This sector is considered a blend of both private equity and infrastructure. For example, the exploration and production of oil & gas is closely matched with private equity, whereas pipelines, storage, and refineries are lower risk/return, so are more closely aligned with infrastructure investments.
It is therefore unsurprising that private investment in natural resources originally developed as an offshoot of the private equity and infrastructure asset classes, eventually growing to become an asset class in its own right. This growth has largely occurred since 2008, with an increased interest in the asset class from investors searching for yield in the wake of the Global Financial Crisis (GFC). While structured financial instruments have struggled to recover since the GFC, commodities such as gold (which can act as a store of value) have increased in price, making them an attractive option for investment.
Investment can be made through unlisted funds, listed funds, or direct investment. Listed funds within this asset class include Master Limited Partnerships (MLPs), which are tax-efficient US-based vehicles focused on natural resources and commonly utilized in the energy sector with oil & gas investments. MLPs combine the tax pass-through benefits of a limited partnership with the liquidity of a publicly traded vehicle. In order to qualify as an MLP, the partnership must earn at least 90% of its income from qualified sources, such as oil & gas, coal, or timber.
Investment strategies
There are five key strategies for natural resources investment. Within these strategies, there are different processes and stage preferences, as well as a range of commodities extracted.
Agriculture & farmland
This strategy can include one or more of the following processes:
- Agtech – investment in the technological processes used in agriculture and farming.
- Land owner – the ownership of land used for farming.
- Operator – a contractor who handles the day-to-day operations of a farm.
- Owner-operator – takes an owner and operator role in agriculture/farmland.
Agriculture/farmland strategies also target one or more of the following commodities:
- Annual/row – crops harvested annually such as grain, vegetables, and cotton.
- Perennial/permanent – crops harvested over many seasons such as vineyards, orchards, and coffee.
- Livestock – animals bred for food production or slaughter.
Energy
This strategy is defined as the investment of capital in processes involved in the discovery, production, storage, distribution, and retail of energy resources. There is significant cross-over between the private equity and infrastructure asset classes in the energy sector, depending on the process involved. Upstream strategies share some characteristics with private equity and therefore has a similar risk/return profile, whereas midstream and downstream are more closely aligned with infrastructure.
Energy strategies can include investment in the following processes:
- Upstream – the exploration, extraction, and production of oil and natural gas.
- Midstream – the processing, storage, transportation, and marketing of oil and natural gas.
- Downstream – operations taking place after the production phase (including the refining of crude oil), such as readying produce for sale.
- Oil field services – providers of equipment and services used throughout the process.
Energy strategies target one or more of the following commodities:
- Oil – including crude oil or petroleum and its refined components, such as petrochemicals.
- Natural gas – naturally occurring gases and their by-products, including natural gas liquids.
- Coal – fossil fuel formed in coal beds or seams.
- Renewables – including wind, solar, hydro, geothermal, and biofuel/biomass energy sources.
Metals & mining
This strategy covers the investment of capital in metals or minerals as a raw product, the exploration of these commodities, or the process of refining such materials to produce their pure form. Institutional investors are particularly attracted to metals & mining opportunities for store value purposes, although their value can be impacted by commodity price volatility.
Metals & mining strategies can include investment in the following processes:
- Exploration – the process of exploration and the mining of metals or minerals (upstream).
- Refining – the process of refining metals or minerals into products of value (downstream).
This strategy targets one or more of the following commodities:
- Base metals – common or inexpensive metals such as iron, nickel, lead, and zinc.
- Precious metals – rare metals of considerable value such as gold, silver, and platinum.
- Ferrous metals – an iron compound such as steel or pig iron.
- Non-metallic minerals – examples include limestone, quartz, mica, clay, and gemstones.
Timberland
Timberland is the investment of capital in land covered with trees or other woody vegetation, either in the form of privately-owned tree farms, or naturally occurring forests. Returns on these forestry investments come in the form of biological growth, upward product class movement, (as the trees grow, the requests for timber increase), timber price appreciation, and land price appreciation.
Timberland strategies can include investment in the following:
- Natural forests – naturally occurring areas of land covered in trees or woody vegetation.
- Tree farms – privately owned forests purposely planted for timber production.
This strategy targets one or more of the following commodities:
- Softwood – cone-bearing seed species such as conifer trees (pine, fir, and yew).
- Hardwood – broad-leafed, flower-bearing tree species such as oak, walnut, beech, and elm.
Water
Water strategies involve the investing of capital in water-related assets and processes. There is significant cross-over with the infrastructure industry in the water sector, with many institutional investors viewing water treatment and water utility systems as infrastructure assets. Water utilities tend to be regulated by the government, which can affect their investment profile as regulations change over time.
Water strategies include investment in the following processes, with water as the only commodity:
- Water industrials – systems for clean and safe water, known as ‘water treatment.’
- Water utilities – systems for pumping and piping water to the end-user.
Natural resources risk and return
Natural resources is one of the higher-risk private capital asset classes. what are the risk/return characteristics of the different sectors?
Agriculture & farmland
Agriculture and Farmland investments can have different risk/return profiles depending on the process or stage targeted. The strategy can typically be expected to achieve notional IRRs of 6-10%. Agtech and project developments exhibit higher risk and potentially higher returns of 10% or more.
Energy
Energy strategies, particularly those targeting the upstream stage, can be high risk/return. However, midstream and downstream investments tend to be less capital intensive and lower risk.
Metals & mining
Metals and mining risk/return profile is dependent on the process and stage, with exploration higher risk/return than the refining process.
Timberland
Timberland investments can be expected to provide steady returns, typically at an IRR of 8-10%.
Water
Water assets tend to provide high single-to-low double-digit returns for equity investors.
Why Invest in natural resources?
Many different types of institutional investors are active in the natural resources asset class. Natural resources is suitable for large institutions with longer-term investment horizons such as pension funds.
In a recent survey, Preqin asked institutional investors for the key reasons they invest in natural resources. The chart below shows their responses:
Institutional investors’ main reasons for investing in alternative assets
