LONDON (Dow Jones)--The downturn in mining equities may open the door for private equity funds to play a more important role in the industry in the future.

Their entry could ease the logjam of underfunded projects thrown up by the credit crunch that some industry participants believe may keep supply tighter than expected.

Many private equity funds have been sitting out the financing and buyout deals seen in the mining industry during the boom of the past couple of years. Valuations were too high to provide the returns private equity funds sought, while booming demand from institutional and retail investors for mining equities meant junior miners could easily obtain capital for their projects on exchanges.

"We weren't doing a lot of investments at the peak of the market," said Jon Dugdale, president of Asian Lion Limited, a $21.6 million fund established by the Australian mining investment house Lion Selection to take stakes in Asian resource projects. The fund has invested just $4.5 million of its capital since its launch in 2006.

But now, smaller exploration and mining companies with projects in development are grappling with the problems of both the credit crunch and a strained equity market. Many might have to take hold of private equity funds' lifeline.

Junior mining stocks are hemorrhaging from sharply lower metals prices and liquidation by funds facing investor redemptions. The juniors are reluctant to turn to equity markets to raise capital because of share dilution.

And they prefer private equity financing to traditional debt finance providers because of the high interest rates on loans and the larger hedging component debt providers require.

"Long-term fundamental institutions such as ourselves may view their current situation as a buying opportunity," said Peter Ruxton, head of mining investment at private equity group Actis, which has $150 million invested in African-based mining companies. "It depends on whether you think this is the end of the commodity bull run or a temporary aberration due to the credit crunch."

So far, most private equity funds are looking at the downturn as a temporary dip. It's widely agreed that there's a lot of value in mining stocks, although they're reluctant to dip into the market until they see a bottom. The funds foresee a shakeout in the mining equity market in the coming year, as hedge funds and other investment groups who've been providing equity capital withdraw from the sector.

Miners with marginal projects are likely to fall by the wayside, while those with good projects will likely be much more willing suitors. "We see that things will be pretty tough for juniors over the next 12 to 18 months," said Dugdale. " For our model, this is the perfect time for investing."

This should give private equity the chance to acquire larger equity stakes in both listed and unlisted junior miners, and the control to bring their expertise in engineering, financing and management to the companies' projects. "There's a lot more willingness from mining companies to come back down to earth," said Andrew Pullar, assistant fund manager at Baker Steel Capital, a UK-based resource hedge fund. "Sometimes it's worth taking a haircut to advance the project."

And as investments in their funds are locked up for a five- or 10-year timeframe as a condition of joining, many private equity groups aren't facing investor redemptions because of the credit crunch and are sitting on large cash holdings. Others are still raising new war chests.

Lion Selection in July closed its $79.2 million African Lion 3 fund, its third Africa-focused mining fund. A month earlier Baker Steel Capital launched a $60 million equity fund to invest in early-stage mining projects, with a three-year initial lockup, a shorter timeframe than most.

Other private equity firms such as The Sentient Group, Pacific Road Capital Management, Resource Capital Funds, Black River Asset Management and Emerging Capital Partners all have several hundred million dollars under management for investment in the mining industry.

MinQuest, a C$225 million ($212 million) fund backed by Caisse de Depot et Placement du Quebec, Canada's largest institutional investor, is expecting its deal flow to "increase substantially in the next couple of years," according to Paul Carmel, the president and founder.

"With the buoyant prices there's been a lot of capital raised, a lot of projects have been started or discovered. So there's a pipeline that's full, but now the capital tap has been turned off," Carmel said.

Many of these funds are looking to get returns of two times to five times their investment over a seven- to ten-year investment horizon. They typically take $10 million to $60 million equity placements in companies that are at various stages along the supply chain: pre-feasibility, post-feasibility as well as at the production stage, although they rarely invest in pure exploration plays.

Exits normally involve selling the company to a mining major, or finding an institutional investor to take their stake once the project is in production or after the company has listed.

A growing minority of private equity groups invest in existing mining and metal operations. UK-based Klesch made a splash last year with its agreement in principle to purchase the 290,000-metric-ton Zeeland Aluminum smelter in the Netherlands from the former Alcan, and is developing an $8 billion greenfield aluminum smelter and oil refinery development in Libya. Founder Gary Klesch said in a Dow Jones interview last week the company's now sizing up copper and zinc assets.

One mining company that turned to private equity for financing in September is Minerva Resources (MVA.LN), a GBP3.5 million UK company listed on the London Stock Exchange's Alternative Investment Market that's developing a resource estimate for a gold project in Ethiopia.

Minerva Director Terry Ward says the current environment is very difficult for financing. "For an exploration company, it's difficult to pay the interest (on the debt) because all outgoing cash is going into exploration activities."

Private equity firms won't be alone in the next buying spree. Cash-rich mining majors will likely be dusting off the books of many smaller companies, and commodity hungry companies in China and other emerging markets will also be eager to buy in at current prices instead of paying top dollar as they have in recent years.

All of these investments should help avert a bottleneck building up in the project pipeline because of the credit crunch. Last week, BHP Billiton (BLT.LN) chief Marius Kloppers said the financing difficulties junior miners are facing could do just that; with less capacity being added than expected, supply could remain tighter long enough to keep raw material prices high.

-By Matthew Walls, Dow Jones Newswires; +44 (0)20 7842 9412; matthew.walls@ dowjones.com