Oil and Gas Firms Devise Structures to Unlock Private-Equity Cash

NEW YORK (The Deal) -- In January, when oil prices were hitting their lowest levels in five years and oil and gas companies were reeling, Linn Energy (LINE) signed a novel agreement that had everyone in the business talking.

The Houston oil and gas explorer said that it had lined up $500 million from GSO Capital Partners, the credit arm of the Blackstone Group (BX), to fund oil and natural-gas development. The non-binding letter of intent called for GSO to pay for the costs of new wells under the agreement for five years in exchange for an 85% working interest until they achieve a 15% internal rate of return.

"This agreement creates a dynamic alliance, combining world-class expertise from a highly respected investor with Linn's ability to acquire and develop oil and natural gas assets," Linn Chief Executive Mark Ellis bragged at the time.

It is expensive money at 15%, vs. the 5% debt deals companies were doing about a year ago, which may be the reason why no other deals have come out of it.

But observers say that it may be a new paradigm in the way private-equity firms invest in oil and gas, at least while oil prices are bumping around below $80 per barrel.

"It's another tool in the tool kit," said Deborah Byers, U.S. oil and gas leader at Ernst & Young.

Others have followed suit in setting up unusual structures with private-equity firms, from Rex Energy's (REXX) joint venture with ArcLight Capital Partners in the Marcellus last month (worth $67 million) to Breitburn Energy Partners (BBEP), attracting a $1 billion equity and debt investment from EIG Global Energy Partners in March.

"As long as commodity prices stay in the range of where they are now and don't go up to $80 or above, this is going to be the wave of financings," said a source involved in such deals who asked not to be identified.

Private-equity firms have raised about $50 billion to invest in oil and gas sector, $100 billion if you throw in debt funds, including EnCap Investments ($6.5 billion), NGP Energy Capital Management ($5.3 billion), the Blackstone Group ($4.5 billion), Riverstone Holdings ($4.5 billion), Warburg Pincus ($4 billion) and Quantum Energy Partners ($3.25 billion). There is plenty to choose from: IHS Energy recently estimated that there is $150 billion worth of oil and gas assets on the market.

But since the bottom dropped out of oil prices, private-equity investment in the industry has been lackluster.

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