Portfolio: First Reserve and KrisEnergy

Despite years of effort, Cambodia has yet to become an oil-producing nation. The first production-sharing contracts were awarded to foreign firms in the late 1990s, but only Chevron stuck it out, finding oil on its block in 2004 and declaring a commercial discovery six years later. Progress then stumbled, not helped by a tax dispute, and this led to KrisEnergy being drafted in a bid to turn around the situation.

The oil and gas exploration and production (E&P) player took a 25% interest in the block in 2010, and a number of successful exploration wells were drilled. This month it completed the acquisition of the remainder of Chevron's 55% holding for $65 million. The company will now see if it can overcome the various regulatory, geological and logistical obstacles and bring an estimated 650-700 million barrels of oil equivalent (mmboe) to commercialization.

Chevron first brought in KrisEnergy because it knew the team and its capabilities. In their previous incarnation as Pearl Energy, the founders had taken a challenging asset - the Jasmine field in the Gulf of Thailand - into production. Less than 17 months after the company acquired Jasmine, oil was being generated; within three years cumulative output had reached 17 mmboe. Chevron was looking for a repeat performance.

The situation also offers an insight into how KrisEnergy has built a portfolio of 215.2 mmboe - including proven and probable reserves (2P) and best estimates of contingent resources (2C) - as of mid-2014.

"We never succeed in competitive tenders because we refuse to pay top dollar. But we don't need to compete because we've been in the region for so long and relationships are everything in Southeast Asia," says Richard Lorentz, co-founder and business development director at KrisEnergy. "We have contacts, relationships and friends across the region and that's how we source deals."

Proven operator

First Reserve, which backed KrisEnergy as a start-up in 2009, is already sitting on handsome returns from its investment.

The PE firm committed $500 million and ended up deploying $300 million, taking a stake of around 98%. Keppel Corporation acquired a 20% interest in KrisEnergy for $115 million in July 2012 and was a cornerstone investor in the company's S$270.8 million ($213 million) IPO in Singapore a year later. Just before the offering, Keppel exercised an option on First Reserve-owned shares to increase its holding to 36%. If this was done at close to the IPO price of S$1.10 per share, the PE firm would have taken about $140 million off the table. First Reserve still holds 45.2%, currently worth over $380 million.

The deal-sourcing ability and strong performance confirm the positive vibes that came out of the due diligence process.

"First Reserve has a history of working with management teams with a proven track record," says Will Honeybourne, managing director at First Reserve and non-executive chairman at KrisEnergy. "We saw the team had the technical, operational and commercial skills aligned with the nature of the opportunity. They also have incredible depth of knowledge and experience in the region. They are like encyclopedias; they know everything that has been done by everyone, everywhere. With our global culture and specialized industry knowledge, it was a great pairing."

Notably, the KrisEnergy team had also proved it could operate as an independent. The founders, Keith Cameron, Chris Gibson-Robinson and Lorentz, each had more than two decades of industry experience in Southeast Asia. They set up on their own in 1999, incorporated as Pearl Energy in 2003 and won backing from 3i. Shortly after listing in Singapore in 2005, the company was acquired by Aabar and then sold on to Mubadala for $833 million in 2008. Both entities are controlled by the Abu Dhabi government.

First Reserve had looked at Pearl ahead of the Aabar transaction. "We made it clear to the team that if they wanted to do this again we would be extremely interested in talking to them," Honeybourne adds, noting that the KrisEnergy investment was signed within five months of the team making contact.

First Reserve had long recognized the potential for an oil and gas E&P start-up in Southeast Asia. The region as a whole is resource-hungry, populated with fast-growing economies, yet offshore hydrocarbon basins remain relatively underdeveloped; certain areas haven't been explored for a long time, so they haven't benefited from the latest technologies capable of reaching previously inaccessible reserves. Southeast Asia is also seen as increasingly politically tenable, with governments doing more to ensure consistent application of the rules governing foreign investment.

The challenge remains finding the right team. First Reserve looked at a number of different operators without being convinced any of them. For example, some were trying to do Southeast Asia from bases in Europe and the PE firm felt they lacked an affinity with the region. By contrast, the KrisEnergy team was well known within the industry in Southeast Asia, as well as among government and regulatory stakeholders.

Other management teams have succeeded in getting PE backing, but they are still few in number. The investors may be partly responsible for this. While First Reserve has been an early sponsor of E&P start-ups in Brazil and Romania, most private equity players focus on North America. It could therefore be argued that the start-up thesis has yet to be fully proven in Southeast Asia, although an increasing number of GPs are looking for opportunities in the region.

Lorentz adds that the talent pool just isn't very deep. "When oil majors come into the region they normally cycle their expats out in 3-5 year periods," he explains. "So someone would have to come in, fall in love with Southeast Asia and its oil and gas potential, resign and then come back in as an independent. That's a difficult proposition."

Issues of scale

While the KrisEnergy team remains true to the business model that worked for them at Pearl, they are now operating on a much larger scale. With First Reserve's financial backing, the company opened for business with more than two dozen employees compared to just the three founders and a skeleton support staff at Pearl. This allowed it to begin work quickly on the pipeline of investments.

