NorTex Gas Storage: Production and storage

In February, Falcon Gas Storage closed a $335 million financing for the expansion and upgrade of its Worsham-Steed and Hill Lake gas storage projects. The NorTex portfolio is a landmark financing for the sector, although one that might not be repeatable, given its reasonable pricing and borrower-friendly covenants.

For the sponsor, the financing is an even more impressive achievement, since it took the $8.5 million purchase of two decrepit storage plants and turned them into a business with an enterprise value of roughly $420 million. Since the year 2000, and Falcon's formation, it has endured swings in debt and power market sentiment. It has also benefited from the huge growth in nearby Barnett Shale gas production.

In mid-2000, on the back of a small equity investment from Energy Spectrum, Falcon acquired the Worsham-Steed gas storage project from TXU for roughly $1 million, and bought Hill Lake, again from TXU, for roughly $7.5 million. TXU had not used Worsham-Steed since 1997, and used Hill Lake for serving the Abilene market during winter. The Texas utility was, at the time, much more focused on building up its presence in European energy trading.

At the time, few bank lenders had much interest in the sector, either. While for the first two years of the decade, gas use in electrical generation was projected to rise sharply, most lenders and developers assumed that pipeline operators would be capable of fulfilling the same needs as storage operators.

Falcon's first priority was to bring Hill Lake back online and then to connect it to two regional pipelines. It built a 300,000 cubic-feet-per-day pipeline, called Cisco, to connect the project to TXU and El Paso's North Texas Pipeline and the Lone Star Line X. The assets, located close to the growing population centre of Dallas-Fort Worth, provided useful back-up for utilities, traders and generators.

After several years the case of redeveloping Worsham-Steed and starting a second phase at Hill Lake became more compelling. Pipeline capacity was constrained, and shippers need to make use of their available capacity much more efficiently. Advanced recovery methods and high gas prices brought producers to the Barnett Shale to drill for tight gas.

In July 2005, Arcapita, a Bahrain-based bank, agreed to buy out Energy Spectrum and take an 80% stake in Falcon. The acquisition was the first step in increasing the capacity of the two projects and converting them to run on a high-deliverability multiple cycle basis.

The properties are not typical gas storage assets. Most recent financings, with one Tenaska-sponsored exception, have not been for depleted oil reservoirs, but normally for salt caverns. This means that lenders are not as familiar with the technical challenges of operating such facilities, even though they are more commonplace in the US.

One advantage to the set-up is that producers typically enjoy some revenues from the residual oil and gas liquids located at these sites. In the case of NorTex, the proceeds from oil and gas sales account for a third of the total revenues, with a mixture of short and medium-term contracts for storage capacity or services accounting for the remainder.

The hydrocarbon element is the main reason why the sponsor did not have to contribute additional cash equity to the transaction. The value of the existing assets, including Arcapita's equity contribution, can be considered to be equivalent to roughly $120 million. The capital cost of the project is roughly $300 million, while the sponsor managed to raise $335 million in debt against the project.

It selected Barclays Capital as administrative agent and WestLB as financial adviser, in effect co-leads, after interviewing several banks in the last quarter of 2006. The two were mandated in December, brought in Citigroup (senior managing agent) and ING (documentation agent) as subunderwriters, closed the financing for the project on 4 January, and syndicated it by 14 February.

The 6.5-year $280 million term loan, which compliments a $55 million working capital facility, probably represents the high mark for borrower-friendly terms for a gas storage project financing. The project used short-term costless dollar hedges to mitigate some lender discomfort, but also allowed for operational buyout flexibility. The deal also included cash sweeps and contingent debt facilities to deal with potential cost overruns.

The debt achieved pricing of 250bp over Libor, which will rise by 25bp every two years to maturity. This pricing would probably not be replicated in the present debt markets, and features such as the operational buyout might not be available in the future. But the financing incorporates high levels of collateral, and the sponsor's first priority in a refinancing will be to get this released.

Before that, Falcon will need to convince lenders that it can safely and efficiently intermingle hydrocarbon extraction with storage operations. Construction, which primarily consists of the installation of compressors and pipeline equipment, is now a process that lenders entrust to operators without demanding a high-priced turnkey contract. They will require a large budget contingency, and on NorTex trapped cash from operations to fund this, but will need convincing before easing the covenant package.

But, according to John Hopper, Falcon's CEO, it will be looking, once the operations have proven themselves, to refinance in the bank market. "We were able to benefit from strong market conditions early last year, but our priority will be to refinance in a way that reduces our collateral requirements and increases our flexibility."

NorTex Gas Storage Company
Status: Syndication closed 13 February 2007
Size: $335 million
Location: Texas
Description: Financing for the expansion of two gas storage facilities to 27 billion cubic feet capacity
Sponsor: Falcon Gas Storage
Lead arrangers: WestLB, Barclays Capital, Citigroup and ING
Debt: $280 million term loan, $55 million working capital facility
Tenor: 6.5 years
Independent engineer: E3
Market consultant: Pace Global
Legal counsel to sponsor: Vinson & Elkins (financing),
Locke Lord Bissell & Liddell (ancillary)
Legal counsel to the lenders: Dewey Leboeuf