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Earlier this year, a consortium of private equity firms led by Kohlberg Kravis Roberts banded together to acquire TXU Corp., the Texas utility company, for $32 billion in one of the largest private equity deals ever proposed. According to private equity experts, a new regulatory climate and innovative derivatives smoothing volatility are drawing attention to energy, along with a macro-environment in which emerging economies demand a growing share of the world's energy resources. Meanwhile, other firms are making investments throughout the sector, including funds established to finance infrastructure and others dabbling in alternative energy.

"I would say this has been the most active period for private equity involvement in energy I've ever experienced. There's a lot of competition for deals that are out there, and there seems to be interest in just about all sectors of the energy industry," says Jim Dillavou, who leads the national energy and utilities practice at Deloitte & Touche in Houston, Tex.

While energy encompasses a range of businesses with widely varying profiles, a survey by the Association for Corporate Growth and Thomson Financial predicts that energy will be among the top three sectors for deal-making in the coming year, behind health care and life sciences, but ahead of business services.

Demand for energy is expected to keep growing. According to the U.S. Energy Information Administration, despite world oil prices that are predicted to be 35% higher in 2025 than was projected in 2005, world economic growth continues to increase at an average annual rate of 3.8% over the period through 2030. Total world consumption of marketed energy is expected to expand from 421 quadrillion British thermal units (Btu) in 2003 to 563 quadrillion Btu in 2015, and then to 722 quadrillion Btu in 2030 -- representing a 71% increase.

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When Jonathan Farber, cofounder and managing director of Lime Rock Partners, a private equity firm specializing in energy, started the company in 1998, there were just five or six other private equity firms in the energy business with about $2 billion worth of capital invested. Now, there are 15 to 20 competing firms with $30 billion invested in the industry.

"It was very rare, to the point of never happening, that generalist private equity firms would dip their toe in the water of the hard-core energy space," says Farber. "Firms didn't look to oil and gas as an appropriate place to invest."

Now, some of the biggest names in private equity -- Kohlberg Kravis Roberts and Texas Pacific Group -- are teaming up to buy TXU. Dillavou says the new interest in energy is driven by the volume of capital pouring into private equity overall. At the same time, he says, investors are deciding they want to be more involved in this key segment of the economy, particularly following the recent rise in commodity prices. Meanwhile, capacity shortages in many markets make energy an appealing sector for private equity investors, at least for the near future.

"There are a lot of opportunities, and some that didn't look that attractive a few years ago look much different today," says Dillavou.

Wharton professor of business and public policy Matthew White says the enormous capital requirements of most energy investments have, until now, been beyond the reach of private equity firms. These days, however, with so much money pouring into private equity funds, deals on the scale of the TXU transaction are possible.

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White adds that private equity movement into the electricity and gas markets remains difficult because these parts of the energy business have a lot of regulatory and political oversight. "The rules of the game are changing substantially over time. Deregulation in electricity and gas continues in fits and starts, and a lot of it is at the state level. There's a great deal of uncertainty about the reward to investors, and that will give any set of investors pause during due diligence," says White. "One might look at this and say there are greener pastures elsewhere -- at least until the regulatory environment becomes a little more transparent."

Pulling off a change of control in this area is very difficult given the political approvals that are necessary, according to White. New Jersey regulators balked when publicly held Exelon, of Chicago, attempted to take control of Public Service & Gas in their state. Private equity firms have hit similar roadblocks. In 2005, regulators prevented a $1.25 billion bid for Portland General Electric Co. over concerns about potential rate increases and the short-term nature of TPG's investments. Arizona regulators refused to sanction a buyout of UniSource Energy Corp. in 2004 by a group of investors that included KKR, J.P. Morgan Partners and Wachovia Capital Partners.