The deepwater Gulf of Mexico is a frontier in hydrocarbons exploration, one of the most demanding areas in the US to look for oil. It is also one of the few remaining areas where project finance can play a meaningful role in creating infrastructure, in the no-man's land between the major offshore oil producers, and the less adventurous independents. Cameron Highway, a novel and unique hybrid of project and reserve-based financing, shows what can be accomplished in the space.

Cameron Highway is a 380-mile pipeline designed to bring some of the output of the promising deepwater Gulf of Mexico oilfields to currently underserved markets in the central and west of the United States. The project's sponsors are Gulfterra Energy Partners, a master limited partnership formerly known as El Paso Energy Partners (EPN), and Valero Energy, which has a focus on refining and retail operations.GulfTerra is one of the larger master limited partnerships in the US, with a speciality in oil and gas transportation and gathering, whether onshore or offshore.

Valero, while well positioned physically to work on the project, has a slightly different focus. It does have a master limited partnership, Valero LP, but this was too small to assume the equity component of the project financing. This was one key challenge in structuring the financing.

The pipeline connects oil-producing properties in the Mad Dog, Holstein, and Atlantis, fields operated by BP, BHP, and Unocal, with delivery points in Texas. The main rationale behind the project is that current landing points on the Louisiana coast are congested, and the market there is well served. The producers' crude will have unfettered access to the Texas markets, including Valero's refineries.

The deal creates a solid offtake market for the roughly $5 billion in investment the majors expect to sink into the fields. Nevertheless, Valero was only selected as a partner after tendering the best offer for the joint venture stake. February 2002 marked the announcement by the then EPN of the project, while Valero's involvement was only announced at financial close on 14 July 2003.

Under this agreement, Valero was to pay GulfTerra roughly $51 million, equivalent to 50% of the equity spent so far on construction. Valero will then pay a total of $35 million in participation fees to GulfTerra for developing the project. Of this $19 million was paid at closing, $5 million will be paid once the system is completed and the remaining $11 million by the end of 2006. The project is scheduled for completion in the third quarter of 2004.

GulfTerra mandated JP Morgan, a consistent relationship bank for the MLP, and WestLB, home of a number of former JP Morgan bankers, to arrange the $325 million debt, equivalent to roughly 70% of the project's $458 million total cost. The banks structured a deal that sidestepped credit risk - the majors pay a throughput fee to the pipeline - but embraced volume risk.

Lenders to the project must be sure that the three fields, as well as third party production from the nearby Flextrend and Deepwater fields, will be sufficient to service the debt. The fact that one of the sponsors is expected to generate consistent levels of free cashflow will be of some comfort.

Valero Energy will probably attempt to sell its holding in the pipeline to Valero LP as soon as MLP has enough cash to fund the deal, or sufficient size to raise the necessary acquisition facility. Although this is not a foregone conclusion, the documentation had to reflect the likelihood of this change in control.The debt in turn is split into a short-term bank tranche and a longer-dated institutional tranche. As one arranger put it "the competitive pressure between the bank and institutional market kept the cost of the financing down". This tranching may also have been the result of an unsteady market for energy financing - one factor in EPN changing its name.

The debt consisted of a $100 million private placement and a $225 million bank facility. The private placement, underwritten by the two leads, was sold down to John Hancock and ING, and was priced at 325bp over the 10-year Treasury. The remainder was a five-year loan priced at 300bp over Libor. This brought in Royal Bank of Scotland, Fortis and BNP Paribas as arrangers, alongside the two placement agents. It also attracted Bank of Scotland, Scotia Capital, Bayerische Landesbank, GE Capital, Erste Bank, Southwest Bank of Texas, Natexis Banques Populaires and RZB Finance as participants. The leads provided $32.5 million apiece.

The deal is described by the leads as the first true project financing for the deepwater Gulf of Mexico, although there have been a number of structured deals for the region's players. Now that Cameron Highway has a lock on access to the Texas coast, other infrastructure deals will be thin on the ground, although other markets may be lucrative enough to attract finance, including long-mooted pipelines to Florida.

Cameron Highway

Status: Closed July 14 2003

Size: $500 million

Location: Gulf of Mexico

Description: 380 mile pipeline running from Holstein, Mad Dog and Atlantis fields to Texas coast

Sponsors: GulfTerra; Valero Energy

Debt: $225 million, five-year bank piece, $100 million, 10-year private placement

Bank arrangers: WestLB; JP Morgan; Royal Bank of Scotland; Fortis and BNP Paribas

Placement agents: WestLB; JP Morgan

Lawyers to the arrangers: Vinson & Elkins

Lawyers to the institutions: Freshfields

Independent engineer: Stone & Webster

Reservoir engineer: Netherland, Sewell & Associates