Secondaries buyers and sellers are waiting for more clarity on the impact of the fall in oil prices on energy-focused funds, but opportunities remain in some pockets of the market.
While the fall in oil prices in the past year could ultimately create opportunities for secondaries investors to snag limited partners’ stakes in energy funds on the cheap, price volatility and uncertainty regarding the direction of those prices is currently creating a state of limbo in most energy secondaries.
The average price of a barrel crude oil has hovered between the high $50s to the high $60s in the last couple of months, but fell as low as the high $40s at the beginning of the year.
“Energy is too volatile and too risky right now,” said a secondaries investor. That person added that part of the uncertainty is that nobody really knows what the Organization of Petroleum Exporting Countries is going to do.
Even those who believe that oil prices have stabilized note that it usually takes time to trickle down to the bottom line of portfolio companies and to fund valuations. This is an important factor for secondaries investors, who often assess the potential purchase of an LP stake in a fund using bottom-up analysis and scrutinizing the potential value of underlying portfolios, including a forecast on what cash flow might look like and when exits may happen.
“Most people are scared because it takes time for fair value write downs to go through market,” said a market participant. “You end up with the buyer becoming more conservative and asking for a bigger discount.
There’s also uncertainty among sellers who don’t want to be forced to sell at a discount and might want to wait for more clarity. As a result, there’s not really any confluence in pricing. But once general partners start writing their portfolio down, pricing will level off, some say.
Energy-focused funds saw average pricing of less than 70 percent of net asset value in the first quarter of 2015, compared with 96 percent for buyout funds, according to data from Greenhill Cogent. “But we expect discounts to narrow materially in the second quarter as funds begin to price off marked down Q4 2014 NAV,” the firm wrote in its secondary briefing for the first quarter of the year.
That’s the overall picture in energy secondaries. But as another market participant noted, there are still opportunities within energy that aren’t directly dependent on the actual price of the commodity.
“You have to be careful regarding what falls under the category ‘energy’,” that person said, adding that there’s a big difference between upstream and midstream.
Upstream involves the exploration and production of oil gas and is highly dependent on the price of commodities. It’s anything from drilling to extraction. Midstream represents processing, storing, logistics and transporting oil. There’s almost no commodity risk in midstream.
So while secondaries energy transactions related to upstream may be on hold, market participants have noted that deal flow continues to be robust on the midstream side as well as in infrastructure as it relates to energy.
Once there’s more clarity on the direction of oil prices and its impact on portfolio companies and GPs that invest in them, opportunities on upstream side will likely come back as well as some LPs may want to reduce their exposure to funds whose valuations have suffered from the oil price roller coaster.