And how can you move from a specific industry group in investment banking (oil & gas) to a hedge fund or private equity firm with a similar focus?
The answer, as it turns out, is “Modeling out ultra-deep water contracts on a ship-by-ship basis and taking into account multiple scenarios for revenue, expenses, and utilization rates.”
And if you have no idea what that sentence means but want to move to an industry-specific fund, it’s a good thing you’ve stumbled across this article.
Here’s what we’re going to cover in this in-depth interview:
- What it’s like working in an oil & gas investment banking group, and what types of deals you’ll be working on.
- How easy or difficult it is to move into private equity firms or hedge funds afterward, coming from a specialized background.
- The real way to tackle case studies, and the top mistakes to avoid – and why you never hear other people mention this part.
- What it’s like working at an energy-focused hedge fund and how it compares to banking.
Banker Begins: The Origin Story
Q: Let’s get started with your “origin story,” since it’s an interesting one.
A: Sure. I came from more of a “mixed” background than other people, and had worked full-time at a Big 4 firm (in restructuring / distressed M&A) and had completed a few internships before that.
So I was not coming into oil & gas investment banking as a bright-eyed and eager undergraduate or MBA student.
I was a lateral hire and joined the energy team of a top bulge bracket bank, originally planning to transition over to the industrials group since I didn’t want to focus on such a specialized sector.
Q: But seeing as how you stayed in the group and then moved to the energy fund, I’m guessing that you changed your mind?
A: Yeah, pretty much. It turned out that I actually enjoyed the work and got a lot more exposure to modeling and deals than other people on my team.
Originally, they were planning to put me on oilfield services deals and work with companies there – but that was shifted around and I ended up working mostly with exploration & production (E&P) companies instead and doing a lot of M&A deals, while other people on the team focused on capital markets deals.
If you’re not familiar with the industry, E&P companies are the most “different” since you use completely different metrics and valuation methodologies (NAV) when analyzing them, whereas oilfield services companies and a few others are closer to “normal” companies.
I also got to travel a lot as a result of all these deals, and that was a great experience as well.
Q: So I just heard you say a lot of positive things about your experience in this group.
I’m disappointed that you didn’t have a crazy VP or MD who forced you out… do you really have no dramatic stories?
A: Hah, funny that you mention that. I didn’t see anything quite as dramatic as a VP punching his fist through a car door window, but the office politics got to me after a while.
In banking, you always get penalized for saying that someone sucks or isn’t good at their job – and if you piss off the wrong people, you’re in trouble regardless of how much you contribute.
They like to claim that they punish you because you’re not a “team player,” but here’s what really happens:
- They hire people who don’t know what they’re doing, in the interest of “paying back favors” or “bringing a greater perspective” to the team or things like that…
- And then, those people turn out to be horrible at doing the job.
- And then when you bring up their poor performance, you get penalized.
So that’s why I decided to start exploring “strategic alternatives” – I liked the work itself and the industry focus, but couldn’t deal with the politics.
Whither the Buy-Side?
Q: So how did you go about recruiting for buy-side roles once you decided that you were set on moving in that direction?
A: I interviewed very sparingly, for a couple reasons:
- I didn’t want to just hop somewhere else for the sake of moving somewhere else – for the same reason that you have to be careful of the “rebound” phase right after a relationship ends. Yes, it might feel good at the time, but in the long-term it’s not great for you.
- I was only interested in fairly large energy-focused PE firms and hedge funds, and only in very specific sectors within those.
- I didn’t want word to get out that I was thinking of moving elsewhere.
Several headhunters actually reached out to me, and I just focused on opportunities that they presented.
This wouldn’t work as well if you’re at a middle-market or regional boutique bank and you don’t have as much visibility with headhunters – you’d have to be more proactive.
Q: That all makes a lot of sense, but I want to circle back to one of the points you raised about energy-specific funds…
I was under the impression that there aren’t too many PE firms and hedge funds that focus on investing in E&P companies due to commodity price volatility. Is that not the case?
A: That’s not entirely true. It is true that traditional leveraged buyouts are less common in the space for the reasons you mentioned: if oil or gas prices plunge, your returns could be obliterated.
But there are energy teams at the biggest private equity firms and hedge funds, and there are even a few large firms that are dedicated to energy:
- Riverstone – $22 billion fund focused on energy and power
- First Reserve – $23 billion PE fund focused on energy and infrastructure
- EnCap – $18 billion PE fund focused on the oil & gas sector
And the list goes on. So they’re out there, but you’re right that traditional LBOs are less common.
Q: So if traditional buyouts are less common, how exactly do these types of firms invest?
A: Their strategy is basically “Acquire lots of acreage and resources, and then resell them to other companies once these resources have proven somewhat viable.”
