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Private Equity Offering Silver Lining Playbook For New E&Ps, Technologies

Stagnant oil and natural gas prices have put the hurt on the exploration and production (E&P) sector and oilfield service firms, but there's probably no better time to make investments in energy, particularly new companies and new technologies, two private equity (PE) experts told a Denver audience on Wednesday.

EnCap Investments LP's Brad Thielemann, a managing director on the upstream staff, joined Neal Dikeman of Shell Technology Ventures (STV), a senior venture principal for the Royal Dutch Shell plc arm, to share their views at the 27th Annual Rocky Mountain Energy Summit.

There's not a lot of optimism in the energy sector, but PE firms are looking at the market in a different way.

"You don't want to launch at $140 oil," Dikeman said at the forum, sponsored by the Colorado Oil & Gas Association. "You'd get creamed. Now, the upside potential in the technology, the capabilities and the resource is tremendous. Why wouldn't you be happy to get into that?"

PEs probably have close to $80 billion earmarked for E&P investments today, Thielemann said. "It's a staggering number with a lot of interest."

Thielemann's firm is a big player in the U.S. onshore. Dikeman's task is to ferret out trending technologies at PE companies through STV, which was formed by Shell two years ago (see Daily GPIApril 3, 2013).

The two firms have similar, simple investment philosophies: find the best management teams with the most compelling business plans and provide them growth capital and support.

Today, EnCap has investments in 40 upstream portfolio companies and 10 midstream firms.

"We are looking for opportunities, and there are good ones that will come out of this cycle, as painful as it is," Thielemann said.

EnCap to date has raised about $27.5 billion in 19 funds. Among the startups it has backed is the recently formed American Resource Development LLC, as well as EV Energy Partners, Eclipse Resources, Paloma Partners IV, Halcon Resources, PennEnergy Resources LLC and Talon Oil & Gas II. Midstream ventures include Caiman Energy II, Cardinal Midstream II and the newly formed Evolution Midstream LLC (see Shale DailyAug. 25).

Dikeman, a self-described "serial entrepreneur" formerly worked in the Silicon Valley and has been with STV for close to two years. He prowls for "a great team, with great technology that will have a chance to change the world." STV "takes risks on something that we think will work, assuming the market size is there." Shell's in-house research and development staff has been investing in technologies for more than 20 years; it annually invests about $1 billion in technology alone.

"The reason that Shell does this is to drive an excellent rate of new technology," Dikeman said. "Shell recognized...over the last couple of decades that the future of this industry depends on new technology, on doing things bigger and faster."

Among STV's investments is Veros Systems (USA), a self-learning monitoring technology that continuously analyzes fluctuations in the power input of electric motors driving equipment such as pumps, turbines and compressors. Norway's Magseis makes a low-cost ocean-floor seismic technology that allows for in-sea automated handling and data downloading. WellDog (USA), an operator in the domestic onshore today, developed a sensor to detect the sweet spots in coalbed methane that helps identify where to land laterals (see Shale DailyOct. 7, 2014).

Investments "are across the spectrum for young startups and an exciting team that can change the way the world operates," Dikeman said. STV acts as an investor and a partner to commercialize innovations.

While the investment pool hasn't dried up, finding the right vehicle still requires the right mix of an experienced team and a solid strategic plan.

"It's very simple," Thielemann said. "We find the best management teams in the business to partner with and then we align ourselves this those teams."

While STV is looking for new technologies, EnCap backs small private firms usually composed of former executives from large public companies. If the company's management team and strategic vision look like a good bet, EnCap offers funds and strategic advice.

"We start with teams that generally have no assets, sort of a venture model to help them grow and build something over time," Thielemann said.

There is a silver lining to the collapse in oil prices, he said.

"We're excited about what potentially could come out of this," he said of today's commodity environment. The squeeze on prices "has challenged a lot of our teams that have put assets together and built assets. That's dramatically changed." Many of EnCap's 40 investments were in "various stages" of preparing to go to market, some this year. "Now we only expect one or two; we've pulled most of them for now."

And the mood has changed from "growth to evaluate. Everyone is talking about efficiencies and the retracted rig count. It's clearly contracted our activity."

However, "at the same time, we're still looking for opportunities. We have $12 billion ready to go for the next several years...We see some opportunities for dislocation in the market."

EnCap and STV view their investments as long-term projects, which don't get pulled at the whim of the commodity markets.

"In the last quarter of 2014, there were lot of iterations of budgets and planning," Thielemann noted. "We do a lot of planning and step back and try to grow a business that ultimately will be sold to a strategic buyer. We're not up to sell in the short term." Viewing investments over an extended period allows a company to "survive in this cycle and to be on the offense at some point."

The price decline is been "a double-edged sword," Dikeman said. "On the bad side, the things we find in the oil patch are tighter budgets, margins are under pressure and things are sliding to the right..." It's especially difficult, he said, for new technology trying for its first win.

"On the plus side, companies now are talking about ways to save money, whereas two years ago these conversations weren't taking place," it was all about how much money there was to be made without working on perfecting wells.

In determining which new technology teams to support, Shell has specific criteria.

"How big is your market" for the idea? Do you have a price that's worth bidding on? Do you have something that will make a big difference, not a small one?" he asked the audience.

"It's an exciting time for the industry," he said. "It feels very much like 2001 in the tech sector," a time when many startups in the Silicon Valley went under. "This time is very similar. We just had blood in the water.

"But out of that came technology companies that have driven the world in the last 20 years." Investments didn't stop, but operators turned their focus to "delivering value. We'll see that. There's a silver lining here. When we are looking back five years, we will see this as a period when new technology started pouring into E&Ps."

The "tough conversations" are happening now and companies are challenged, as are their strategies," Thielemann said.

"But this is necessary to flush through the system. There's a lot of things that are gloomy. The good part is we are sitting in the United States...with so much opportunity...There's a huge opportunity set here and it's a good time to put money to work over the next couple of years."

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