What are the latest investment trends dominating the energy market and how do they differ by regions? Patrick Adefuye gives us an overview of the energy market and whether conventional or renewable energy is the better performer.
Energy has consistently dominated the unlisted natural resources industry, accounting for 88% of total capital raised in 2017. Energy-focused funds have seen strong fundraising levels in past years, posting a record in 2015 as 88 funds secured $71bn. 2017 came close to these levels, with 75 energy funds securing a total of $65bn.
However, the sector has seen capital increasingly concentrated among the largest fund managers, which account for a larger and larger proportion of aggregate capital. These fund managers are able to raise increasingly large funds, but are depressing the overall number of vehicles which are able to complete their fundraising process and hold a final close. It is striking that even though energy-focused funds raised their second-highest annual capital total in 2017, the number of funds closed was the lowest since 2011. Furthermore, the average size of energy-focused funds closed in 2016 was $663mn, but has more than doubled to $1.3bn in 2018 so far.
Conventional dominates in North America while Europe focuses on renewables
Preqin splits natural resources energy funds into three main sub-strategies: conventional, mixed and renewable energy-focused. Preferences for these sub-strategies vary across different regions: while North America-focused funds tend to be conventional vehicles, Europe-focused funds tend towards renewables. Conventional vehicles account for 68% of energy-focused funds closed for North America since 2008, while renewables-focused funds represent 75% of fund closures focused on Europe in the same period. Strategies vary more among Asia- and Rest of World-focused funds.
With North America’s reliance on and reserves of coal, gas and oil, it is unsurprising that since 2008 funds focused on the region have shown a preference for conventional energy. Contrastingly, Europe has put more focus on renewable energy sources in the past decade, and have been at the forefront of development and adoption of renewable technologies.
Mixed energy funds are the rising stars in the market
Even though, globally, the energy fundraising market for conventional- and renewable-focused funds has generally exceeded fundraising levels of vehicles following a mixed energy mandate, this sub-strategy has seen activity spike in recent years. Although the number of mixed energy funds reaching a final close in recent years has fallen – just 10 funds closed in 2017 and 2016, respectively – mixed energy funds have seen a boom in aggregate capital raised. While 13 funds raised just $9.7bn in 2015, in both 2016 and 2017 mixed energy funds raised around $25bn.
Much of this growth in capital results from investors increasingly seeing value in greater levels of diversification within their portfolios. The growth of mixed remit vehicles could also be from investors choosing to invest more capital with fewer, and generally larger, fund managers.
High investor satisfaction as performance delivers
Investors are satisfied with their natural resources investments: over three quarters (79%) of investors surveyed by Preqin in December 2017 felt that their natural resources investments met or exceeded expectations in the past 12 months. Equal proportions (44%) of those investors cite both conventional energy and renewable energy as presenting the best investment opportunities.
This marks an increase from the 38% of investors surveyed in December 2016 who felt that conventional energy presented the best opportunity, as well as a slight decrease from 46% who felt that renewable energy presented the best opportunity. Geographically, the majority (66%) of investors find that North America presents the best investment opportunities in natural resources, followed by Europe (35%).
This is line with performance trends: although renewable energy funds have been successful in raising capital from investors, conventional energy funds have generated higher returns. The median net IRR for conventional-focused funds is 12.8% across all vintages, significantly higher than the 8.6% posted by renewable energy funds (as at April 2018). Mixed natural resources vehicles saw returns just slightly above those of conventional energy funds, returning an average of 8.7%.
Despite the falling number of energy funds reaching a final close, fundraising activity could very well match levels seen in previous years. There are 190 energy-focused natural resources funds seeking investment as at May 2018, targeting a combined $119bn in investor commitments. It is quite possible most of them will find success – the significant majority of investors are satisfied with their past investments, and are looking to invest even further. If fund managers are able to continue generating strong returns, proving to investors the value of the energy market, then the strategy seems set to continue dominating the natural resources landscape for years to come.