MidAmerican Energy has closed a $1.2 billion expansion deal for the Kern River pipeline and the $875 million in project debt has become this year's must-have paper. Lead arrangers Commerzbank, Credit Suisse First Boston (CSFB) and Union Bank of California have signed in a large group of co-arrangers and further sell-down looks, at this point, unlikely. The deal's success, in fact, while a tribute to its solid structure, also says a great deal about the priorities of participants in the present volatile US market.

Kern River Gas Transmission company carries gas from the extensive reserves of Wyoming, through Utah and Nevada and down into the Californian market. The existing pipe has a length of 926 miles and a capacity of 835 million cubic feet per day. Its original financing was a construction bank loan of $634 million that was refinanced with a CSFB-led capital markets transaction 1 March 1996.

The pipeline's debt has one of the highest non-sovereign backed ratings for a project financing available. Moody's Investors Service rates the Kern River Funding Corporation at A3, down a notch from its original A2 rating, but much higher than the Triple-B that is the market norm. Its last transaction was a $510 million capital markets deal led by CSFB, Lehman Brothers and Merrill Lynch that was designed to pave the way for the current expansion deal.

The reason for the project's strong profile is a revenue stream backed by strong long-term ship-or-pay contracts with financially strong oil and gas majors. The blended rating of these offtakers, about 14 in all, is A-. The expansion project will change this profile a little.

The new project is essentially a reaction to the increasing demand for gas in the Californian market. California's new capacity is mostly gas-fired, and the crisis of 2000 has added some urgency to the building of new capacity, although new plants are presently financed on balance sheet. But the companies that want new capacity are generally financially weaker merchant energy providers, and have had their ratings hit hard by Enron-related liquidity concerns.

The Expansion Project consists of both new pipeline and above-ground facilities. Most of the 717 miles of new pipeline will be laid in the existing Kern River right-of-way at a 25-foot distance from the existing line. Three segments along the route ? roughly 205 miles in Utah, Nevada and California ? will not need additional pipeline.

The above-ground facilities include construction of three new compressor stations, and installation of additional compression and modifications at six existing stations. Activities at the six existing compressor stations will be confined to the area within the fenced facility. The work will almost double the system's capacity.

The most important task for the arrangers has been to structure the debt in such a way that it will be easily sellable to the bank market, be ripe post-completion for a capital markets take-out, and not interfere with the credit profile of the existing debt. While the last bond issue, which closed in August 2001, contained covenant language that facilitated the raising of the expansion debt, the sponsor must maintain a strong rating on the project.

The most important risk factor and the one traditionally least popular with bond investors, is construction risk. In this respect the new ownership has helped the arrangers. Williams has faced a number of difficulties related to its underperforming telecoms investments and worries about having sufficient cash reserves to meet counterparty obligations. It sold the pipeline to MidAmerican in April 2002 as part of efforts to shore up its balance sheet. The choice must have been a difficult one ? one source close to the deal calls Kern River a ?crown jewel? asset.

MidAmerican's main assets are an Iowa utility, the former CalEnergy independent power business, and now Kern River. It is in turn owned by Warren Buffet's Berkshire Hathaway group. Buffet is known for his fondness for stable, cash-producing investments, and Kern River fits the bill nicely. MidAmerican, rated on its own at BBB-, has provided a completion guarantee on the debt, and has thus removed the chief area of uncertainty for lenders.

The $875 million debt is structured as a construction-plus-15-years loan. In theory, therefore, the financing is also one of the longest tenors encountered in the bank market for some time. This length, however, is slightly misleading ? there is little intention on the part of the sponsor to keep the bank debt in place.

The reason for the long tenor is that a shorter deal, even if it did not amortize, would have taken too much cash from the existing revenues from the pipeline to service the bank debt. The bank financing is secured on the expansion assets (essentially the shipping contracts) until completion, when it ranks pari passu with the bond debt, raised at the Kern River Funding level. The debt, however, features a particularly aggressive cash sweep mechanism that begins trapping cash from completion, so the urge to refinance in the bond market will be overwhelming.

The arrangers went out to a number of institutions, some of which are familiar project lenders and others relationship banks to MidAmerican or CalEnergy, as Comerzbank and UBoC are. The first category has became increasingly desperate to fill their books with some high-quality paper at the end of a lacklustre two quarters. In fact, initial market read surmised that most of the 23 banks that came in wanted co-arranger titles on a commitmet of $75 million ? lowered to $28.5 million for fees of 87.5bp. One manager title held $45 million since it was happy to settle for 70bp fees.