THE GREATEST INVESTING OPPORTUNITIES
How bad is the oil bust? Even the big believers in an inevitable rebound are hedging their bets.
Avenue Capital Group, Och-Ziff Capital Management Group LLC, Carlson Capital LP and Blackstone Group LP's GSO Capital are among firms that have raised or are raising money from investors to plow into the energy sector, investors say.
But wary of the sharp price declines that stung early bargain hunters, they are approaching their investments more cautiously. Some funds are focusing on senior, secured loans—those that are first in line to get paid back if energy companies run into problems handling their debt. Others are buying hedges against further declines in oil or natural-gas prices.
Those steps will mean lower gains than if they took riskier positions. But they also could guard against the risk of being too early in a market that, while battered, continues to post steep declines.
Last month, David Rubenstein, a founder of private-equity firm Carlyle Group, said he anticipates "maybe the greatest energy investing opportunities we've ever seen." Marc Lasry, founder of hedge fund Avenue Capital, has described energy as a "once-in-a-lifetime opportunity."
Oil has plunged further since those bullish pronouncements, as have global growth expectations. Still, Mr. Lasry and others argue that losses can be limited for those approaching the sector with the right mind-set.
The debt of some high-profile, struggling oil-and-gas companies have traded for less than 40 cents on the dollar, raising the possibility of a wave of restructurings.
If energy companies skirt bankruptcy, investors will pocket large returns on low-priced, high-yielding bonds, Mr. Lasry said.
If many U.S. exploration-and-production companies go out of business, he said, U.S. oil production will sink, perhaps finally putting a floor on global prices following the approximately 70% decline in U.S. crude prices since June 2014.
On Wednesday, light, sweet crude for March delivery settled up 85 cents, or 2.7%, to $32.30 a barrel on the New York Mercantile Exchange. Brent, the global benchmark, gained $1.30, or 4.1%, to $33.10 a barrel on ICE Futures Europe.
"The only way we get hurt is if oil goes to $20 a barrel and stays there for a year or two," Mr. Lasry said. "I'll make that bet, because if oil goes to $20 and stays there, that means the whole industry is in bankruptcy."
Avenue is buying senior debt of companies including exploration company Halcón Resources Corp. and oil-rig operator Ocean Rig UDW Inc. that pay annual interest payments of more than 10%. If the companies survive, Avenue will pocket these high bond yields. If not, the firm said it wouldtry to profit from turning its debt into equity of the companies.
Baupost Group LLC, a value-oriented hedge fund run by Seth Klarman, recently purchased about 20% of a bond deal sold by American Energy Partners-Permian Basin LLC, the U.S. oil-and-gas venture of former Chesapeake Energy Corp. Chief Executive Aubrey McClendon.
The senior bonds, backed by assets in the productive, low-cost Permian Basin, came with yields of about 13% and covenants that will make Baupost among the first to be paid back in a restructuring, investors say.
Monarch Alternative Capital LP has been purchasing various hedges on its distressed energy investments, including derivatives that rise in value if oil prices fall, according to an investor. The hedge fund also is getting involved in various restructuring processes where the firm thinks it can help squeeze out value by taking steps like rejecting or renegotiating various contracts.
Rather thanmake a direct bet that energy prices will rebound, "a better play is to focus on securing quality assets, hedging the commodity risk and creating value in the restructuring process by rejecting contracts and lowering" various costs, said Andrew Herenstein, managing principal of Monarch.
Still, none of these strategies is foolproof. Workout situations can be complicated and prolonged, and it isn't clear what the upside might be if global prices stay under pressure.
GSO Capital is approaching the sector cautiously. The Blackstone unit has invested about $100 million from a $3.5 billion energy fund raised last year, said people close to the matter, and is examining new investments.
GSO said it believes oil prices could begin to stabilize later this year, as U.S. oil production slips; the firm is searching for companies likely to survive a shakeout, the people said.
Some of those putting new money into energy are dealing with losses from earlier investments.
Avenue, for example, raised a $1.3 billion fund about 10 months ago. It has lost $200 million of the $600 million or so the firm has invested from that fund so far, an investor said. Avenue has been investing about 5% of the fund each month, the investor said.
Debt investors including Apollo Global Management LLC, Brookfield Asset Management Inc., Cerberus Capital Management LP, Oaktree Capital Group LLC and Silver Point Capital LP all bought discounted debt of energy companies nearing or under bankruptcy protection only to see the debt drop amid falling oil and gas prices.
"Anybody who went long in energy over the past year or so was crushed," Mr. Herenstein of Monarch acknowledges.
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