Q&A Spotlight with Evan Smith: Private Equity & Family Office Energy Financing Trends

Evan Smith, Senior Vice President of Stephens’ Energy Investment team, recently spoke on the Private Equity and Family Office Energy Financing Trends panel of Hart Energy’s 16th Annual DUG Appalachia Conference.

He shared insights along with Mark Burroughs, Managing Director of EnCap Investments, and Jay Salitza, Managing Director of KeyBanc Capital Markets. Here are the highlights of Mr. Smith’s panel discussion.

Energy Sector Performance and Outlook

How are financing conditions in the energy sector shaping up as we head into 2025?

One of the major trends helping operators and investors alike since the pandemic is that balance sheets and capital discipline have improved. Bid-ask spreads have become more manageable as the oil market has remained rangebound at approximately $60 to $80 per barrel for some time now.

The industry overall is also healthier now that buyers have become more discerning about potential investments, and many firms have decreased their leverage to 1.5x debt-to-EBITDA or lower. However, the gas market has continued to experience volatile prices and less dealmaking than the oil market. It also helps that oil and natural gas demand is expected to rise by more than 20% during the next two decades, according to the U.S. Energy Information Administration.

What is the appetite for investments within publicly traded entities in the energy sector?

Energy has been the best performing sector in the S&P 500 since 2021 by a wide margin, up more than 130% and nearly triple the S&P 500 index over the same time period. Although a considerable amount of that growth occurred during 2021 and 2022, this performance, along with a healthier industry as a whole, has started to translate to more follow-on and IPO activity in the sector.

Multiple upstream master limited partnerships (MLPs) have successfully completed IPOs in the last 18 months. Beyond those, several growth oriented exploration and production firms are currently in the queue to go public, in large part due to the healthier industry fundamentals described above. We expect that market to continue to open up more in the coming 12-24 months.

Private Equity and Family Offices in Energy, Oil, and Gas

Which private equity firms have been active in energy, and what are they targeting?

PE firms such as EnCap Investments, Quantum Energy Partners, NGP, Carnelian, Kayne Anderson and the like have been active in the space, among others. While many of the largest private equity firms have exited the energy sector after endowments and pensions pulled their funding during the volatility of previous years and due to ESG pressures, the entities that remain are in an excellent spot to capitalize on lower competition and more reasonable valuations.

The latest round of PE fundraises have been somewhat smaller funds than during the pre-COVID era, yet they remain sizable and allow the firms to remain very competitive in the $250 million to $500 million A&D market, where there remains significant opportunity. Opportunity is present both from consolidating mid-sized privates, long-in-the-tooth portfolio companies from sponsors who have exited the sector, and with the ability to acquire non-core assets that may shake loose from the wave of larger corporate M&A that has occurred in recent years.

Why have family offices continued to gain traction in energy and oil and gas sector investing?

Several factors are at play. Family offices have stepped in to fill a void created by dwindling LP capital and fewer PE firms in the energy space, along with much less availability of bank debt and unitranche debt. Family offices began making significant advances into direct energy investments during the pandemic, when technology companies became overbought and upstream companies were trading at record low multiples. The lack of competition in the space due to the capital void created an opportunity for new entrants.

As a result, family offices purchased high yielding, low leverage businesses or assets with growth potential for cash flow multiples of ~3x, while receiving significant tax benefits such as depreciation and intangible drilling costs. Family offices also have acquired quality assets from PE firms who merged portfolio companies during the last few years amidst a wave of consolidation and a focus on G&A reduction / corporate cost efficiencies. That PE consolidation has also created opportunities for family offices to back teams to go after acquisitions, something that is more possible now given the lower number of active private equity firms in the market vs. in years past.

Beyond direct investments in energy companies, we have seen more and more family offices investing at scale in private equity funds. We’ve been mandated to help place some of that capital from our family office network and have seen interest grow this year.

What are the key characteristics of family offices active in energy, and their priorities?

Stephens Investment Banking has a dedicated coverage group that tracks more than 300 family offices both domestically and globally. In general, compared with PE firms, family offices seek to provide longer-term capital (versus PE funds who generally have 10-year fund lives), have more modest return expectations (generally prefer long-term compounding versus short-term, high IRR investments), and are more passively involved in day-to-day operations than PE firms. Since family offices are not dependent on LPs, their intent is often tied to preservation and return of capital.

Experienced family offices are targeting assets across the energy space, including minerals, operated assets, non-operated working interests, development drilling projects and bespoke assets and structures given the flexibility of their capital.

We are seeing a significant uptick in continuation vehicle opportunities targeting family office capital, particularly in situations where a private equity fund or GP has assets that are not ready to sell, yet they are running into end of fund life issues. Continuation vehicles are an elegant solution for that situation, and we expect that to continue into 2025 and beyond.