Highland hits market with $200m oil and gas effort

Highland Capital Management is raising an oil and gas fund in partnership with commodities investment firm PetroCap that is targeting $200 million and comes with some LP-friendly terms.

The fund, called Falcon E&P Opportunities Fund, has a $300 million hard cap. Management fees on the fund are set at 1.25 percent. The fund’s principals expect a first close at the end of June or early July, and hope to hold a final close by the end of the year.

The San Diego County Employees Retirement Association, which made a $75 million commitment to the fund last week, negotiated carried interest down to 15 percent from 20 percent as part of its commitment. San Diego was the first LP to make a commitment to the fund.

The Falcon fund will invest in domestic, onshore oil and natural gas projects that have current production and cash flow. The fund will invest in the smaller end of the market, where the recession has left “a lot of good projects stalled, a lot of good operators that lost their financing”, according to Lane Britain, a manager with Highland, who leads the firm’s natural resources private investment programme. Britain, who was speaking to SDCERA’s investment board 3 June, will be a director for the Falcon fund.

The partners are targeting a 30 percent internal rate of return for the fund, a return that will have two components. About half the return will come from wells that are already producing oil and making money, with LPs receiving distributions from the current production, Britain said. The balance of the 30 percent return will come from digging new wells, Britain said.

“In essence, we’re exiting investments every day in oil coming out of the ground,” he said. “By buying current production, we put a floor on the downside. If oil and gas prices fall off a cliff tomorrow, you don’t have to worry about losing your money.”

Falcon’s principals believe the opportunity to make money in the oil and gas sector is growing.

“We’re running out of oil. I don’t believe we’re going to have zero oil, but we’re running out of cheap oil,” Britain said during the investment presentation last week. “Despite the offshore fields in Brazil, it doesn’t matter. We use 85 million to 90 million barrels a day here. We have to do that just to barely keep up.”

Natural gas prices will go up as the production glut of the past few years slowly fades. “We’ve oversupplied ourselves … that rapid decline curve will push us back to a flat situation in the next two years,” Britain said. Demands on electricity, especially with the development of automobiles powered by electricity, will put more demand on natural gas, he said.

Dallas-based Highland is well-known for its activities in credit and distressed investing. The firm manages more than $27 billion in senior secured loans, high yield bonds, structured products, mezzanine debt and equities.