So they might acquire a piece of land, drill enough to get energy production to the level where it’s good enough to sell, and then go and sell the asset to a diversified energy company like Exxon-Mobil or an E&P-focused company.
Asset sales and divestitures are extremely common in the energy sector because it’s very expensive and time-consuming to actually go out and find new resources yourself – so acquiring reserves that have already been proven to some extent tends to be more cost-effective.
There are several firms that have become well-known for this style of investing, including Cordillera Energy Partners (1-3).
Other examples include HK (Petrohawk and now Halcon Resources) and Oasis.
Q: Great, thanks for explaining that one.
Everything you’re describing here sounds very specialized – do you think it’s harder to move to a generalist role on the buy-side after working in an oil & gas banking group?
A: Yes, it’s harder to move to a generalist role, but it can be done. My group, for example, had guys who moved to the Carlyle tech team, the TPG generalist team, and the Fortress generalist team.
But I think it’s much harder to move from a generalist role into an energy role than to do the reverse – there’s a lot of specialized lingo and modeling and valuation are very different, so you really need to know your stuff to work in this industry.
Q: Thanks for clarifying that.
I know you’ve also been through our Oil & Gas Modeling course – after working in the field for a few years now, would you say that it’s actually accurate / helpful?
A: Definitely, it’s great if you’re new to the field and need a crash course on how energy is different.
There are some things I would do differently – for example, typically you build a Net Asset Value (NAV) model for a company first, and then create the financial statements based on that.
You might also create a NAV for each individual asset a company owns, but obviously you can’t do that if the company doesn’t disclose the information in its filings.
And, of course, in real life when working on real deals you might use more detailed / specific assumptions.
But it’s great for learning about how accounting differs, how to work with reserves and production numbers, and how financial statements, valuation, and modeling differ.
The Recruiting Process
Q: Thanks, I’m glad it was helpful.
You mentioned before how headhunters contacted you about opportunities – what was the recruiting process like?
A: Sure. At the firm I ultimately accepted an offer with, here’s what happened:
- The headhunter reached out and wouldn’t even give me the name of the fund (typical), but claimed they were “rapidly growing their energy team.”
- First Round Headhunter “Interview”: Before the headhunter would even set me up with a real interview, I had to “interview” with him/her first because of my random background – even though I had a lot of deal experience.
- Second Round Interview: I spoke with 2 PMs on the phone – this interview was quite technical and they grilled me on my knowledge of oil & gas.
- Third Round Interview: I completed a case study on an E&P company that also had midstream (transportation pipeline) and downstream (distribution and refinery) assets.
- Fourth Round Interview: I met the Group Head and a few other analysts in the group. This was less technical and they focused on my “fit” with the group and whether or not I would like working on their team. They asked a few more general questions about investment ideas and how I thought about the investing process.
- Several days pass: Get used to this part.
- Yet Another Case Study: They gave me another modeling exercise, this time focused on an offshore drilling company. I didn’t have as much experience in that sector, but I was able to figure out enough to do a decent job with it.
I was also interviewing with a PE firm at the same time, but I received the hedge fund offer quickly so I didn’t continue talks with the PE firm.
Q: Thanks for describing the process in that level of detail. We’re going to jump back into what you had to complete for these case studies in a bit, but I wanted to ask a more general question first…
What were the key obstacles you faced in the recruiting process, and how did you stand out against other candidates?
A: Surprisingly, the biggest obstacle I faced was that I went to a “non-target” school and hadn’t followed the typical Ivy League –> Bulge Bracket Bank –> PE / HF –> Greatness path.
I wish I were joking, but this still came up repeatedly even years and years after I had finished undergraduate.
Headhunters are still a lot more hesitant to deal with you because they assume that if you didn’t go to a top school, you might be horrible or you might embarrass them in interviews.
So you have to be VERY selective in choosing who you work with, and go the extra mile to show them that your deal experience and technical / modeling skills are exceptional.
In terms of standing out, it’s what I just mentioned: proving that you can hit the ground running and immediately add value and contribute to getting deals and investments done by pointing to what you’ve done in the past.
You also must be extremely specific with what you want – pick an industry, geography, and firm type and size, and stick with those criteria.
You might think that my own criteria were too specific – “Large-cap E&P-focused energy hedge funds or PE firms” (I also added geography to that mix).
But that specificity actually helped because headhunters were much more likely to respond and introduce me to the right opportunities. If I had walked in there and said, “I want to work in PE!” they would have just tossed aside my resume and put it in a stack with everyone else’s.
Q: That’s a great point. You can never be too specific in the recruiting process.
What else were they looking for in interviews?
