CenterPoint Energy and Spectra Energy have priced a $375 million rule 144A bond financing for the Southeast Supply Header pipeline. The deal is the latest in a trickle of Americas pipeline deals to come to market, and confirms that investor interest in midstream gas assets has recovered. The investment banks, sidelined from US infrastructure finance even as commercial bank lenders reeled from a spike in funding costs, hope to apply bond structures to a wider range of assets and risk profiles in coming months.

The joint bookrunning managers for the bonds were Deutsche Bank, Barclays Capital and Royal Bank of Scotland. The bonds priced at 212bp over the five-year treasury, and at a discount of 0.053% to par, roughly 25bp inside early market sounding, and 12.5bp inside price talk. This gave the bonds a coupon of 4.85% and a yield to their 2014 maturity of 4.862%. The coupon is roughly 200bp inside that of the Maritimes & Northeast Pipeline, of which Spectra is also a sponsor, which closed $500 million in 2014 bonds at a 7.5% coupon in January.

The financing is most notable for the sponsors not providing any security over the pipeline to bondholders. Bondholders are protected from increases in leverage by a combination of a prohibition on the pipeline creating liens on the assets and the sponsors' willingness to maintain the bonds' rating. Moody's rated the bonds Baa3, while Standard & Poor's rated them BBB-.

Southeast Supply Header (SESH) is a 440km bidirectional natural gas pipeline running from the Perryville Hub, near Delhi, Louisiana, to Coden, Alabama, across the state of Mississippi. The two sponsors each own 50% of the issuer, while the issuer owns 50% of the first 185km of the pipeline. Southern Natural Gas, a subsidiary of El Paso Corporation, owns the remaining half of this first section, which runs from the Perryville Hub to a connection point with Southern's pipeline in Mississippi.

This first section has a diameter of 42 inches, rather than the 36 inches on the rest of line, and a capacity of 1.5 billion cubic feet per day, rather than the 1 billion on the rest of the line. The agreement with Southern Natural Gas is for it to own an undivided interest in the pipeline, making offering a security interest over the entire length impracticable. In any case, the operational demands of running an interstate pipeline make raising unsecured debt without restrictive covenants much more attractive.

The pipeline is designed in part to carry gas from shale deposits near Perryville to the gas pipelines that run parallel with the Gulf Coast to Florida. The aftermath of Hurricane Katrina left Florida's traditional sources of gas – wells offshore – out of action, and left Florida, highly dependent on natural gas to fire generation, vulnerable. The SESH pipeline is part of an overland route designed to lessen this dependence on offshore sources.

The pipeline serves other markets, including the newly-built, and little-used, liquefied natural gas receiving terminals on the Gulf Coast, as well as several gas storage facilities. It connects Centerpoint's Carthage-Perryville and CenterPoint Energy Gas Transmission pipelines to the Gulfstream pipeline, of which Spectra owns 50%. The project goes back to a 2005 agreement between Centerpoint, once part of Reliant Energy, and Duke Energy Gas Transmission (now Spectra) to build a pipeline. The El Paso agreement came a year later.

The regulated pipeline has signed up a variety of shippers, primarily A-rated Florida utilities, to long-term contracts, and will keep roughly 5% available for spot market and interruptible sales. The project came online in September 2008, at which point 68% of its capacity was contracted, while 80% was taken when the bonds closed, and 92% should be under contract by June 2011.

The two sponsors funded construction using equity and shareholder loans, which this bond issue will partly repay. The project came in with a final cost of roughly $1.2 billion, or 50% above budget. The overruns have the incidental effect of giving the project a low gearing of 30%, though it produces a less flattering book-value-to-cashflow ratio.

But the project is not really being financed using conventional project finance techniques. Bondholders' main source of comfort is a negative pledge, under which SESH cannot grant other lenders any security over any of the pipeline system's assets. The bond documents contain no other covenants or restrictions on the operator, only the desire to protect the pipeline's rating by keeping leverage to a minimum.

The sponsors of SESH decided to issue the bonds with a five-year maturity, partly because this end of the yield curve offers the most attractive pricing, but also because as bond maturity approaches, more of the pipeline's capacity will be under contract, and a better-priced, longer-dated refinancing should be possible. As it stands, the coupon on the bonds is less than half the level at which similarly rated utilities were raising financing in late 2008, and the bonds were four times oversubscribed.

According to sources close to the underwriters, the project should be able to support between $600 million and $700 million in debt. The pipeline's capacity could be increased by between 20% and 25% through the installation of improved pipeline technology. An expansion financing, combined with a pitch for a longer maturity, is likely around the time the pipeline reaches its higher level of contracted capacity. "At the moment," explains the source at the underwriters, "the gap with a ten-year is a little too wide."

Investment banks have been unable – so far – to bring bond financings for infrastructure assets to market that match what banks, even in their weakened condition, can offer. But institutional appetite for projects seems to have picked up, and several wind and conventional power developers are examining pure institutional or combined bank/bond deals. Providing construction risk and negative carry concerns can be creatively mitigated, the market might come back strong.

Southeast Supply Header, LLC
Status: Closed 13 August 2009
Size: $1.2 billion
Location: Southern United States
Description: 440km bidirectional natural gas pipeline with a 1-1.5 billion cubic feet per day capacity
Sponsors: Spectra Energy and Centerpoint Energy (50%)
Debt: $375 million
Managers: Deutsche Bank, Barclays Capital and Royal Bank of Scotland
Maturity: 2014
Coupon: 4.85%
Underwriter legal: Chadbourne & Parke
Sponsor legal: Baker Botts