American Oil and Gas Reporter - July 2020 - 39

Q:

You have indicated that Tailwater sees some of the most
compelling buying opportunities in years on the nearterm horizon. As difficult as conditions are, what types of opportunities
do you see emerging as industry activity starts to recover? How do
you expect capital constraints to factor into the equation?
DOWNIE: "Compelling" has a couple different meanings
for us, but they share the common definition of generating high
risk-adjusted rates of return. The question is how to accomplish
that. Should it be organically through green-field projects or by
acquiring cash-flowing assets? The risk profiles are very different.
We seek to accomplish high rates of return by deploying capital
in lower-risk assets with existing cash flows, but that also
provide rates of return similar to green-field projects.
Access to public capital has been meaningfully reduced. When
capital access is limited, private equity usually fills the gap. Even
before the COVID-19 crisis, we were seeing the start of a cycle
in which cash-flowing assets with contracts in place could be
bought at favorable valuations. Continued post-COVID capital
constraints will only amplify opportunities over the next six-12
months. Those opportunities can take many forms, but if you can
buy good assets at today's valuation levels and capitalize them
right, the potential returns on those investments can be significant
over the longer term, even if demand is slow to fully recover.
We are optimistic that the unfortunate event of COVID-19 will
lead to business rationalizations that needed to happen regardless,
and that ultimately will provide a more solid foundation of certainty
for the entire oil and gas sector, including the midstream. That
would be a healthy long-term outcome for the industry.

Q:

Since its inception in 2013, Tailwater's portfolio has been
weighted toward the midstream. How do individual prospective investments differ for Energy Fund IV than for those targeted in
Tailwater's previous three funds? To what degree do you envision
Energy Fund IV supporting exploration and production companies?
DOWNIE: U.S. shale plays are entering a manufacturing
mode. In any manufacturing business, scale and/or vertical integration are important to becoming a low-cost producer. When
the products are hydrocarbons, which do not have much brand
or technological differentiation, scale and integration are everything.
The onshore U.S. market is undergoing a period of consolidation
and rationalization. Energy Fund IV investments will concentrate
on midstream infrastructure in the plays that are most competitive
in terms of how they stack up to global supply basins.
When I think about gas, it's hard not to like the Haynesville,
and there are still opportunities in the Marcellus/Utica. For oil, the
Permian Basin clearly has a long inventory runway and low
breakeven costs. We also have been incredibly pleased with how
resilient the Bakken has been through the last two downturns. For
small and mid-sized producers, the Denver-Julesburg and Powder
River basins have very good economics. And I can't forget about
the Eagle Ford.
Tailwater's E&P Opportunity Funds invest in nonoperated
producing wells. It has ownership in close to 800 wells, all on

shore. That business exists because shale plays have good rates
of return when investing with the right operator. As a middlemarket player, we are not out to create a large exploration,
drilling and production company, but participating in a large
E&P company's wells is a great outcome for us.
We continue to look outside of the core midstream to participate
more in follow-on downstream projects. While under pressure
because of COVID-related demand destruction, the petrochemical
and refining markets have the capacity to remain very competitive
globally because of the huge reserve profile of the U.S. onshore.

Q:

Studies by the Interstate Natural Gas Association of
America and others suggest that new midstream infrastructure spending has peaked. How do you see build-out opportunities going forward? What role will private equity play in
financing the next generation of projects?
DOWNIE: There will continue to be green-field infrastructure
projects, although they will tend to be smaller and basin-specific.
For example, we recently participated in a transmission line
project on the Texas side of the Haynesville/Cotton Valley for
Sabine Oil & Gas, which is an independent operator that is
majority owned by Osaka Gas Co. The interesting dynamic in
shale plays is that there is always a need for additional capital deployment for infield gathering, compression, saltwater disposal
and other facilities as acreage is developed. Even though there is a
lot of existing infrastructure, there will be a need for new projects.
The other major role for private equity is in rationalizing capacities. We are starting to see a wave of consolidation in both
the upstream and midstream as noncore assets are rationalized
and operations are consolidated. Private equity historically has
been a facilitator of the rationalization process, and we expect
Energy Fund IV to play a role in midstream aggregation, which
will mutually benefit the upstream side as well.

Q:

What makes a management team attractive to Tailwater?
What particular factors do you look for in an investment?

DOWNIE: We pride ourselves in creating a culture of alignment,
transparency and partnership. The executives in our portfolio
companies are not employees; they are partners. Our goal is to
support them in making decisions, particularly capital deployment
decisions. We are deliberate in committing to only a few teams in
a basin to foster an environment where management teams feel
confident that Tailwater is aligned with their success and they are
freed to execute their business plans. We want our teams collaborating to create value instead of competing against one another.
Creating proprietary deal flow and being a first mover are
crucial in the midstream sector. Let's face it, midstream
companies aren't winning many new technology awards. Value
often is created when teams have historical experience in a particular basin or vertical segment, which gives them competitive
advantage. To fully leverage that, we try to put an incentive
structure in place that is completely aligned with our management
partners so we are all pulling the oar in the same direction. ❒
JULY 2020 39
American Oil and Gas Reporter - July 2020

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