OGInterview: Building EIV Capital’s Midstream Investment Strategy

Patricia “Patti” Melcher, EIV Capital co-founder and managing partner, came to oil and gas private equity via investment banking in Houston. But the road to EIV’s formation in 2009 was a winding one. Her first foray into the field came in 1986, when oil traded for $9/bbl and she was working for Simmons & Co.

“I got a really good education quickly into which companies survived and which ones didn’t,” she told Oil and Gas Investor (OGI). “I just really love being in the energy industry. It is always something different, and it's never boring.”

She went to work in private equity in 1989 with SCF Partners founder L.E. Simmons, investing capital, watching investments grow and engaging with management teams—work that she loved, but took a temporary backseat to caring for her two children, one of whom had special needs. While working "part-time” for about 50 hours a week, she founded The Joy School in Houston, a K-8 school that assists students with learning differences in their journey to traditional classroom settings.

Through her part-time consulting work, Melcher developed a rapport with Anthony “Tony” Annunziato, and together, they founded EIV Capital in 2009.

“It was a good time to get back into energy private equity,” Melcher said. “We started with $50 million as our first fund and then used that track record to then go raise institutional capital for Fund II. Tony basically backed me as a management team as he had backed others in the energy companies. And so here we are. We have grown quite a bit. We started investing $2 [million] to $12 million [into] each fund, and we always needed more capital. Now we typically invest $50 [million] to $150 million of equity per investment, with the ability to go higher.”

EIV Capital partner and CEO of EIV Resources, Claire Harvey, strode a more traditional path toward oil and gas investing. Her grandfather was a landman for Southland Royalties; her father was a four-time private equity-backed wildcatter, making Harvey a third-generation oil and gas investor.

“This was a family business. I'm an only child, and so I remember very vividly in 1987, my dad drilling his first prospect on his own, called Vermilion 117, and I was asleep on the two seat cushions in his office,” she told OGI. “My parents looked at me and my mother started crying and she said, ‘Today's a good day.’ It was probably 1 o'clock in the morning, and our lives had changed.

“That is what really drew me to the business—not just following in anyone's footsteps—I really liked the energy of the oil and gas business.”

Harvey joined EIV Capital in 2022 to lead the upstream, non-operated interest investment business as chief of EIV Resources. An industry and investment veteran even then, she had previously founded Gryphon Oil and Gas, a Blackstone-backed firm focused on non-operated oil and gas interests in the Permian Basin.

Together, the two women lead energy private equity investing throughout the energy value chain with focuses on midstream infrastructure and non-operated assets. Melcher and Harvey talked with OGI this spring about the opportunities ahead for private oil and gas endeavors as well as their financial backers.

Starting in the middle

Prior to 2021, EIV had no exposure to the upstream space but post-COVID, things began looking a bit different, Harvey said.

“The upstream investment landscape finally looked a lot more from a risk adjusted returns basis, a lot more like what EIV had historically done from an investment perspective, less risk, you can protect principal for your investors a lot better, and we do that by buying things,” Harvey said. “So we can buy cash flowing assets for lower multiples than we used to, so our payback periods are lower and we can hedge the commodity price exposure.”

The first fund has grown significantly. From early investments between $2 million to $12 million, EIV’s typical backing today is between $50 million and $150 million in equity.

“It's all for growth,” Melcher said. “We like to find a management team and back their business plan. Ten years ago, most of these teams were focused on developing greenfield midstream infrastructure projects. Today, we are more likely to acquire existing, cash-flowing assets, which our management teams can then focus on growing further.”

EIV was also an early mover in the renewables space, but the projects generally had a midstream element.

“Our first renewable deal was a landfill gas-to-energy project in 2010. It looked just like a midstream project with a gas processing plan, a pipeline, some engines and long-term contracts—but the methane came from a landfill instead of an oil and gas well,” she said. “We've done a good job in investing in both traditional and transition.”

