For investors seeking high potential returns and the thrill of participating in market innovation, the smallcap energy space is where it’s at. Managing Director and Co-Founder Laird Cagan of merchant bank Cagan McAfee Capital Partners has built his career by backing companies that are both filling current demand and creating new markets. In this exclusive interview with The Energy Report, Cagan shares his experiences and discusses several companies at the forefront of the energy revolution.
The Energy Report: Laird, you and your partner are active investors. You are company founders, you sit on the boards and you actually run the businesses in some cases. What kind of advantage does that give you?
Laird Cagan: We are involved with fewer portfolio companies compared to a private equity or larger firm. Because we take a very active role and are starting companies at early stages, our preference is to create a new platform company and a new business opportunity. So the benefit is that we can be very close to the company and try to launch it quickly to take advantage of whatever market opportunity we see. We have a lot of skin in the game, a lot of ownership, and we try to help guide companies in the right direction. But like private equity investors, we generally have professional managers from the industry who were either co-founders or who were brought in to lead the company on a day-to-day basis. One exception is the case of my partner Eric McAfee, who has been running Aemetis Inc. (AMTX:OTCPK) since 2005, when we started that company.
TER: What kinds of companies interest you most?
LC: For the last 10 years or so we’ve been focused on building companies in the microcap public space. We have found that this has given us better, faster access to capital for the right opportunities. Public investors don’t want to take the three, six, nine or 12 months that venture capitalists and private equity firms take to investigate opportunities before making an investment decision. Public investors want to see something faster and want an opportunity that they can understand. Typically, that means we stay away from pure-play technologies, but we do look for technologies that are creating new markets. For example, we founded Evolution Petroleum Corporation (EPM:NYSE) in 2002, when oil was $25 per barrel (/bbl). We created that company to do enhanced oil recovery using technologies like lateral drilling, which was not very prevalent back then. We could take mature oil and gas fields and extract additional reserves using new technologies. But we also benefited greatly from having oil prices go from $25–100/bbl. We founded Pacific Ethanol Inc. (PEIX:NAS) to replace gasoline additive MTBE (methyl tertiary butyl ether), which was outlawed in 2004 in California and many other states. Ethanol was the only known oxygenate that would burn gasoline cleanly enough to meet the clean air act. So, it was less of an alternative energy play than a replacement-commodity play with a West Coast focus. Those companies, Evolution Petroleum and Pacific Ethanol, got us into the energy space. With rising energy prices and a multitrillion-dollar marketplace, all sorts of new opportunities began to arise because of technology. Aemetis, originally called AE Biofuels, was focused on next-generation biofuel moving from corn to other feedstocks that would be more plentiful, more predictable and would not be in the food chain.
TER: Was horizontal drilling technology more capital-intensive at the time, with oil at $25/bbl?
LC: Not particularly. There were thousands and thousands of wells around the United States that had been drilled and shut-in or were at a trickle of their former production. Some were getting ready to shut down. People would practically give them away because it costs money from an environmental standpoint to close them. For us, Evolution was an opportunity to create an early-stage platform company to produce oil using enhanced oil recovery. We were fortunate that by 2006 oil prices were at $40–50/bbl.
TER: What’s the technique?
LC: The technique used is called CO2 (carbon dioxide) flooding, where you inject CO2 into the ground and it releases the trapped extra oil, which then bubbles up. The CO2 adds pressure, just as it does in a carbonated beverage. When you drill an oil well for the first time and release the virgin pressure by traditional means, you might get 40% of the oil. This means somewhere between 50% and 60% of the original oil in place is still there. With the CO2 floods, you can typically get between 15% and 20% of the original oil in place, and that’s a meaningful well.
TER: As a pioneer of this technology, where did you incur the most extensive costs?
LC: You have to have a pipeline to get your source CO2, and that’s a challenge. If you’re close to a source, the cost of injecting it can be around $10/bbl. But a project’s viability depends a lot on the fixed cost of getting the CO2 to the site. At the Delhi Field in Northern Louisiana, Evolution Petroleum formed a very effective partnership with the leading CO2 player in the industry, Denbury Resources Inc. (DNR:NYSE). Together we’ve done very well. The Delhi Field was 14,000 acres and is estimated to be capable of releasing an additional 60 million barrels (MMbbl) of oil. And with oil now over $100/bbl, that’s $6B worth of oil, and you can afford to spend a lot to go after that.
TER: Great foresight.
LC: I would say yes, it was foresight and some luck. We didn’t anticipate $100/bbl oil at the time. But, we really do focus on trying to get a play at the beginning of a growth cycle. Of course for any investor, being at the beginning of a rising tide is one of the keys to success and having superior returns.
TER: You’re not as actively involved in Camac Energy Inc. (CAK:NYSE) as you are in some of your portfolio companies, but starting the company has been an interesting saga. Can you tell us about that?
