From $2 billion to zero: A private-equity fund goes bust in the oil patch

Oil barrels in Colorado FBN

A $2 billion private-equity fund that borrowed heavily to buy oil and gas wells before energy prices plunged is now worth essentially nothing, an unusual debacle that is wiping out investments by major pensions, endowments and charitable foundations.

EnerVest Ltd., a Houston private-equity firm that focuses on energy investments, manages the fund. The firm raised and started investing money in 2013, when oil was trading at more than double the current price of about $45 a barrel. But the fund added $1.3 billion of borrowed money to boost its buying power. That later caused it trouble when oil prices tumbled.

Now the fund's lenders, led by Wells Fargo & Co. (NYSE:WFC), are negotiating to take control of the fund's assets to satisfy its debt, according to people familiar with the matter.

"We are not proud of the result," John Walker, EnerVest's co-founder and chief executive, wrote in an email to The Wall Street Journal.

The outcome will leave investors in the 2013 fund with, at most, pennies for every dollar they invested, the people said. At least one investor, the Orange County Employees Retirement System, already has marked its investment down to zero, according to a pension document.

Though private-equity investments regularly flop, industry consultants and fund investors say this situation could mark the first time that a fund larger than $1 billion has lost essentially all of its value.

EnerVest's collapse shows how debt taken on during the drilling boom continues to haunt energy investors three years after a glut of fuel sent prices spiraling down.

At its onset, the oil bust was expected to cause widespread losses for private-equity investors. While most funds have been able to navigate the downturn and are hanging on for higher prices, there have been pockets of acute pain. EnerVest's struggles have been among the most severe.

Only seven private-equity funds larger than $1 billion have ever lost money for investors, according to investment firm Cambridge Associates LLC. Among those of any size to end in the red, losses greater than 25% or so are almost unheard of, though there are several energy-focused funds in danger of doing so, according to public pension records.

EnerVest has attempted to restructure the fund, as well as another raised in 2010 that has struggled with losses, to meet repayment demands from lenders who were themselves writing down the value fund of assets used as collateral, according to public pension documents and people familiar with the efforts.

Mr. Walker in an interview last year said he and his partners put $85 million of their own money toward satisfying the banks, but it wasn't enough.

A number of prominent institutional investors are at risk of having their investments wiped out, including Caisse de dépôt et placement du Québec, Canada's second-largest pension, which invested more than $100 million. Florida's largest pension fund manager and the Western Conference of Teamsters Pension Plan, a manager of retirement savings for union members in nearly 30 states, each invested $100 million, according to public records.

The fund was popular among charitable organizations as well. The J. Paul Getty Trust, John D. and Catherine T. MacArthur and Fletcher Jones foundations each invested millions in the fund, according to their tax filings.

Michigan State University and a foundation that supports Arizona State University also have disclosed investments in the fund.

None of these investors commented. It is possible some of them earlier sold their stakes in the fund, paring losses.

In the earlier interview, Mr. Walker said the struggles of EnerVest's 2013 and 2010 funds had sparked ire among his investors: "We've had some chew us out and hang up on us."

EnerVest was launched in 1992 and says it operates more U.S. oil and gas wells than any other company. It started out investing for GE Capital, General Electric Corp.'s (NYSE:GE) finance arm. Eventually it began pooling other big investors' cash, which it used to buy producing oil and gas wells. EnerVest hunted for fields already producing oil and gas but neglected by big oil companies. Once EnerVest bought them, it made improvements and drilled more to increase output.

The strategy isn't as risky as staking wildcatters or borrowing heavily to buy entire oil companies, but profits are usually lower. To juice returns, however, funds managed by EnerVest and rivals that shared the strategy borrowed money as if they themselves were oil companies, encumbering all of the funds' assets with the same debt.

Doing that eliminates a key protection for private-equity investors, which generally finance each investment independently so that soured deals don't put good ones at risk. The use of fund-level debt effectively cross-collateralizes assets, meaning that good investments can be pulled down by bad ones.

Institutional investors were drawn to these so-called resource funds because they typically pay out steady streams of cash as soon as they make their first investments, unlike other private-equity investments that can take years to bear fruit, said Christian Busken, who advises endowments and other big energy investors as director of real assets for Fund Evaluation Group LLC.

"It shouldn't be something where you can be wiped out. But you are exposed to commodity prices," said Mr. Busken, who hasn't worked directly with EnerVest.

EnerVest's funds historically returned more than 30% or so, which enabled it to raise progressively larger pools of cash. In 2010, it raised about $1.5 billion for its 12th fund and added $800 million of debt. Three years later it raised $2 billion for its next and borrowed $1.3 billion. The fund bought wells in the Texas Panhandle, Utah, outside Dallas and elsewhere, according to securities filings from some of the sellers. The purchases were made largely as U.S. oil prices hovered in the $100-a-barrel range and when natural-gas prices were higher.