EIV’s earliest investments were in the midstream space, where principals’ investment had some built-in protection through long-term contracts or offtake agreements, Harvey said. Similarly, the firm looks for ways to protect upstream investors in cash-flowing assets, often through hedging.

“It plays a big role, and the only way you can hedge is if you actually have forecasted volumes and in the form of wells that are already drilled that you can actually hedge,” Harvey said. “If the volumes didn't show up [from new wells] and oil prices go up, then you might owe your hedge counterparty money that you're not receiving from the wells themselves. Really what we invest in here at EIV is a lot more production heavy, so it's wells that already exist.”

Melcher said the firm buys non-operated working interests, and then hedges much of the commodity exposure for the next few years to protect principal “and make it look a lot more like a midstream investment.”

In a midstream deal, EIV would look for a contract that has minimum volumes or minimum cash flows, and then use our management teams’ commercial expertise to go find new volumes, use their operational expertise to optimize, or say if it's a gas processing plant, to better reduce its emissions.

A midstream investment would be supported by contracts. But given the current commodities market, a clearly defined hedging strategy can replace those contract structures, she said.

But we would do it, typically we'd have contracts. And so given the market and clear strategy using hedges, replaces those contract structures

In 2022, EIV Capital underwrote Harvey’s ARM Resource Partners using the hedging strategy to protect its downside risk, and the portfolio company performed well, Melcher said.

“We deployed a lot of capital pretty quickly, and so then we worked with Claire and we were able to convince her to bring her team inside EIV,” she said, which created a new investment platform called EIV Resources, which Harvey leads.

“That has allowed the collaboration with Claire and her team, which is very technical and that brings a broader array of expertise into EIV, which we are very excited about,” Melcher said. “Her team is focused on the upstream investing, but her team helps us evaluate the rock under our midstream investments or to think about share insights from how they look at things with our team and vice versa.”

The competition

New private equity firms are emerging to fill a financing void within the traditional midstream and upstream spaces created by the emergence of anti-fossil fuel investor movement, which now appears to be on the wane.   

“Right after COVID, it felt like no one was ever going to invest in oil and gas again; the pendulum is starting to swing the other way,” Harvey said. “I think institutional investors have looked at how well the publics have performed in terms of return on capital employed in terms of distributions, and so that's making people want to come back. They see that there are good returns possible.”

Also, the public is acknowledging that the transition will take a lot longer than envisioned a couple of years ago, Melcher said.

“There's still a number of institutional [limited partnerships] who will not touch oil and gas—or maybe they won't touch upstream, but they'll do midstream,” Melcher said. “The capital discipline has been one of the best things for the industry I've ever seen, and that is all driven by investors.”

Today there are opportunities to investor and financiers who want to engage, she said.

“It's just such a different environment when you don't have that capital just sitting around waiting to invest. It's created so much opportunity in the space, and it's repriced risk a lot,” Melcher said. “And so risks that we used to take, we used to take for a lot lower return risk profile that we take today. We have to take less risk for the same return or we take the higher risk stuff and get much higher returns.”

Some investors may feel like they’ve missed out by sitting on the sidelines.

“People are actually taking phone calls,” she said, adding that it’s a sign of renewed interest.

Still, it will be a “gradual evolution back to traditional energy investing, but I don't think it'll be near as much as it was five years ago.”

But even that point isn’t a negative one because capital needs have changed, too.

As unconventional drilling took hold of the industry, new infrastructure, pipelines, processing and terminals were needed—and those were pricey midstream endeavors. Today, the space is dominated more by expansion than new projects. Similarly, the well costs and input expenses for hydraulic fracturing have come down as technology allowed producers to innovate their way to capital discipline.   

Harvey summed up the industry forecast: “We do not believe that oil and gas is going away today, which is why we invest in it. We also don't believe it's going away tomorrow. I'm not sure we believe it will ever go away in its entirety. There will always be a need for it, but we believe in the transition as well.”