Wall Street thinks it has tapped a new gusher.
Searching for growth in a tepid economy, private-equity firms are zeroing in on the U.S. oil patch.
Deal makers are excited because advances in drilling techniques such as horizontal drilling and hydraulic fracturing, or fracking, have made it easier to extract oil and natural gas from shale and other rock formations, creating an opening for private-equity firms to place big bets in a capital-hungry business. Some early investors already have extracted billions of dollars of profits.
Private-equity firms completed $24.8 billion of energy deals last year, nearly triple the $8.5 billion in 2010, while the value of all deals last year rose just 17%, according to data-tracker Preqin.
Now, Apollo Global Management LLC and Riverstone Holdings LLC together are bidding for the exploration unit of El Paso Corp., which includes prime shale acreage in Texas and Louisiana in a deal that could be valued around $7 billion, according to people familiar with the matter.
Firms "can put a lot of money to work quickly and receive out-sized returns" investing in oil and gas, said Karl Kurz, a former chief operating officer of Anadarko Petroleum Corp. who now works for private-equity firm CCMP Capital Advisors LLC.
But shale drilling is relatively new, so there remains uncertainty about how long wells will produce. And the boom is now several years old, so late-arriving buyers may have to pay up. Some buying in Ohio's Utica Shale—believed by many to be the nation's next major oil field—have paid as much as $15,000 an acre recently, up from around $500 a year ago.
Volatile commodity prices also make it hard to use debt in these investments, a common tactic private-equity firms use to boost profits. Indeed, surging production has sent natural-gas prices plummeting nearly 37% over the past year, pushing down shares of companies focused on gas-yielding shale plays.
"The really great time to do these deals was over the past few years, when some firms hit a series of home runs and billionaires were made, like in the Internet boom," said Scott Stuart, who runs SageView Capital LP, a Greenwich, Conn.,private-equity and hedge-fund firm. "It's more competitive now and while you can still make good returns, with gas prices having plummeted it's trickier."
Recent windfalls illustrate why the gamble is worth taking, private-equity firms in the sector say. Energy-related private-equity investments scored gains of more than 30% in each of the past two years, and have beaten industry averages for 12 of the past 14 years, according to Cambridge Associates....MORE