LC: In 2006, after having had some success with both Evolution Petroleum and Pacific Ethanol, I was introduced to Frank Ingriselli, the former head of Texaco International. He developed some important relationships in China and he had a lot of very high-level experience with majors in that region. After Chevron Corporation (CVX:NYSE) bought Texaco in 2001, he wanted to start a new oil and gas company and needed capital to grow, for which I was approached. We ended up funding a $21M offering and creating a new public entity, Pacific Asia Petroleum. Frank went to China to visit as a long-time contact and was granted a concession of 175,000 acres in the prime coal-bed-methane region of China. Without any upfront money, we got a hold of a major resource that launched the company. The Chinese government’s goal was to bring in people that had expertise and ability and who could bring capital for projects, because the country needs energy. Over time we ended up acquiring Camac, which owned a large property in offshore Nigeria that was just beginning production. In a sense it was a reverse merger for Camac because it became the majority shareholder and ended up taking control by its Chairman and CEO Kase Lawal. I dropped off the board around that period of time.
TER: Camac shares have been flat over the past six months, but down about 50% from a year ago. What accounts for the lag in the stock price?
LC: Its first production well started out at 20 thousand barrels per day (Mbbl/d) and it has gone down to about 4 Mbbl/d, but there’s still a huge reserve there, which is estimated to be between 600 MMbbl–2.2 billion (B) bbl of recoverable oil in the entire field. Camac is working on getting a new partner to come in and develop that. I’m bullish on the long-term. It’s going to take time, but it should be very exciting. I’m still a big shareholder and waiting, watching and hoping for the best.
TER: Were there any other companies you wanted to mention briefly?
LC: I recently became chairman of Blue Earth Inc. (BBLU:OTC), which is in the energy efficiency space. This is a very important new category, and it is frankly the lowest-hanging fruit of energy conservation by reducing energy consumption. Commercial real estate uses about 20% of our nation’s energy. Making those buildings more efficient is very important, and provides quick returns. For example, replacing old motors and with energy-efficient motors produces a one- to two-year payback. Blue Earth is geared toward doing that.
TER: Is the company actually manufacturing new technology?
LC: It’s not a technology company, but it’s using the latest improvements in energy efficiency to retrofit commercial real estate. It will also do energy audits for clients’ buildings and recommend an energy-generation project, be it solar, fuel cell, etc. that fits the client’s needs. This is called distributed generation: Instead of going into the grid and selling power back to the utility, the company sells directly to the customer. It therefore has none of the energy losses of going through the grid, nor any of the capex issues. Retrofitting to localize energy at a site is a tremendous innovation that needs to happen in order to reduce national and even global energy consumption. I’m very bullish on the energy efficiency and distributed generation space for the next 50 years. It has the power to replace and transform our energy production. We are not going to get rid of utilities because we need them, but we can chip away at our use of fossil fuels from our insatiable appetite for energy in a way that is cost effective. It also reduces carbon emissions.
TER: Is Blue Earth a consulting company?
LC: No. It’s more of a contractor, or a construction company. In other words, it does the work. In the solar world it’s called Engineering Procurement Construction or EPC. After the energy audit, the company does the engineering, including procurement of parts and construction. As we move on and migrate this business model, the company will also provide the financing and effectively become the developer. There are some good tax incentives involved in alternative energy, both in solar and fuel cells. Depreciation is also available, and that adds to the return.
TER: Solar systems would be on the roof or on land, but how far away would a generating fuel cell typically be from the building?
LC: Adjacent to the building. There’s no sound, and there are no moving parts. You need a footprint about the size of a tractor trailer. There are a few significant fuel cell manufacturers in the U.S., and they are growing nicely. Fuel cells are significantly more cost effective than solar if you can use energy 24 hours a day such as in a data center and can have net paybacks in 5–10 years at most, whereas it might take solar 10–20-years to payback.
TER: What are the fuel cell companies?
LC: One of the companies to look at is Bloom Energy (private). It has the larger units, and Google Inc. (GOOG:NASDAQ) put Bloom units into its building in Silicon Valley with a lot of publicity a year or so ago. Bloom is different from the other three manufacturers, as there is no waste heat, which is interesting. So, if you have large, consistent needs, Bloom is good. The data centers that Google runs are 24-hour operations. So, it would not be quite as suitable for a company that shuts down at night because you can’t amortize 24 hours, and perhaps solar would be better for a company that needs mostly peak daytime energy. That’s why an energy audit is so important, so clients can understand what’s most appropriate for their business.
Other companies include FuelCell Energy Inc. (FCEL:NASDAQ) and ClearEdge Power (private), the latter of which makes a variety of units, including small residential-size fuel cells. ClearEdge is blitzing homes. It’s the SolarCity (private) equivalent. SolarCity is trying to put solar on your roof, and ClearEdge is trying to put a fuel cell next to your house, and it makes systems all the way down to 5 kilowatts, which is appropriate for a midsize house.
TER: It has been a pleasure meeting you, Laird.
LC: Thank you.
Laird Cagan is managing director and co-founder of Cagan McAfee Capital Partners LLC, a merchant bank in Cupertino, CA. Cagan McAfee has founded, funded and taken public 10 companies in a variety of industries including energy, computing, healthcare and environmental. The company has helped raise over $500M for these companies, which achieved a combined market capitalization of over $2B. Mr. Cagan was the founder/chairman of Evolution Petroleum Corporation (AMEX: EPM), a company established to develop mature oil and gas fields with advanced technologies, and he is a former director of American Ethanol (AEB) and Pacific Asia Petroleum (PFAP).