The PE investor has also contributed significantly on the corporate governance side. Through the First Reserve network, it helped to recruit independent directors who understand the industry and the region, including former CEOs of oil companies. Keppel is a case in point. The Singapore-headquartered company, which boasts an offshore and marine division that is leader in offshore rig design and construction and specialized shipbuilding, brought additional regional expertise to the KrisEnergy board. Keppel's current and former CEOs are the representatives.

The advisory side is particularly important given KrisEnergy's preference for operational control. Of its 19 contract areas, the company is block operator in 12.

"I get baffled when I see private equity backing teams that are not going to operate," Honeybourne says. "You can really only control the timeline if you are the operator and even then sometimes you can't because you have to deal with regulators, governments and partners. But you have a better chance of driving the timeline as the operator."

KrisEnergy also emphasizes building a diversified portfolio so that operations remain sustainable. The company has multiple exploration prospects within its 19 contract areas, as well as various others at the discovery stage, but they are counterbalanced by four properties that are either in production or soon will be - two oil and gas assets and an oil asset in the Gulf of Thailand, and a gas project in Bangladesh. A further eight are in appraisal and development.

As of October 2014, the vast majority of KrisEnergy's 2P and 2C assets were in gas. Broken down by project stage, though, 41% of the portfolio was at the development stage, 44% under appraisal and 15% in production or close to it. The idea is that KrisEnergy will generate cash from properties in production that can then be used to support appraisal and development of other assets.

"If you just look at exploration you are subject to the whims of mother nature. If you just look at production, you have to continue to sourcing assets," Lorentz says. "Having a portfolio where we can buy production when the price is low or explore and find reserves when the price is high."

Examined in a geographical context, however, the portfolio is less diversified. More than 70% of assets are concentrated in Indonesia, followed by Thailand on 18% and Cambodia and Bangladesh each in single digits. This is explained by KrisEnergy's opportunistic acquisition strategy.

For example, earlier this year the company paid $40 million for Premier Oil's stake in production sharing contract in Sumatra, Indonesia, where several gas discoveries have been made. Premier Oil put the asset up for sale a few years ago but failed to find a buyer willing to pay the asking price. Aware that the company had made a sizeable discovery in the Falkland Islands that will require substantial amounts of capital to develop, KrisEnergy approached Premier Oil and agreed a proprietary transaction.

Further deal flow could come from US oil companies in the midst of strategic repositioning. "Many US companies are refocusing on North America because of the shale opportunity, where the risk-return is so attractive. Shareholders are pressuring them not so much towards reserve growth and production growth but more towards return on investment," Honeybourne says. "You are seeing capital being drawn into the US and out of other areas. In Southeast Asia a number of assets sold at auction."

Active sellers include Newfield Exploration, which completed the sale of its Malaysian business in February and is said to be looking to offload China assets as well. Meanwhile, Hess has exited its businesses in Indonesia and Thailand and Murphy Oil has sold its Malaysian interests. In each case, the buyers were local firms but multinationals and independents were also linked to these sales.

Growth story

Two rather obvious geographical holes in KrisEnergy's asset base are Myanmar and Malaysia - the former is next big thing, the latter an established player - though not for lack of effort. Lorenz says the company was outbid on three blocks in Myanmar last year and has lost out on at least half a dozen opportunities in Malaysia over the last five years. However, he does not see deal flow as a problem, noting that the team has reviewed well over 250 potential investments.

"Some of these deals we discarded immediately because the geology was terrible; some we have gone to the data rooms and discarded; and some we have gone all the way to an offer and lost," Lorentz adds. "We can screen deals very quickly. Of the 200 people we have outside of Bangladesh, one third of us are technical and were either born in Southeast Asia or have lived here a long time. There is hardly a single piece of acreage that hasn't had one of our team look at in the past."

Rather, the challenge is recruiting people fast enough to meet the needs of the portfolio. KrisEnergy's reserves are expected to more than triple in the next six months while production - 7,991 barrels of oil equivalent per day as of June 2014, up from 2,737 a year earlier - will rise fourfold over three years.

As production ramps up, revenue and EBITDAX ($43.5 million and $20.9 million in the first half of 2014) should grow, but manpower requirements will also change. Facilities engineers are needed in addition to the geologists, geophysicists and business development executives.

As a financial investor, First Reserve will at some point complete its exit, but Lorentz believes KrisEnergy can continue to grow over the next 10-15 years. He sees the company building the largest E&P portfolio in Southeast Asia, which is what Pearl would have done had it not been acquired and become part of a global platform. But will someone pick up KrisEnergy as well?

"There's no doubt we will be taken over - everyone except Chevron and ExxonMobil is taken over eventually," Lorentz says. "Hopefully we will be taken over by someone who wants to keep us running in Southeast Asia."

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• Topics
• Expansion
• Southeast Asia
• Industrials
• Exits
• Commodities
• energy
• Growth capital
• Exit
• IPO
• Southeast Asia
• First Reserve Corp