The recent wave of transformation in the US gas transportation sector started with Enron's collapse. Enron, formed from pipeline companies Internorth and Houston Natural Gas, grew out of a pipeline company, and led the wave of consolidation between electricity and gas producers. And it was Enron's ventures elsewhere ? in telecoms, water, power and in trading ? that caused it so much difficulty.

It is fitting then, that it is the sale of the rump of Enron's pipeline operations should draw a close to the period of realignment that followed its collapse. In December it completed the sale of the Cross Country Energy Corporation to a joint venture of Southern Union Company and GE Commercial Finance Energy Financial Services (GECFEFS) for $2.35 billion. Enron carved out the company in March 2003, and renamed it in June of that year.

Running Cross Country

Cross Country consists of the Transwestern system, a 2,400 mile pipeline that transports natural gas from the San Juan, Anadarko, and Permian Basins to markets in the Midwest, Texas, Arizona, New Mexico and California; and 50% (with El Paso holding the remainder) of the Florida Gas Transmission system, a 5,000-mile pipeline running from south Texas to south Florida.

It initially included Northern Plains, which owns 82.5% of the general partner of Northern Border Partners, which in turn owns 70% of the Northern Border Pipeline, all of Midwestern Gas Transmission and Viking Gas Transmission and a 33% of the Guardian Pipeline, as well as gas processing and gathering facilities, But the new buyers sold Northern Plains to ONEOK for $175 million.

The two, through acquisition vehicle CCE Holdings, trumped an offer of $2.2 billion from the NuCoastal consortium, led by Oscar Wyatt, who founded, and then sold to El Paso, the Coastal Corporation. Chapter 11 procedures mean that a follow-up auction must be held to determine if there is a better available offer. CCE won, and the Coastal name went back into retirement.

GE and Southern Union funded the deal with $600 million apiece in equity, and a mixture of holding company and operating company debt. Southern Union's equity has been funded partly from a $142 million share placement led by Merrill Lynch and JP Morgan, and partly from a bridge loan from those two leads. Merrill and JP Morgan also put together the debt package, a mixture of bonds and loans, and JP Morgan was financial adviser to Southern Union.

Financing details remain under wraps but according to James Burgoyne, managing director and head of diversified energy at GECFEFS, the package was investment grade and placed privately, with bank debt predominating at the operating company level, and bonds at the holding company. CCE is the largest principal investment that GE has made in the pipeline industry.

The growing enthusiasm of financial investors for this sector ? CCE is GECFEFS's biggest principal investment in pipelines ? is leading to high leveraging of assets by buyers and a growing sentiment among analysts that prices are creeping up to unsustainable levels. But lenders keep coming, with one source close to the CCE arrangers saying that the bank market is still very strong for pipeline assets. Moreover, there has not been the influx of loan and hedge funds into floating rate debt that has characterised recent power deals.

Meanwhile, in a separate auction, Targa Resources bought 40% Bridgeline LLC for $100 million, after no alternative bidders emerged. Bridgeline, in which ChevronTexaco holds the further 60% stake, is a 1000-mile pipeline system centred on southern Louisiana. Targa, formed with equity capital from Warburg Pincus, refinanced and increased to $200 million a $150 million revolving credit from JP Morgan.

Targus' first acquisition was of the ConocoPhilips midstream assets, 1,000km of gas gathering lines, also in Louisiana. And it bid for Shell's Shell Gas Transmission pipeline business, losing to Enbridge's winning $613 million bid. The assets, 1,482 miles of transmission lines which stretch out into the Gulf of Mexico, were less attractive to Shell after it had sold off its producing properties in the region.

Private equity muscles in

The struggle between the two bidders illustrates a wider struggle between the remaining solvent natural resources players and financial investors for midstream assets. Both have been driven forward by continued low interest rates, which have made leveraged financing very attractive. Although there are some indications that big ticket acquisitions will be rarer from now on.

