Shift From Fossil Fuels Leaves Market to Smaller Players

Those left are moving to increase production, but they are relatively small players who won’t be able to make a significant impact on output. Investors are steering capital away from fossil fuels and toward companies that rank high in environmental, social and governance, or ESG, measures.

“Oil-and-gas has seen the worst returns of any sector over the past five years; the returns are volatile and investors feel ESG pressures,” says Wil VanLoh, who runs Quantum Energy Partners, which manages $18 billion, making it one of the few remaining big energy private-equity funds. “There’s been a huge retreat in available capital.”

Prices for oil and natural gas are soaring as concern grows regarding potentially limited sources of energy ahead of the coming winter. U.S. crude prices are at a seven-year high of more than $80 a barrel, having doubled in the past year, while natural-gas prices have posted a similar gain in six months, now trading above $5 per million British thermal units.

Fossil fuels account for about 80% of U.S. energy consumption despite growth in alternative energy. Demand for oil, the main source of energy for transportation, is expected to keep rising in the years ahead. Global oil demand is expected to climb every year through 2026, reaching 104 million barrels a day that year, up 4% from 2019 levels, according to the International Energy Agency.

In the past, higher prices and limited supplies spurred U.S. oil-and-gas companies to open their spigots. Privately held producers are doing just that, but publicly held companies, under pressure to please grumpy investors, have been buying back shares, increasing dividends and cutting their spending. They are on track to spend a little more money pumping oil next year, but most aren’t stepping up output.

That makes privately held operators more important than ever. Today 59% of the nearly 600 active U.S. oil-and-gas rigs are operated by private companies compared with 42% of the 1,150 rigs in January 2019, according to Tudor, Pickering, Holt & Co.

“Growth in U.S. energy supply will have to come from private companies because public companies are under pressure from investors to return capital, not to spend on growing production,” says Doug Swanson, managing partner at EnCap Investments LP, an energy-focused private-equity firm in Houston.

But private-equity firms, which operate many of these companies, are cutting back or leaving the energy business. Major firms including Blackstone Inc. and Apollo Global Management Inc. no longer do as much traditional energy investing as they once did, preferring to make new investments in solar energy, wind or other sources that aren’t as damaging to the environment.

Blackstone, for example, has been putting money in Altus Power Inc., a builder and operator of solar-power installations on the roofs and parking lots of commercial properties. Since 2019, Blackstone has led a $500 million debt financing and committed $300 million in preferred equity to Altus.

There are now nine private-equity firms focused on energy, which together have $22 billion of capital available to invest in the sector. That is down from 29 firms with $90 billion to invest in 2018, according to RBC Capital Markets.

“There’s nobody left, everyone’s kind of gone,” says Sam Oh, who runs Mountain Capital Management LLC, an energy-focused private-equity firm in Houston.

So far this year, $2 billion has been raised by energy funds investing in oil, gas and other so-called conventional-energy investments, compared with nearly $6 billion raised by renewable-energy funds, according to data compiled by Pickering Energy Partners, a spinoff.

By contrast, in 2015, nearly $50 billion was raised for conventional-energy funds, while over $10 billion was raised for renewable funds. Pension funds and other traditional investors in private-equity energy funds have cut their allocation to the conventional-energy sector to as little as 1% of their portfolios, according to Mr. Oh.

Those remaining private-equity firms are stepping up their activity, eyeing the best opportunities in years. Companies owned by EnCap, for example, operate 17 oil-drilling rigs, up from no rigs during the depths of the Covid-19 pandemic last year, and 14 before the pandemic.

In April, EnCap spent $900 million to purchase an oil producer in North Dakota’s Bakken Shale region that is expected to boost its production over the next year or so.

Pickering Energy Partners has spent about $200 million on oil-producing acreage around Midland, Texas, so far this year. The firm saw little competition and was able to pay less than $5,000 an acre, down by more than half from the price a few years ago.

A company controlled by Carnelian Energy Capital recently bought an oil-producing asset in the Permian Basin and competed with just a few rivals.

“Historically, you’d have 15 or so parties bidding on an asset like that,” says Tomas Ackerman, a partner at Carnelian.

The increased oil supply from EnCap’s companies and the remaining energy-focused private-equity firms won’t do much to add supply to the global market, according to Mr. Swanson.

Meanwhile, most investors and lenders refuse to be involved in coal companies despite surging energy prices.

“Coal is dead, it’s untouchable,” says Mr. Oh of Mountain Capital, which recently purchased an oil-and-gas producer in the Permian Basin but is among those that won’t invest in coal-related assets. “You can’t get a coal loan today; you can barely get an oil-and-gas loan, so many banks have left the sector.”

Some energy companies, including TotalEnergies SE, are taking steps to increase spending on renewable energy. Companies such as Total are more appealing to investors as they shift from oil to natural gas, says William Callanan, who runs Syzygy Investment Advisory Ltd.

Other kinds of investors are taking a fresh look at the energy sector. Hedge funds, junk-bond investors and others have begun to become concerned about accelerating inflation and see commodities, including oil-and-gas investments, as among the most attractive in an inflationary environment. Even some investment firms that are under pressure from clients to give priority to the environment have been buying energy shares lately.

But investors, who buy shares but not acreage and drilling rigs, are unlikely to do much to help boost overall energy supplies, analysts say.

Write to Gregory Zuckerman at gregory.zuckerman@wsj.com