Capital Allocators – Inside the Institutional Investment Industry Episode: Striking Oil – CrownRock by Lime Rock Capital (EP.428) Release Date: January 20, 2025 Host: Ted Seides
In this compelling episode of Capital Allocators, host Ted Seides delves into one of the most monumental private equity deals in the oil and gas sector—Lime Rock Capital's CrownRock investment. Joined by Lime Rock Managing Directors John Reynolds, Jonathan Farber, and Jay McLean, Seides unpacks the strategic decisions, challenges, and triumphs that culminated in CrownRock's extraordinary success.
1. Introduction to the CrownRock Deal
Ted Seides opens the discussion by highlighting the sheer magnitude of Lime Rock Capital's CrownRock investment. Initiated in 2007 with $96.5 million in cash and assets, the deal culminated in a staggering $12.5 billion sale to Occidental Petroleum 17 years later. This investment not only yielded a 79x return and a net IRR of 18% but also secured a spot among the top 10 fully exited private equity deals of all time.
Ted Seides [05:31]: “Our conversation covers LimeRock's investment approach and the example of CrownRock. We dive into the initial investment thesis around vertical drilling, the three extinction threats to the business, innovation in horizontal drilling, management excellence, exit options along the way, and the forever hold mindset that allowed Crown Rock to compound extraordinary amounts of capital.”
2. Background of Lime Rock Capital and Its Leaders
John Reynolds and Jonathan Farber share their professional journeys, tracing their roots back to Goldman Sachs' robust oil and gas research groups. Their shared experiences and mutual interests in the energy sector laid the foundation for founding Lime Rock Capital.
John Reynolds [07:37]: “The Goldman experience, for both of us, it was a very unique place culturally in the 90s...”
Jonathan Farber [05:41]: “I went to the Georgetown School of Foreign Service...”
Jay McLean, whose background in Midland, Texas, complements the investment team, discusses his transition from a mid-sized oil and gas company's M&A group to Lime Rock.
Jay McLean [11:15]: “I started my career at a mid-sized oil and gas company in Midland, Texas...”
3. Investment Approach and Strategy
Lime Rock Capital's strategy centered on investing in highly focused, small-cap energy companies that emphasized operational excellence. Inspired by the Canadian oil and gas sector's venture-like approach, Lime Rock opted for capital-efficient growth through land leasing rather than acquiring large, spread-out assets.
Jonathan Farber [12:59]: “The core concept is something that both John and I really saw firsthand at Goldman...”
By leasing land directly from ranchers and mineral owners, Lime Rock minimized entry costs and maximized returns, despite the labor-intensive nature of this approach.
4. The CrownRock Investment Thesis and Structure
The CrownRock investment was a joint venture named Crown Quest Operating, symbolizing the partnership between Lime Rock (“Rock”) and Crown Quest. The initial investment thesis revolved around vertical drilling in promising shale plays, particularly the Wolfberry play in the Permian Basin.
John Reynolds [15:04]: “Crown Quest Operating, which was the name of the company that we formed a joint venture with...”
The company's strategy was to identify and develop high-grade acreage with the potential for significant oil recovery, leveraging advancing fracturing technologies.
5. Navigating Industry Crises
CrownRock's journey was punctuated by three major industry-wide crises:
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The 2008 Global Financial Crisis: Oil prices plummeted, but Lime Rock's prudent risk management, including hedging 90% of crude oil production, provided resilience.
Eric Saiz [16:42]: “We had already sold forward in the financial markets 90% of our next year's crude oil production...”
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OPEC's 2014-2015 Price War: Saudi Arabia's aggressive strategy led to a 50% drop in oil prices, yet CrownRock's focus on the resilient Permian Basin and efficient operations allowed continued growth.
Eric Saiz [24:37]: “That moment where Saudi said, we can punch you out of business whenever we want, really focused the industry...”
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The 2020 COVID-19 Pandemic: Oil prices briefly turned negative, but operational efficiencies implemented prior ensured long-term viability.
Eric Saiz [24:37]: “Two thirds of those operational efficiencies that we really focused on and gathered then persisted for the years after the pandemic...”
Throughout these turbulent periods, Lime Rock maintained a less leveraged capital structure and employed aggressive hedging to weather downturns without compromising growth.
6. The Forever Hold Philosophy
A defining aspect of the CrownRock deal was Lime Rock's "forever hold" mindset. Unlike typical private equity investments with finite lifespans, Lime Rock and CrownRock operated with a long-term vision, aligning interests between investors and the management team.
John Reynolds [28:08]: “The management team philosophy was a forever hold philosophy...”
This approach fostered decision-making based on long-term value creation rather than short-term gains, enabling strategic investments in horizontal drilling and technological advancements.
7. Exit Strategy and Sale to Occidental Petroleum
Despite the initial "forever hold" philosophy, market dynamics and strategic considerations eventually led Lime Rock to explore an exit. In 2023, recognizing peak valuation points and limited additional upside, Lime Rock marketed CrownRock to select firms, culminating in a competitive sale to Occidental Petroleum.
Eric Saiz [48:37]: “We marketed it to a handful of firms that could take down a deal this size...”
The sale was smooth, with Occidental recognizing CrownRock's operational excellence and strategic fit within their portfolio.
8. Postmortem and Key Takeaways
The discussion underscores the importance of simplicity in deal structures and the critical role of a disciplined management team. Lime Rock's success hinged on minimal leverage, strategic land leasing, and a commitment to operational efficiency.
Jonathan Farber [49:29]: “We put together a simple structure around this deal...”
Additionally, the alignment between Lime Rock and CrownRock's management, underpinned by mutual ownership, was pivotal in sustaining long-term growth and navigating market challenges.
9. Industry Shifts and ESG Considerations
The episode addresses the transformative impact of the shale revolution, highlighting how Lime Rock's CrownRock investment not only capitalized on technological advancements but also contributed to broader environmental shifts by displacing coal with natural gas.
Eric Saiz [53:02]: “CrownRock as an investment essentially spanned the entire history of oil shale development in the US...”
Despite the rise of ESG considerations, Lime Rock adapted by spawning separate strategies for new energy initiatives while maintaining high operational standards within their core oil and gas investments.
10. Impact of Success on Lime Rock & Future Investments
CrownRock's unparalleled success has influenced Lime Rock's investment philosophy, emphasizing risk-adjusted returns over sheer ROI metrics. The firm now navigates a more competitive and cash-generative market, adjusting expectations while maintaining rigorous investment criteria.
Jonathan Farber [61:03]: “...we're very driven by conditions in the industry today and ironically that is probably creating an overall lower ROI scenario, but one which on a risk adjusted basis we think is among the most attractive periods of investing that we've seen.”
11. Closing Thoughts and Personal Insights
The conversation concludes with the guests sharing personal anecdotes, favorite aspects of private equity, hobbies, and valuable life lessons. Their reflections emphasize the importance of long-term relationships, strategic decision-making, and continuous personal growth.
John Reynolds [61:09]: “The thing that I love about private equity is you have the opportunity to roll up your sleeves...”
Eric Saiz [62:53]: “I like concerts, live music as much as possible.”
Conclusion
Lime Rock Capital's CrownRock deal stands as a beacon of strategic foresight, disciplined investment, and resilient management within the private equity landscape. This episode provides invaluable insights into navigating complex markets, aligning interests for long-term success, and adapting to industry shifts. For investors and industry enthusiasts alike, CrownRock's story serves as a masterclass in capital allocation and investment excellence.
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