?Going back I think there was a watershed with the collapse of Enron, as a number of distressed players used their pipeline operations as marketable commodities?, says GE's Burgoyne. ?These assets had already been part of the oil majors, or had formed the core of the merchant operators. But not all of the assets have yet changed hands.?

Still one feature of the current market is that given the greater preponderance of financial investors as sponsors, pipeline assets have become much more liquid ? but also much more expensive. ?With the benefit of hindsight,? one banker notes, ?the Kern River Pipeline was a steal. But only MidAmerican had the money back then.?

MidAmerican bought Kern River in March 2002 for $450 million in cash and the assumption of $510 million in debt, and completed a series of refinancings and expansion financings over the following years (search ?Kern? on www.projectfinancemagazine.com for more). Kern is a 962-mile pipeline between the best onshore production areas in the Rockies, to the most lucrative gas market, California.

MLPs ? busting the cap

Yet another complicating factor has been the changing profile of master limited partnerships (MLPs), which have priorities somewhere between the financial and the strategic investor. Over two years ago, many observers (see ?US Masters?. May 2002 issue), felt that the MLPs were the most obvious buyers of assets, either direct, or via their general partners.

Traditionally, oil majors or other oil and gas producers and shippers used MLPs to achieve favourable tax treatment for their long-depreciation, cashflow-rich assets, and pipelines were among the most suitable candidates. The MLP's would issue limited partner units, and use revolving credit facilities to fund short-term acquisitions.

There are still larger MLPs that follow this pattern. In November, Kinder Morgan sold TransColorado, a 300-mile interstate pipeline that runs from western Colorado to northwest New Mexico, for $275 million to Kinder Morgan Partners, the MLP.

In December, KMP sold 6,075,000 common units, including underwriter options, bringing in $291.6 million. The leads were Lehman Brothers and Morgan Stanley, joined by Citigroup, Merrill Lynch, UBS and Wachovia.

But, as Todd Shipman, director at Standard & Poor's, notes, ?not as much has changed hands as we might have expected. While Williams might be said to have sold a crown jewel, and El Paso has made some disposals, many sellers have decided not to sell.? Part of the reason is that many of the likely sellers reconstituted themselves as leaner, more financially astute operators with pipelines as their core.

Shipman has just produced a report that examines an emerging trend in the industry, whereby financial investors have been buying general partners in master limited partnerships. The impact on the credit from financial investors, as Shipman sees it, comes from the way that distributions are split between the general partner, which manages the MLP, and the limited partner, which owns most of the units. The general partner is typically rewarded with a greater share of the distributions above a pre-agreed cap.

The incentive thus exists for a general partner to grow the MLP as fast as possible, because this maximises the cashflow to which it will be entitled. The constraining factor will usually be the rating of the MLP common units, and thus its cost of capital. For an integrated operator, this cost of capital will need to be below the cost at which it can access capital for an MLP to be worthwhile.

But private equity firms might not face these constraints, and have been increasingly eyeing general partner interests. As Shipman puts it in his report: ?As the MLP model has matured, the pressure on credit quality has increased, and the nascent trend toward disinterested third parties owning the general partner may be adding to that pressure.? In support, Shipman notes that S&P has downgraded Buckeye partners from A to BBB+ in the year since Carlyle/Riverstone bought out the GP from management in May 2004.

Its headline acquisition has been the purchase of a refined products pipeline network from Shell for $517 million in October 2004. It closed a $400 million deal in August to fund part of the purchase, but then completed a $275 million debt and $234 million equity offering to cover the acquisition. Management noted in a recent presentation that its take of cashflow is capped at 32%, and that this is lower than many of Buckeye's peers.

Shipman also notes that S&P also has Pacific Energy Partners on CreditWatch negative, following the Anschutz Corporation's decision in November to sell its GP interest to Lehman Brothers Merchant Banking.

