Financing the upgrade of the US transmission network is likely to be a bespoke business, despite the fact that the sums involved will run into tens of billions of dollars. And Path 15 - perhaps the most intricate deal in the US power sector in 2003 - provides invaluable experience, and a wealth of potential solutions. It also highlights the dominance of the bond market in 2003 - even a credit this unusual was a capital markets candidate.

Path 15 is a high-voltage power transmission system with a south-north capacity of 3900MW. Its core is the link between Pacific Gas & Electric's Gates and Los Banos substations and consists of a number of wires: the 500kV Los Banos-Midway line, 2 Gates-Panoche lines of 230kV apiece, and the 230 kV Gates-Gregg and Gates-McCall lines. This capacity is now inadequate for sending power both north and south, and was exposed as such by the California electricity crisis.

The project consists of a 1500MW expansion to south-north capacity, and 1100MW increase in north-south capacity, by means of a third, 84-mile, 500kV line between Gates and Los Banos. It has been a dream of the federally-run Western Area Power Administration (WAPA) for years, but permitting constraints and ideological arguments had hindered its progress.

The California crisis, and the Bush administration's National Energy Plan provided the critical push that brought the deal to market.In 2001, energy secretary Spencer Abraham selected Trans-Elect, the independent transmission operator formed in 1999 to provide funding, and own the project's transmission scheduling rights (TSRs), but it will not own the project. WAPA needed to retain control to ensure a smooth permitting and land acquisition process. The energy department therefore likes to describe the project as a public private partnership, although the structure would not be immediately familiar to European bankers.

Trans-Elect holds little of the equity in the project, which is structured as a holding company, Trans-Elect NTD Holdings Path 15, and an operating company, Trans-Elect NTD Path 15. The holding company is structured as a limited partnership, in which Trans-Elect is the general partner, controlling, but not economically owning, the vehicle. The limited partners are EIF, Arclight Capital, and KB Transmssion. The holding company's only asset is the operating company's, which in turn owns the project's TSRs. These are assigned through the California Independent Operator in proportion to funding and development effort contributed. PG&E, the third sponsor, also receives TSRs, but is not an owner of the holding company. It is responsible for upgrades to the substations at either end of the line. The three have permission to become participating system operators, and also get ratemaking treatment, but it is WAPA that will retain control of the line.

With this structure, Trans-Elect approached Macquarie and DZ Bank about putting together a bank deal. This would be developed against a backdrop of PG&E's uncertain credit, and the desire of the holding company's equity to see a return as soon as possible. Citigroup, however, suggested a bond financing solution that would allow the sponsors to amortize some debt, and achieve a longer tenor.

The final capital structure is made up of $95.5 million operating company delayed takedown bonds; $56 million holding company bonds, a $19.5 million miniperm construction overrun facility; and a $38.3 million equity bridge facility. The holding company gained a Ba3 rating from Moody's, while the operating company stands at Ba1. Citigroup was the co-placement agent on bonds, underwriter on the construction overrun facility and equity bridge, while DZ Bank was lead arranger and underwriter on the overrun loan and bridge, Macquarie was co-placement agent on the bonds, and SG was underwriter on the overrun facility and bridge.

Those bankers behind the deal describe it as conceptually similar to a pipeline financing, with the TSRs analogous to ship-or-pay agreements. Certainly Path 15's credit is not dependent on the volume of electricity carried. It is, however, reliant on the credit of the California independent system operator, through which payments are routed, although the project is in rate base. It also relies upon the substation upgrades to be performed by the PG&E.

The financing probably benefitted from the renewed interest in transmission that followed the August 2003 blackouts. While chaos in the northeast has not quite persuaded lawmakers to enact a solid framework for transmission investment, it has focused banks and corporates on the opportunities in the sector. However, like a number of other deals in the US this year, Path 15, unique and Californian, is unlikely to spawn a clone in the foreseeable future. Its one positive result has been to refocus Trans-Elect's attention on the greenfield opportunities available. When Trans-Elect first looked at the deal it had assumed that most of its activity would come from buying up networks divested by utilities. Since Path 15's close it has formed a new transmission development company, which will entirely chase new projects rather than acquisitions.

Path 15 Expansion

Status: Closed 16 September 2003

Size: $220 million

Location: California, US

Description: upgrade of 83-mile transmission bottleneck by 1,500MW

Sponsors: PG&E; Western Area Power Administration; Trans-Elect

Equity: $48.8 million

Debt: $160.5 million, plus $38.3 million equity bridge

Bookrunners: Macquarie, Citigroup

Bank underwriters: Citigroup; DZ Bank; SG

Equity providers: EIF; ArcLight; KB Transmission

Market consultant: E3

Lawyers to the sponsors: Pillsbury Winthrop

Lawyers to the lenders: Latham & Watkins