A: The will grill you on industry-specific concepts and see if you understand the nuances and are actually enthusiastic about learning more and reading up on it every day.
- They asked me how I’d look up and verify information on individual well reserves.
- They asked if I understood how intangible drilling costs would affect DD&A and the financial statements.
- They asked how you could verify management estimates / sanity-check projections with limited information.
Q: OK, so it sounds like you really need to know the specific industry in these interviews…
But what about the more generic questions? Did they ask you to pitch a stock or to explain how you think about investing?
A: Yes – and with that type of discussion, it is super-helpful to have a personal account that you trade and have traded for a long-time to show evidence that you’re passionate about investing.
No, you can’t really do much investing when working at a bank because lots of securities will be restricted – but you can come up with ideas and act on them before you start working. And you need to do that to prove your interest and commitment.
Having proof of what you’ve done is also good – if you claim to have earned impressive returns, some places will actually ask you for a screenshot or account statement or something like that to verify. Anyone can walk in and claim 200% returns, but few people can back it up with evidence and explain how they did it.
In interviews, it’s also common to get questions on companies that you know nothing about and have never worked with before.
So they might say, “General Electric vs. Honeywell – which one would you invest in and why?”
Do not give an actual answer right away. Instead, you want to talk about the criteria that you’d need to make a decision and how you’d go about gathering the data.
So you might ask, for example:
- What markets are the companies in, and what’s their position in them? Are the markets growing or shrinking? How is the competition doing?
- What drives the company’s revenue and expenses? What do their historical and projected growth and margins look like?
- How are they valued vs. the peer companies? Could anything drive their valuation higher or lower?
Case Studies 101
Q: And I’m guessing that all of those questions are also important to address in case studies as well.
You mentioned receiving two case studies, one on an E&P-focused company and one on an offshore drilling company.
What exactly did you have to do for both these case studies and what was the format?
A: Sure… the basic format was:
“Here’s Company X, currently trading at such and such per share. Should we invest in it? And if so, why, and at what price? And if not, why not, and at what price would it be a good investment?”
The most common mistakes:
- Failing to properly explain your assumptions – for oil & gas, for example, you need a very strong view on where commodity prices are heading and you need to be able to back that up in your discussion.
- Not being granular enough – if you’re projecting revenue as a percentage growth rate, for example, that won’t be enough detail to satisfy them unless it is a very quick, time-pressured case study where they tell you to do that.
- Not making a decision one way or the other – you can’t say, “Well, maybe…” in investing. You have to reach a firm Yes / No decision.
So let me start with how I approached the first case study, on the E&P company.
Step 1 was breaking it down into the different regions they operated in, and projecting how many wells they would construct in each region.
Then, I created a type curve / single well model for an “average” well in each region, and then I applied different risking to each of the specific areas – so if one area was more proven, maybe it would get an 80% reserve credit vs. another area that was less proven that would have received a 60% reserve credit.
Next, I split the production into different categories based on the Proved vs. Probable vs. Possible categories in each of those regions.
Once all that is in place, you estimate the annual production each year, project how much it declines by as the reserves run out, calculate the expenses associated with each well, and sum up everything over the entire region.
Then, you discount all the after-tax cash flows to find the net present value of the reserves in each region, add those up, and then add in other assets such as midstream (transportation) and downstream (refining) and make the normal balance sheet adjustments to calculate NAV and NAV per Share.
So at the end of this analysis, you’ve calculated a range of values for NAV per Share and you can compare that range to the company’s current share price to determine whether it’s overvalued, undervalued, or valued appropriately.
That range is based on different cases for commodity prices and perhaps different assumptions for long-term production decline rates, among other factors.
Q: OK, so you just mentioned what sounded like a very complex exercise here.
And you actually sent me the Excel model you used, so I see how complex it is.
How can you possibly build something this granular in the span of only a few hours? It would take days to replicate the model you used.
A: That’s true, and it really depends on the nature of the case study and how much time they give you.
If you don’t have that much time, simplify and focus on the key drivers rather than going into a ton of granular detail.
So maybe instead of splitting out all the wells by region or reserve type, you just model 1 or 2 separate locations in your NAV and combine that with production multiples for some areas, acreage multiples for other areas, and something as simple as an EBITDA multiple for the other segments like midstream.
The most important thing with these case studies is to show them that you understand how to break down and analyze a company’s operations, even if you don’t have enough time to do it in extreme detail.
It’s also very important to include scenarios in a case study like this – whenever you’re dealing with commodity prices (oil, gas, mining, etc.) – because they make a huge impact on the implied valuation and your investment recommendations may be completely different depending on commodity prices.
But you don’t need the extreme amount of detail I went through – if you’re under time pressure, simplify, don’t create as many granular projections, and show them that you’ve at least thought about different scenarios.
