Energy and Commodities Outlook 2022

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For some time, private equity (PE) firms have focused on investments in the traditional energy sector. This usually involved investing in oil and gas companies that extracted crude oil and produced refined petroleum products. In recent times, however, PE firm investors have shifted their focus from traditional fossil fuels-based businesses to energy transition companies that focus on clean energy and renewables. Does this signal a fundamental and permanent shift for PE investment away from traditional fossil fuels-based businesses? Also, how does the PE sector view traditional energy companies and their move into cleaner and greener spaces? We take a look at these questions through the PE lens.

Current fundraising landscape, for traditional and for clean energy

Starting in the early 2000s, PE has generally had a relatively easy time raising capital for oil and gas projects. More recently, however, PE firms have increasingly focused more investment into energy transition companies with a focus on industrial decarbonization, clean energy and renewables. One reason for a shift in focus is the low rates of returns over the last 10 years from traditional energy investments. Also, the public is demanding more carbon reductions in a bid to protect the atmosphere and reduce human influence on climate change. For example, pension and endowment funds are less willing to invest sizeable equity into the traditional energy space. Some would argue that clean and renewable energy companies have outperformed both listed fossil fuel companies and public equity market indices in recent years, and with lower volatility.

Global energy supply investment by sector 

The above chart, obtained from the International Energy Agency (IEA), shows a decline in capital investment in traditional oil and gas sectors, and an increase of investment in renewable power and electricity networks and battery storage.

The IEA says more governments, companies and financial institutions are making commitments to achieve net zero emissions by 2050 or soon thereafter.

Current approach to capital raising in the energy sector

According to James Wang, managing director of Ara Partners, the issue of capital allocation by PE firms in the energy sector appears to be LP specific. On one end of the spectrum, some LPs want none of their investments to be in fossil fuels-based businesses, whereas other LPs believe in an incremental shift away from fossil fuels to investments in industrial decarbonization businesses such as hydrogen blending and renewable competing alternatives.

Wang commented on the historical return rates of traditional energy plays. Over the last 10 years, the return on investment in the traditional energy space has not been encouraging, especially taking into consideration steady, low gas prices (barring the impact of recent world events in hiking prices). In making their investment decisions, LPs not only look at the ESG policies and goals of the businesses, but also their potential return on investment.

Key takeaways
  • Private equity firms focus increasingly on clean energy transition projects
  • Hydrocarbon consumption, however, is not expected to abate in the next five to 10 years
  • PE investors help traditional energy companies as they diversify into cleaner sources
  • Countries need to be energy independent and secure in light of geopolitical events
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