MEG: Slow on the draw

One of the first B loan project financings to use a delay draw term loan, MEG Energy's $750 debt package for its Christina Lake oil sands project was also unprecedented in terms of delay draw time (24 months) and delay draw tranche size relative to the drawn portion.

MEG is a start-up developer in Alberta, Canada, with a good asset story. It owns a lease on a 52-section oil sands block that contains roughly 4.8 billion barrels of bitumen – equivalent to 2 billion barrels of oil produced at 95,000 bpd over 65 years. Among its main investors are Warburg Pincus and CNOOC and a highly experienced management team led by CEO William McCaffrey.

Despite its strong intellectual credentials and backers, MEG posed a number of issues for structuring bank Lehman Brothers and joint bookrunner Credit Suisse to overcome.

Not only will MEG have no cashflow for the first three years and be subject to commodity prices when income does come on-stream, but oil sands projects (which take the heavy bituminous sands of the Canadian northwest and turn them into synthetic crude oil) struggle to compete on production price with, for example, GCC originated deals.
Furthermore, the debt financing came with no maintenance covenants which meant lenders had to get comfortable with the asset value of the start-up – in effect its reserve base.

And finally the project needed flexibility in both timeline (many similar projects have suffered delays and cost overruns due to increased construction costs caused by higher commodity prices) and the ability to borrow further to increase acreage without having to renegotiate with its original lenders.

A number of these problems were partially mitigated by market forces. In terms of production competitiveness, MEG is benefiting from high oil prices and the US' stated goal of sourcing more oil from reliable countries. Oil sands projects, a creature of high oil prices and constricted production, are tremendously lucrative, provided these prices stay high. Furthermore, the MEG extraction process (steam-assisted gravity drainage) is energy intensive, since the steam used in the process comes from burning gas. As long as the price of gas roughly tracks the price of oil, the project benefits from a natural hedge.

Getting lenders comfortable with the underlying asset was approached in two ways – an independent reserve report from GLJ Petroleum Consultants (based on a lot of core drilling by MEG) and comparison with the proliferation of similar projects in the same region. MEG's lease lies adjacent to Devon Energy's Jackfish project (the two sponsors are jointly developing the 340km Access Pipeline to bring their output to the Edmonton marketing hub) and EnCana also has a producing site at Christina Lake.

The EnCana template not only gave credence to reserves reports but also enabled lenders to more accurately assess the likely construction costs on MEG and a C$175 million three-year interest reserve account and a C$72 million cost overrun fund were incorporated into the deal.

The debt package comprises a $700 million term loan, split equally between drawn and undrawn portions, and a $50 million revolving credit. The revolver was syndicated to Canadian commercial banks for tax reasons and was led by Scotia Bank, with BMO and CIBC participating.

The $350 million drawn and undrawn tranches were offered as combined takes with the arrangers insisting that buyers commit to both equally: B lenders usually prefer to put their money to work immediately and interest in uptake on the undrawn tranche would not have been as strong had the two tranches been sold separately.

The debt attracted strong commitments – enough that the bookrunners were able to tinker with the pricing on both tranches. The drawn portion went down in price from 225bp over Libor to 200bp while the undrawn portion went up from a straight 75bp to 100bp of the $350 million debt in year one, rising to 125bp for year two and 150bp thereafter.

Because the funding was aimed at US investors a ruling on withholding tax was sought. Although not a major issue given it only becomes applicable if 25% of a loan is repaid in the first five years and MEG has no cashflow for the first three years, lenders were comforted by the fact that any tax, however unlikely, could be deferred.

The financing's close was also contingent on MEG raising C$200 million in additional equity – it had already raised C$424 million of private equity, and had spent C$260 million by the end of 2005. The equity raising was a success, and attracted $350 million in orders for placement agents Credit Suisse and Lehmans. The shares were allotted to existing shareholders, as well as some new US investors.

Further funding followed in September when MEG bought more acreage with further finance from Lehmans and Credit Suisse in a short term deal that will be replaced by an equity raising that is expected to close shortly. Although not integral to the original financing the arrangers were aware of future funding needs and structured the original deal in a way that allowed MEG to raise more funds without having to renegotiate with the original lenders.

MEG Energy
Status: Closed 3 April 2006
Size: C$1.264 billion ($1.15 billion)
Location: Alberta, Canada
Description: 4.8 billion barrels of bitumen oil sands project
Sponsor: MEG Energy
Debt: $750 million
Lead B loan arrangers: Lehman Brothers, Credit Suisse
Revolving credit lead arranger: Scotia Bank
Independent engineer: Purvin & Gertz
Sponsor legal counsel: Latham & Watkins (US), Bennett Jones (Canada)
Lender legal counsel: Simpson Thacher (US), Blake Cassels & Graydon (Canada)