Q: I think a second major problem, though, is where to find all this information.
Companies don’t exactly break out everything you’ve described in their annual filings.
A: Sometimes yes, sometimes no.
It’s true that you may have to go beyond the filings at times and look at investor presentations, equity research, and so on – and it’s actually a good idea to review all of those just to check your own numbers and see if you’re coming up with ranges that make sense.
Many oil & gas companies do actually disclose reserves, wells drilled, and production by location, but you’re right that they may not include 100% of what you need.
So a lot of it does depend on the company and how much they’ve chosen to disclose – the company I valued gave a lot of information in their filings and I found more via a recent investor presentation and equity research.
Q: OK, I see. So do the best you can with the information you have available, but if it’s not there, don’t kill yourself trying to get the numbers.
What about the second case study on the offshore drilling company?
A: Sure… that one was a little more straightforward and it’s also easier to explain.
The format was similar: “Here’s an offshore drilling company, currently trading at $X Per Share. Should we invest?” So once again, you need to determine whether it’s overvalued, undervalued, or valued appropriately.
I split it into the ultra-deep water (UDW), deep water (DW), and jack-up segments, and determined a “day rate” (i.e. how much money each type of ship makes per day), a utilization rate, and daily expenses for each category, all based on what was in the company’s most recent filings.
Then I used the company’s “fleet status report,” a supplementary document that lists all the rigs and the categories for each one, to calculate yearly revenue and expenses on a per-rig basis.
It was not terribly complicated: you simply take the daily revenue and expenses and multiply by the days in the year, maybe factoring in inflation over time as well.
I also used scenarios for this one and included Base, Downside, and Upside cases. The expense profile was the same in each case (reflecting reality), but the daily revenue and utilization rates were slightly higher in the Upside case and lower in the Base and Downside cases.
Then, I created a DCF analysis that pulled in revenue and expenses from this buildup and went through the normal steps of projecting and discounting the cash flows and the Terminal Value at the end.
Q: That sounds too easy. Are you sure this was a real case study, or are you just making stuff up now?
A: Hah, good one…
It was definitely more straightforward. But there were a few tricky parts:
- Getting the CapEx correct and splitting it into Maintenance vs. Growth CapEx – since some of the rigs had yet to be completed. So the earlier years were more CapEx-heavy, and in the later years the spending moved more toward Maintenance CapEx.
- Factoring in planned asset sales – yes, you need to include these in a DCF. They only existed in a few early years, but if a company mentions that it plans to sell a specific asset in its filings, you need to include it and reflect the cash inflow.
- Properly constructing and defending my assumptions – a few other candidates attempted to complete this case study, but made much simpler assumptions for revenue growth or did not take into account factors like the completion of new rigs, the higher upfront CapEx, and so on.
Q: So let me stop you right there – how would you defend something like the numbers you used for your different cases here?
A: I mostly based them on the company’s historical numbers. So for the Base Case, I looked at the Daily Rate over the most recent quarter.
And then for the Downside and Upside cases, I looked at historical data further back and used the general range that the rate was in over time to get those.
You don’t want a super-wide range for these or the analysis doesn’t mean much; my numbers were about 10-15% different in each case.
On the Job and the Future
Q: Great, thanks for describing these case studies in such detail. I think everyone but the hardcore oil & gas geeks has had enough by now, so let’s move on…
Any thoughts on your new job at the hedge fund so far?
A: Admittedly, I haven’t been here that long yet, so don’t take my views as “the inside scoop from a seasoned industry veteran.”
But my main impression is that it’s far less structured than banking.
That’s quite challenging because it’s easy to find yourself sitting around and doing nothing but surfing the web… when in reality, you need to be generating investment ideas.
If you’re not constantly thinking of new ideas, looking into opportunities, and doing research and due diligence yourself, you’ll never make it here.
It’s not like banking where they just give you tasks and you have to execute everything.
Q: But it sounds like you like it more, despite the added challenges?
A: I like getting to dig into companies and understand what makes them tick.
Let’s say you come up with a long / short equity idea… you could go and call up investor relations for that company, meet with management, or even fly out to their headquarters and do a deep dive on everything you want to know about.
So it’s different from banking where you often just go with what the client wants to see and don’t do as much critical thinking.
Q: Any downsides so far?
A: Not really, though I do miss the team environment you get in banking.
You don’t really see that as much here – you’re flying solo a lot of the time and don’t necessarily collaborate with others as much.
On the other hand, that also means that I get to avoid the office politics that were driving me crazy as well.
I have no plans to leave anytime soon, as I really like the industry and enjoy working with these types of companies.
Q: Awesome! Thanks for such an in-depth interview.
A: My pleasure.