But there are arguments against the new owners causing a wholesale decline in credit, if only because a severe ratings decline would make it hard for them to complete acquisitions, and it is worth noting that the previous owners were not averse to squeezing assets for as much cash as possible.

However, there is good evidence that the presence of private equity is keeping prices high, or as one banker puts it, ?I'd assume that most of the assets are fully valued.? GE's Burgoyne goes further, saying that ?there's no doubt the MLPs are a competitive force in the business, since their market capitalisation has grown significantly, and proposed tax law changes would benefit them even further.?

Burgoyne says that he has not necessarily noticed a significant change in the behaviour of MLPs, although some other observers have suggested that the dearth of reasonably-priced interstate pipeline assets might have led MLPs to bid up riskier assets in the gas storage and gathering segments.

Bulking up for LNG?

And at present newbuild pipeline financings are rare. Even El Paso, which flirted with a financing from WestLB for the Cheyenne Plains pipeline, is understood to be still using equity to construct the pipeline, which runs from Cheyenne, Wyoming, to Greenburg, Kansas, although in a filing it has said that it will ultimately fund 60% of the cost using a long-term debt placement.

FPL Group, El Paso and Tractebel have joined forces to develop an LNG receiving terminal in the Bahamas, accompanied by a pipeline to Florida. EL Paso had been developing a terminal in the Bahamas, in which FPL had a option to buy all the equity, and half of a proposed pipeline, while Tractebel was pursuing its own terminal and pipeline plan. All three will now be equal partners in both projects, and move forward with the most feasible option, while Tractebel and FPL, which has a preliminary agreement with Ras Laffan for LNG deliveries, will jointly develop a terminal.

But while LNG-related pipeline business may be far off, there is at least one more acquisition deal waiting to launch. Loews Corporation will shortly issue a $575 million bond financing for its acquisition of the Gulf-South assets. Loews announced in November that it would pay $1.136 billion to buy the pipeline system from Entergy-Koch. It finalised a sale on 29 December using a mixture of equity and a $575 million bridge loan to fund the purchase.

The two bridge loan providers were Citigroup, which was financial advisor to the buyer, and Lehman Brothers, which advised the sellers. The two lead managed a bond issue of the same size, split between $275 at the Gulf South operating company, and $300 million at the TGT Pipeline operating company. TGT, short for Texas Gas Transmission, is an existing subsidiary of Loews, and is a 5,800-mile pipeline network stretching across the Midwestern and Southern US.

Gulf South owns 6,800 miles of transport pipeline, 1,200 miles of gas gathering pipeline and 68.5 billion cubic feet of gas-storage. Its sale follows the decision of Entergy and Koch to unwind their joint venture and sell their trading operations to Merrill Lynch. The Gulf South operating company bonds are rated BBB+/Baa1 (S&P/Moody's) and the holding company debt at BBB/Baa2.

The offering closed on 24 January, with the $300 million operating company notes due 2017 carrying a 5.50% coupon, and the $275.0 million holding company notes due 2015 have a 5.05% coupon. The holding company bonds are unsecured and subordinated to the operating company bonds. The operating company bonds are unsecured but unsubordinated, although, in common with many acquisition financings, there is scope for the company to raise additional debt, and this would rank above the notes.

At least part of the reason for such a flexible capital structures is the need for operators to adapt to the potential opportunities from liquefied natural gas import terminals. LNG terminals, at least the ones that gain permits, could be an important source of business for operators. The necessary expansions, whether in the form of new pipe or additional compressors, would be substantial

Some operators, in particular Sempra Energy and Duke Energy, have been tempted to angle their business towards these opportunities. But such opportunities will likely be funded on balance sheet. And since most analysts believe that LNG presents a distant potential for upside, however, few financial owners will sacrifice much leverage to accommodate such plans.

Koch, with a number of pipeline assets on its own balance sheet, might provide the next big ticket financing for Houston's bankers. Sources in the city's bank market suggest that a sale of some of its midstream assets could be imminent.