion of the output and productivity of the Permian Basin of West Texas, and the role of private equity in accomplishing it.Although the Permian has been a major source of oil and gas since 1920, the combination of massive horizontal drilling and hydraulic fracturing has contributed to a tripling of production volumes from about 800,000 barrels per day to 2.5 million during the past ten years. In fact, the productivity gains are said to be so great that, even with the huge run‐up in the cost of acquiring acreage (to as high as $40,000 per acre), today's producers are projecting annual operating returns of 20% even if oil prices fail to rise above their current level of about $50 a barrel.What's more, there appears to have been a fairly clear division of labor between private and public companies in this recent development of the Permian. With most of the high‐priced acreage now being acquired by larger public companies, the primary role of private equity has been to identify and make good on opportunities to increase the productivity and value of smaller operations that can then be sold to public companies—companies that have the size and access to capital to benefit from the economies of scale produced by combining them with their other operations.Thanks to their earlier position in the value chain, investments by private equity groups have generally not only produced higher payoffs, on average, but involved larger operating and financial risks. And this difference in risk profile is reflected in a notable difference in hedging practices between public and private equity‐controlled companies. This difference was summed up as follows by a private equity partner who has also run several public oil and gas companies:To a much greater extent in private equity than in public companies, we think of our projects and companies as delivering value that is largely independent of changes in oil prices. Hedging is our way of saying we don't want to take oil price risk if we don't have to. We do not count on price increases to make our required returns. The returns come from operating the company successfully without the help of commodity prices.