HOUSTON—Enormous amounts of capital will be required to develop the deepwater reserves so desperately needed to meet world energy demand, yet private-equity firms (armed with more money than ever before) are reluctant to invest offshore.

With oil prices not yet at $60/bbl, the economics of deepwater drilling and production are still very challenging for industry and for capital providers, said Dan Pickering, chief investment officer for Houston investment banker Tudor, Pickering, Holt & Co.

The challenge is figuring out how to get the right mix of projects in your portfolio, he said.

“When you look onshore, there are hundreds of [private equity]-backed portfolio companies, but when you look at deep water, you can count them on two hands. There is not an obvious fit between the offshore industry and private capital,” he said.

The problem is, industry players need more capital for these long-term projects. From discovery to final investment decision or project sanction to first oil can take up to eight years, yet private-equity providers expect to get a return on investment sooner in three to five years.

“It’s time to think outside the box. I don’t have any answers for you, but I think there can be an intersection if like-minded people get together.”

Deepwater production is still relevant, amounting to 12 MMbbl/d in a world that produces 25MMbbl/d offshore. It’s one of the few places where the industry can spend lots of money yet still find big reserves.

Exploration is needed, but it is no picnic, he said. The firm maintains a “50 Wells to Watch” list, and from 2013 to 2016 some 70% of those wells were dry holes. “The biggest public companies in the oil business are shrinking. Yes, they have found natural gas, but deep water is going to be very important. Even when prices were $100/bbl, they were shrinking,” he said.

Deepwater economics don’t seem to work the old way anymore, Pickering said. “We needed $79 on a full-cycle cost basis in 2015 for the average project to break even in the Golden Triangle (the Gulf of Mexico [GoM], Brazil and West Africa). These numbers don’t work if you look out to 2020 on the oil futures curve. That’s why commitments to new offshore projects have fallen off a cliff … worldwide floater utilization fell to less than 50%.”

He said the firm calculates that the average breakeven price required in the GoM is $70/bbl, off Brazil it’s $78 and off Nigeria it’s $86. The majors need $60 oil merely to tread water. He includes in that group BP, Chevron, ExxonMobil, Galp, Repsol, Shell, Statoil and Total.

Pickering conceded that most offshore companies have done an impressive job bringing their costs down. “We have an industry doing its best to right size its cost structure, but it’s not able to find enough new opportunities and the economics are still challenging,” he said. To pay down debt, pay a dividend and have capital to spend, the majors have committed to $150 billion in 2017.

A new deepwater rig can cost $1 billion and one project could cost $10 billion or more, he said, so a lot of capital has to be spent, and the first source of that is the majors themselves.

Ironically, private-equity funds for energy have more money than ever; some 20 such funds have more than $1 billion each, yet they seem reluctant to fund offshore companies or projects. Only a handful of private-equity firms do.

As of August 2016, Tudor, Pickering found these companies had fire power of $150 billion of investable capital (counting a 1-to-1 ratio of debt to equity), with $75 billion of equity raised but not committed to energy projects yet.

Private equity was spooked with the downturn in 2015 and 2016 but is ready to go back to work now, he said. The problem is private-equity expects 20%-plus returns and a certain exit after five years, whereas deepwater projects take much longer and major companies are willing to get a 10% or 20% return. Also, private equity tends to invest in increments of $50 million to $300 million, he said, yet deepwater projects require far more money.

“So deep water and private equity are not an obvious fit,” Pickering said. “Unlike other areas of the oil business, there is no established way of raising capital and collaborating in deep water. The deepwater industry wants a 10% return but [private equity] wants 20% plus.”

Pickering said the industry needs to create innovative financial structures “outside the box” to move beyond this standoff. Some sovereign wealth funds are looking at deep water, and unlike private equity they are patient and willing to wait on an investment.

Leslie Haines can be reached at lhaines@hartenergy.com.