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Private Markets Prepare for End of Fossil Fuel Era

Alternatives investors shunning future opportunities in oil and gas, despite bumper year for natural resources returns.

Despite soaring prices and record high returns in the year 2021-2022, private markets investors are turning their backs on investment in natural resources such as oil and gas, a report has found.

In the first three quarters of the current financial year, funds raised just US$3.8 billion in new investment, against US$13 billion for 2021 as a whole.

“We believe the sharp decline in fundraising indicates investors’ lack of interest in the conventional energy industry,” said the report’s author, alternative investments data and analytics provider Preqin. “In our view, the main driver of this trend is investors’ growing appetite for exposure to the energy transition and renewable energy investments, which is making new investment opportunities possible.”

Until now, it has been suggested that private equity and other non-listed investors would provide a ready home for traditional energy assets that had fallen out of favour on public markets, but these latest figures put a question mark over that assumption. The 2021 total was raised by 29 natural resources funds, which dropped to 19 funds raising the much smaller figure seen in the first three quarters of 2022.

“Private-private” equity

The paradox outlined by Preqin is that natural resources formed the top performing alternative assert class in the year to March 2022 and seems now to be shunned by many in the markets.

Natural resources posted a one-year rolling internal rate of return (IRR) of 34.6% through Q1 2022, said Preqin, due to the strong commodities rally. This was ahead of an IRR of 33% for real estate and 29.3% for private equity.

In addition, natural resources ended 2021-2022 with assets under management at a record high of $208.8 billion, of which energy accounted for almost 68% followed by metals and mining at 10%.

Nevertheless, fundraising has plummeted with US$3.8 billion figure for the first three quarters of 2022 representing the lowest level in nearly two decades. Further, overall natural resources dry powder – financing available but not committed – dropped to its lowest level as a share of AUM since 2001, standing at 16% end of Q1 2022. For energy-focused natural resources funds specifically, dry powder stood at US$25 billion, the lowest level since 2012.

With mainstream private equity cooling on natural resources, a new type of “private-private” equity could be stepping into the gap, according to Moses Rahnama, AVP, Research Insights at Preqin.

Rahnama noted the shift from traditional to renewable energy investments noted in the private markets could be part of a wider trend leading to ESG assets in general being over-bought and over-priced, but that this was already happening to some extent, with major European banks already putting an ESG premium on stocks they have been charged with selling.

“No real long-term investment case”

Preqin said that investment in conventional natural resources would continue to offer attractive returns in the short term, noting the rush to expand use of liquid petroleum gas in Europe in response to the energy crisis fuelled by Russia’s invasion of Ukraine.

“Considering all the geo-political and macro-economic factors, we believe the natural resources asset class can still play a significant role in the years ahead,” it said.

In the longer view, it added, those metals vital to the transition to new forms of energy will also provide openings for investors.

Rahnama said it was too early to write the obituary for “black gold”, saying it will be needed for petrochemicals, aviation and shipping for decades to come. “But once we hit the inevitable peak oil and the following down cycle, there would be no real long-term investment case for an industry that is in secular decline.”

Gas will remain a key fuel, he added, saying: “It is also an attractive investment opportunity given the supply hole left in the market by sanctions on Russia,” pointing also to gas’s potential role as a ‘transitory green fuel’ having been included in the EU’s environmental taxonomy.

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