Five Point offers energy exposure without the volatility

The US private equity firm plans to invest its second midstream fund, which closed in March on $750m, in what it describes as ‘in-basin’ infrastructure.

In March, Houston-based private equity firm Five Point Energy closed its second midstream-focused infrastructure fund at its hard-cap of $750 million.

Only in market for six months, Five Point Energy Fund II, which has already committed $100 million, has attracted interest from institutional investors seeking exposure to the US energy sector but who want to avoid the volatility of upstream investments, according to Five Point chief executive David Capobianco.

He spoke to Infrastructure Investor about the potential for US midstream investments, his firm’s in-basin infrastructure strategy and an untapped need for water management in the energy sector.

Q: What is Five Point Energy’s second fund going to invest in?

David Capobianco: Our fund is, broadly, a midstream infrastructure fund, but we are focused on what we call “in-basin” infrastructure. The in-basin segment is everything that connects from the wellhead to takeaway pipelines. It tends not to cross state lines as much. It tends to be regulated by states and not the [Federal Energy Regulatory Commission]. And it tends to be in areas where we can execute our core strategy of buying assets and building businesses out of those assets.

The last piece of the midstream strategy for the fund is water handling. Gathering lines to gather produced water, treatment, disposal, recycling and return path supply water for fracking.

Q: What kind of market exists for midstream water investments?

DC: Water is in a nascent stage of recognition for the massive demand of infrastructure needed. Across the United States, about four barrels of water are produced for every barrel of crude oil. In some basins, that ratio rises. That water production needs to be managed, and it needs to be managed effectively, as if it were a hydrocarbon being gathered from a wellhead and taken to an end market. The end market for water is either disposing it in a brine aquifer thousands of feet below the surface, or treating it, recycling it and returning it back to the exploration and production companies for reuse in the fracking process (EPC).

Q: Are return expectations from ‘in-basin’ infrastructure and water different from average midstream assets?

DC: We believe we have a much higher return profile than the standard midstream project, and definitely for the larger infrastructure projects. The reason our area of focus gets higher returns is because it’s more operating intensive. We buy assets and build companies out of them, and by the time you’ve built a company, it trades at robust multiples.

Small assets serve single customers or just a few customers. When you take assets and put them together in a network and create a business with long-term cash flow streams, well-constructed contracts and high credit quality counter-parties, you have assets that trade at company valuations.

Q: Why do you think LPs are interested in your strategy?

DC: Many of our investors don’t like the volatility of upstream but they want exposure to the energy sector. We offer a way to get the upside of investing in the energy sector in a downside protected way. We offer downside protection where, if commodity prices fall or production volumes decline, our investments are structured to protect the downside and capital we’ve invested. The flip side is that the structure has phenomenal upside. We  call our strategy the “asset-to-company arbitrage.” If you’re buying and building assets with downside protection at five-to-seven times, and you are able to build them into companies, you’re able to sell them at 10, 12 or 15 times, depending on the market conditions.

Q: Why has the US midstream sector attracted so much investment over the past few years?

DC: The sector is benefitting from the build-out need for infrastructure to manage growth in commodity production. You need midstream infrastructure to manage growing hydrocarbon production, to take those hydrocarbons to their end markets.

Typically, when commodity prices are robust, capital markets will freely fund the build out of midstream infrastructure by E&Ps. But we’re in an interesting moment where we have constructive commodity prices but constrained capital markets. Those constrained capital markets are limiting the capital E&Ps spend each year. They’re limiting their capex and forcing these companies to live within their cashflow. What that’s doing is it’s forcing E&Ps to high-grade their drilling and outsource their infrastructure build out. We believe our “value-added-partner” approach is a very attractive solution for the E&P players.