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Stanford GSB News

 

Energy Could Be a 21st-Century Boom Industry

November 2004

STANFORD GRADUATE SCHOOL OF BUSINESS—The search for alternative energy sources could rival the Internet boom of the 1990s in terms of opportunities for investors and entrepreneurs, a speaker told the inaugural Stanford Business School Energy Conference.

"It has been the technology of tomorrow every day for the past 20 years," joked Andrew Beebe, president of Energy Innovations, referring to the proliferation of solar energy and other alternatives to fossil-based fuels. Developing alternative, renewable energy sources—such as solar power—represents an even more captivating investment opportunity than the Internet, he said. "First of all, this is a business in which you're making products. It's a very tangible business with revenues that are relatively easy to track, unlike many of the Internet companies that sprouted up in the 1990s." Solar power also is a highly cost-effective energy source; every time production doubles, the cost of production drops by 20 percent, he said.

Organized by the school's student-run Energy Club, the Nov. 10 conference boasted an impressive roster of speakers that included industry leaders, investment bankers, private equity investors, and venture capitalists who outlined the challenges and opportunities of meeting the increased global demand for affordable energy.

"As 2004 draws to a close, we're finding ourselves in uncharted territory where energy is concerned," said Matthew Simmons, chairman and CEO of Simmons & Co., a Houston-based investment banking firm focused exclusively on the global energy industry. "Prosperity and poverty are driving demand for energy, and the rate of population growth means that demand will soon surge above supply." Oil is now the world's single largest energy source, but there are numerous obstacles to expanding the oil supply and none is easy to correct, he said.

"Unconventional energy resources [coal bed methane, oil sands, and deepwater oil and gas] will become the conventional resources of the future," predicted Charles Williamson, chairman and CEO of Unocal Corp. "Natural gas will become an increasingly important part of the energy mix over the next several years, supplying about 25 percent of the world's energy needs by the year 2020," he added.

The energy industry always has been both a capital—and risk-intensive business, one in which long project lead times, price volatility, and geopolitical uncertainty make forecasting notoriously complex. In today's competitive landscape, the need to understand conventional energy sources better—and develop unconventional sources faster—means that the industry's capital requirements and risk profile are only increasing. "I can't think of an industry where more complex commercial and technical issues come into play," said Williamson, "and the industry is becoming much more high tech, which means that energy businesses and investors alike are forced to make even bigger bets than they have historically."

As the energy business becomes more technologically advanced, energy companies require more capital—including human capital—to locate and develop untapped resources wherever they may be. "This is an old industry," said Williamson, "and we desperately need innovators in this business to replenish the talent we're losing." Simmons agreed: "The average age of people in this industry is 48 to 50, and new talent isn't coming in fast enough. This will take a few decades to correct."

Faced with this reality, private equity firms and venture capitalists must rely heavily on the existing technical and managerial expertise of the companies in which they invest. "We look to back companies with top-notch management teams who have the technical expertise to reinvest cash flows effectively," said William Quinn, MBA '98, a managing director at Natural Gas Partners, a Dallas-based private equity firm that backs relatively small, entrepreneurial companies in the energy sector.

Quinn's colleague, Kenneth Hersh, MBA '89, explained the investment philosophy that NGP uses to evaluate potential opportunities. "Playing commodity prices doesn't make a business," Hersh said, referring to the strategy of investing in companies whose success depends on increasing oil and gas prices. "To be successful, you have to consider the enterprise as a business, not as a trade, and your focus should be on return on equity rather than buying low and selling high." Timing is important, too. "Among the early entrants to a new opportunity, 9 out of 10 will probably make money," estimated Hersh. "The later you come to the game, the less likely you are to realize big returns."

With the industry's risk profile, capital requirements, and technological demands increasing, the challenges of meeting the global demand for energy seem daunting. However, speakers stressed that these industry trends create real opportunities for the investors, entrepreneurs, and future industry leaders willing to tackle them. "If we don't meet this challenge," warned Simmons, "the world will be a darker place, and we'll wonder why on earth we waited so long." On the other hand, if the industry does rise to the occasion—and if experts like Hersh and Beebe are right about the importance of investing in energy innovations early—then many will wonder why on earth they waited so long to get involved.

—Lisa J. Vollmer