Power plants alter pipeline financing strategies, banker says

Electric power plants are changing the methods of financing natural gas pipelines, requiring more creativity at the same time demand for pipeline capacity is rising, an investment banker said here Tuesday.

More than $8 billion in capital will be needed to build some 30 announced pipeline projects between now and 2004, Walter T. Weathers III, vice-president with Credit Suisse First Boston, told a Center for Business Intelligence conference.

Traditionally, pipeline customers included integrated oil companies, exploration and production companies, and utilities that typically had “A” ratings from credit agencies, But a changing customer mix will require pipeline sponsors to change their approach to pipeline financing. With electric generation projected to account for more than 80% of incremental gas demand, new pipelines will have merchant plants and generation companies as their primary customers, Weathers said.

The changing customer mix raises distinct concerns in the capital markets and requires distinct responses to those concerns, Weather said. During pipeline construction, most contracts will be conditioned on permitting and financing of a power plant, and there will be no certainty of any customer base when construction begins.

He said transactions will require sponsor support at this stage, while corporate-style debt will not be possible. After completion, customers will consist primarily of mid to low “BBB” generation companies and unrated to “BBB-” merchant plants.

Project financing
Traditionally, customers signed firm contracts subject to pipeline completion. But power plant customers of new pipelines cannot begin construction until they are certain the pipeline will be built. Weathers said most new pipelines will have to be project financed initially either by banks or the capital markets, carry heavier debt to capital ratios, and the debt is likely to be more expensive.

If the shippers aren’t known for sure at the outset of the pipeline project, Weathers said, interim short-term financing is preferable, otherwise, “getting long-term debt will be very, very expensive.” Debt ratios can be has high as 70% using project financing, compared to corporate financings, which typically have higher levels of debt coverage.

“There are a million ways to skin a cat with project financing,” Weathers said. Longer term, pipeline companies can choose a permanent financing strategy or a corporate finance strategy, he said.

Project finance requirements include a firm understanding of the economics, shipper contracts, a shippers’ credit strength, market position, gas reserves, technology, and structure. Many of the elements are new concerns, he said.

If, for example, contracts don’t allow shippers to recover their costs, they could “go away,” Weathers said. Lenders are also interested in what the risk to the pipeline is of a loss of supply, available alternatives, and the potential for exploration in a region, he said.

Quality of service is a rising concern. Combined cycle power plants need high pressure and dry gas, he noted. Pipelines are catering to marketers and customers who want to pack the pipeline and who need multiple points of delivery to facilitate trading. In the past, traditional customers such as utilities were primarily concerned with certainty of supply, and producers were interested in access to markets and the net price of gas, Weathers said.

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