Energetic LPs

Cezary Podkul explores some of the reasons why LPs are so willing to open up their wallets to GPs in the energy sector.

Any GP feeling blue about the fundraising climate would envy going to market in the second quarter and emerging in December with $2 billion of committed capital.

It sounds like something out of the pre-credit crisis days of 2005 or 2006. But for Houston-based Quantum Energy Partners, which just gathered $2 billion for its fifth energy fund targeting $2.75 billion, it's not.

Similar fundraising successes are being echoed by Quintana Capital Group, also of Houston, which scooped up more than $250 million for its second fund in just four months. And the energy sector's standard bearer, First Reserve, is reportedly three-fourths of the way into its twelfth global energy buyout fund targeting $12 billion.

With nearly $30 billion of energy funds in market or expected to come to market during the next 12 months, according to data from placement agent Probitas Partners, other GPs are surely hoping to ride their coattails.

Which begs the question: why are cash-strapped LPs so willing to commit capital to GPs trolling the energy sector?

Strong returns have certainly played a role. Witness a page from the Pennsylvania Public School Retirement System's (PSERS) board resolutions, which indicate an overall gross internal rate of return of 35 percent for First Reserve funds VI through XI. In August, PSERS helped First Reserve along its way toward $12 billion by committing a maximum of $250 million to its Fund XII.

These kinds of returns matter even more in an environment where 61 percent of LPs say they will sell secondaries in order to refocus on better performing GPs, according to a recent survey by secondaries firm Coller Capital. All the more reason LPs are flocking to strong-performing sectors like energy and shunning more risky strategies as they rebalance their portfolios.

Meanwhile, GPs know that they owe their returns to more than just favorable macro trends such as rising energy needs and past under-investment in energy infrastructure. They say the energy sector was generally not overleveraged and that multiples were not very high even prior to onset of the global financial crisis, making it relatively easier for companies to stay in business and operate out of cashflows. So as LBO-related bankruptcies in retail, media, food and consumer goods swell with each passing day, energy firms as well as their sponsors are staying out of the headlines. LPs, it seems, are taking notice.

But even successful GPs who have enjoyed this boon of fundraising for energy admit that difficulties lie ahead. Privately, many admit that 2009 will be a much tougher fundraising climate than 2008 and that they will have to be more careful in deploying their newly gathered war chests.

To make matters worse, energy consultancy CERA's latest upstream and downstream capital cost indexes show that costs are continuing to escalate despite the economic slowdown.

So far, though, whether committing cash from private equity, infrastructure, hard asset or other allocations, LPs are keeping their wallets open to the energy sector.