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Understanding investors’ roles in private equity and the energy transition

April 4, 2024

The global energy landscape is in a state of flux, propelled by a growing emphasis on sustainability and the urgent need to address climate change. In fact, a recent NOAA analysis showed the United States has experienced the warmest winter on record. In this dynamic environment, private equity investors in the oil and gas sector find themselves at a crossroads, facing a multitude of challenges and opportunities. Carbon Tracker’s latest report, “Private Eyes Wide Shut: Private Equity Investments in Oil and Gas at Risk from Energy Transition,” offers valuable insights into the complexities of navigating this evolving landscape.

Understanding the transition
The report paints a vivid picture of the ongoing energy transition, driven by a confluence of factors including technological advancements, shifting consumer preferences, and regulatory pressures. Renewables such as solar and wind have emerged as viable alternatives to traditional fossil fuels, with their costs plummeting and deployment rates surpassing expectations. Concurrently, the rise of electric vehicles threatens to disrupt the demand for oil, a cornerstone of the global energy system for decades.

Private equity in the North Sea
Carbon Tracker’s report focuses on upstream operations in the North Sea as a case study, where production has been at a steady decline in recent years. Oil majors have been retreating from the basin, while private equity firms have been increasing their presence, buying up assets from the public markets and taking on the risk associated with operating upstream assets in a depleting market. This has been a trend occurring widely, with private equity firms buying up at least $25 billion in fossil fuel assets from public oil companies between 2021 and 2022. 

Ten oil companies in the North Sea basin were profiled in the report, all backed by private equity firms including HitecVision, EIG, AtlasInvest, and Blackstone. While it is certain demand for oil and gas will fall in the future, it is less certain how far or how fast; which creates a challenging cost environment for operators in the basin.    

Risks for private equity
Private equity firms must grapple with and respond to a host of risks induced by the energy transition. The CTI report highlights the risks faced by PE portfolio companies that are burdened with substantial debt and are susceptible to cash flow disruptions stemming from lower demand or commodity prices. Moreover, firms face the challenge of accurately assessing the pace of the energy transition, with potentially dire consequences for investment returns if they underestimate its speed. Additionally, the pursuit of production expansion strategies amidst the transition’s accelerating dynamics poses significant risks, further complicating investment decisions.

Implications for investors
Amidst these challenges, investors (i.e., limited partners  or LPs) in private equity investments must also navigate a landscape fraught with uncertainty. Investors typically include large public pension funds, as well as university endowments and other institutional investors. While transition risks in public equity and debt holdings have garnered considerable attention, investors in private equity transactions are not immune to these challenges. The report underscores the potential impact of declining fossil fuel demand on investor returns, highlighting the need for heightened awareness among investors. Investors risk being locked into illiquid investments that may suffer from value erosion as the transition progresses, necessitating careful consideration of the implications for their portfolios.

Recommendations for investors
In light of these challenges, the report offers recommendations for investors to effectively mitigate risks and align investments with sustainability objectives. Investors are advised to scrutinize future fossil demand scenarios provided by private equity firms and actively engage in discussions regarding valuation methodologies for upstream companies. Furthermore, investors should leverage their influence with private equity managers to ensure adherence to climate and transition investing parameters, thereby safeguarding their investments against potential downside risks.

What’s next
The energy transition presents both challenges and opportunities for private equity investors in the oil and gas sector. By embracing a proactive approach to risk management, fostering transparency in investment processes, and aligning investments with sustainability goals, investors can navigate this complex landscape with confidence. 

The Private Equity Energy Tracker is a helpful new searchable database of the energy holdings of eight of the largest PE firms in North America. This new data set will allow investors, policymakers, regulators, and the general public to better understand the role the private equity industry is playing in the production of fossil fuels. Additionally, PESP developed a new aid for institutional investors concerned about their capital titled “Climate Risk and Energy Transition Questions for General Partners.” The questions posed in the guide are geared to help investors assess how private equity firms are adapting their portfolios for the energy transition. As the world marches towards a cleaner, more sustainable energy future, private equity investors have a vital role to play in driving positive change and shaping a resilient and thriving energy sector for generations to come.


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