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| Risk & Reward |
Crude Investments
Eileen Gunn
11/01/2004
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Bill Weidner, managing director of Cosco Capital Management, an
Avon, Conn., investment bank specializing in energy, says that through the early
to mid-1990s, “companies bought properties assuming things would go up and down,
but would always revert to a mean of $18 a barrel. They had good discipline and
made money.” Now, with supply-and-demand trends pushing prices skyward,
conventional wisdom embraces a new, higher mean. Even so, he says, companies
reportedly are resisting using the latest highs to crunch their numbers.
“Companies are probably building their business models on $28 a barrel now. I’m
comfortable with $28.”
| New private equity funds that focus on small oil and natural gas companies are springing up daily, while existing funds are getting
bigger. |
To help investors hedge their bets, fund managers are
encouraging companies to place long-term contracts that lock in a price slightly
above what they need to break even. “We don’t want to take significant commodity
price risk,” VanLoh says. “We’re trying to back guys who have a systematic way
of building a business that will make money in all cycles.”
While the
arguments in favor of restraint and consistent returns are sound, few deny the
role sky-high oil prices have played in attracting investors and increasing
returns. Most experts did not expect prices to go as high as they have, or as
quickly, leaving some cautious about the long view. “The risk and reward balance
has changed from a few years ago, from positive to neutral,” says William Quinn,
a managing director with Natural Gas Partners in Dallas, which closed its
seventh fund in March 2003 and manages more than $1.5 billion. “There is
probably more room for prices to go down than up.”
While that may be so,
would-be energy investors should consider that overall demand is expected to
remain high. In July, the International Energy Association in Paris estimated
that global oil demand will grow by 2.9 percent this year, the biggest increase
since 1980. It expects that pace to slow next year, but only to 2.2 percent.
Questions to Ask Your Private Wealth Advisor About Oil and Gas Ventures
1. How have leading E&P funds performed relative to the rest of
my
portfolio?
2. Of those funds requiring a 10-year commitment, which
are best positioned to succeed in the long term?
3. How do management fees compare among leading oil and gas funds?
4. How quickly have the energy funds under consideration grown over the past three years?
5. Given current Treasury rates, would MLPs or bonds make a better
investment? |
In the meantime, domestic supplies continue to become scarcer and
international supplies have the clouds of terrorism and political uncertainty
hanging over them. “A portion of the premium that we’re seeing in prices is
unrest,” Quinn maintains. “Something as simple as Tom Ridge saying that there
could be an attack in the United States in the near term riles markets.” Some
fund managers argue that the potent combination of strong demand and
international unrest will keep prices high. Both factors are, however,
unpredictable. If India and China, where oil consumption has soared, see their
economic growth stall as suddenly as it did for other Asian tigers in the late
1990s, demand growth would fall quickly.
The Long View
Ultimately, even investors who are bullish on energy should
hold out for management teams that take a restrained, long-term view. “You want
to ask about their historical rates of return, the consistency of returns and
the size of deals completed, and you want to see how those things have evolved,”
Weidner says.
“I would especially look at the track record through different
price cycles for oil,” adds John Farber, a cofounder of Lime Rock
Partners.
It is also important to understand the types of companies in which
a firm prefers to invest. Companies that buy proven reserves at the best prices
will have more modest, but reliable, returns. Firms that focus on finding new
streams here or abroad take on more risk, but the payoffs can be bigger if
explorations are successful.
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