Private Equity, Energy, and Resources: How the Leopard Has Changed Its Spots
Authors: Gray Peter N. 
Published: February 2015

Guest editorial
In recent months, private equity groups increasingly have signaled their intent to be material players in the ongoing consolidation in the global economies of energy and natural resources. The appeal of cash flow and increasing multiples in the sector have, for the present, eliminated doubts and fears that private equity has held on the vagaries of commodities prices. This is seemingly the case across myriad commodities including base and precious metals, alternative energy, and oil. Somewhat surprisingly, private equity also appears to be taking its first cautious steps across emerging and developing technology plays in biofuels and biomass and into such areas as coal to liquids. This increased appetite for investment and development across the sector is arguably a departure for private equity and may signify a paradigm shift in risk tolerance and investment strategy.
Traditionally, private equity groups have been acquisitive from the standpoint of securing opportunities for value creation. This is often demonstrated most visibly in situations in which a private equity firm is presented with an opportunity to invest in superior management opportunities and, in particular, situations where capital availability had been constrained. Private equity, however, has been somewhat reluctant to direct its investment toward commodity plays, especially mining and energy, given the perception that commodity-price volatility and industry operating costs made for a difficult investment scenario. Private equity has seen the commodity play as being fundamentally at odds with its accepted investment approach—to undertake investment, restructure business opportunities, enhance operations, and exit or refinance the opportunity across a short to medium time frame.
The exit strategy for private equity within the constraints imposed by commodity-price cycles always has been difficult to balance. This is a direct consequence of the fact that an investment in a mining company or an oil play is often a longer-term play across the commodity-price cycle, which is an investment during the extended period of mine or oilfield exploration, development, and extraction. This requires patience and a long-term view on the investment and risk/return profile, which deviates from current private equity investment strategies.

Unprecedented Consolidation
What has caused this changed behavior and increased sector commitment? The answer, in one word, is consolidation. Across the energy sector, which includes mining, oil and gas, alternative energy, alternative fuels, and utilities, for the past several years there has been an unprecedented wave of consolidation activity in a flight to quality. Many of the world's larger energy companies have diversified their commodity and geographic footprint in an effort to derive market strength and economies of scale.
Growth through the current commodities-price cycle has been directed through acquisition, as opposed to exploration and development; in many cases, this growth has been supported against a backdrop of sustained higher cash flows and commodity prices. Global energy companies have leveraged this cash position into accelerated growth.