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If the world needs more energy, the companies that explore for oil and natural gas need more money to find and produce it.

That's where EnCap Investments comes in.

The Houston-based private equity firm has raised a new $1.5 billion fund from major institutional investors and wealthy individuals. Gary Petersen, one of EnCap's founders, calls the pool of capital the largest private equity fund ever raised specifically targeting the upstream oil and gas business.

Investment in the energy sector is white hot, with worldwide demand for fuels still swelling and commodity prices continuing to climb. There are many private equity firms raising a lot of capital, including First Reserve Corp. in Houston and Natural Gas Partners of Irving, but those haven't limited their investments to exploration and production.

Petersen and the other EnCap principals — Robert Zorich, David Miller and Martin Phillips — aren't saying the energy business isn't cyclical anymore. They met a couple of decades ago while working at Republic Bank of Dallas and have lived through too many of the industry's ups and downs to make that assumption.

But they do acknowledge the cost to drill new plays or buy out another company for its reserves has escalated in recent years, creating the need for more capital.

"We're going to be very careful. We're going to take three years to invest it," Petersen said.

While they bicker amongst themselves about peak oil theory — the idea that global crude production has reached a high and will slump into a steady decline — they all agree that it's unlikely oil and natural gas prices will collapse to a level that would derail the need for bulked-up energy investment anytime soon.

"We plan for volatility," Phillips said. "Yes, things are positive now with prices at this level, but opportunity presents itself across the cycle. You just may have to change strategy somewhat."

Of EnCap's 115 capital placements, only two have lost money. "And even those were small; just a small amount," Zorich added.

EnCap works with 30 management teams at any one time. In the company's downtown offices on Louisiana, the walls are lined with plaques commemorating client deals with companies such as Diamond Offshore Drilling, Petrohawk Energy Corp., Chesapeake Energy Corp. and Copano Energy.

First on the scene

Another client, Pitts Oil in Dallas, was one of the first companies on the scene in the Barnett Shale, an unconventional natural gas play northwest of Fort Worth.

Kicking in substantial funding ensures EnCap influential seats and significant power on boards of directors. While companies' execution strategies differ, Petersen said there's one piece that's always constant: "Always have an exit strategy."

A typical EnCap deal involves backing a handful of experienced energy players — a landman, a geologist, an engineer and someone on the financial side of things.

They take up land positions, drill exploratory wells and hopefully hit pay dirt, adding to the company's oil or gas reserves. Then they sell out. Case in point: client Stroud Energy that announced its sale to Range Resources for $456 million in early May.

Selling doesn't mean that management team is put out to pasture. In fact, Glenn Hart of Laredo Energy has been funded by EnCap four times to start four companies.

Hart said his staff has been working in the South Texas Lobo trend for years, and his team knows the area like the backs of their own hands. Laredo is just the latest iteration of the business.

EnCap has totally grasped our business model and given us free rein from a technical standpoint," Hart said, adding it has an "ability to pick successful management teams and then empower them to do what they do without interference as long as the projected results are being achieved."

Bigger firms acquired

EnCap companies don't always sell out to larger companies. Sometimes they buy bigger players.

Greg Armstrong, chairman and CEO of Plains All American Pipeline, said EnCap was instrumental is bringing his company an acquisition prospect in 1997 that would eventually propel the company onto the New York Stock Exchange.

At the time, Plains was valued at around $300 million. Even so, Armstrong said EnCap offered to finance the purchase of a much larger company, All American Pipeline, for $420 million.

"They thought it fit our skill set even though All American Pipeline was much bigger than we were at the time," he said. "That particular transaction gave us the critical mass to go public."

This latest fund is the 12th EnCap has assembled since the company formed in 1988 and includes money from the likes of Citigroup, the University of Virginia endowment, insurance heavyweight St. Paul Travelers and the California State Teachers Retirement System.

According to David Miller, another principal at EnCap, the firm has seen a 25 percent return across the previous 11 funds.

While the bulk of this fund will be invested in domestic energy plays, Petersen said some international deals in the North Sea, Indonesia and South America are being considered.

Copyright 2006 Houston Chronicle