It has the potential to be one of the few consequences of the Enron collapse to benefit structured finance lenders. While the sharper bankers and lawyers learn to wean themselves from share trust structures and, possibly, synthetic leases, balance sheet salvage operations have put a number of prize midstream gas assets onto the market. At the same time the poor state of the forward power price curves will have little effect on increased reliance upon natural gas as an energy source in the US. This means ? in theory ? pipeline and LNG expansion deals.

But integrated energy players in the US face the same difficulties in raising cash for these expansion plans as they, and their peers, do in the independent power business. Few had much interest in raising non-recourse finance here, even during the boom years for gas-fired capacity. Instead the major operators concentrated in building up large, linked portfolios of assets that would give them a countrywide reach. This orgy of mergers and acquisitions activity made it fairly easy to pinpoint scapegoats for the California crisis.

Indeed, El Paso was one of the earliest California shippers to be examined by the regulators, who felt they had a very strong case in examining market power exercise by El Paso Natural Gas. El Paso was able to demonstrate that the high gas prices in California were the result of high demand at either end of its pipeline to Southern California, and not manipulation. Nevertheless, El Paso's substantial asset base has been thinned by investor aversion to its off balance sheet financing vehicles.

El Paso's unfortunate timing in its share trust issue from last year has been amply examined (see Project Finance, January 2002). In addition to being forced to rework these vehicles, El Paso has embarked upon a number of asset sales, some completed, some planned. The first big sale, of a number of midstream assets, raised $560 million.

This collection includes 10,677 miles of natural gas transportation assets, gathering systems, and an interest in the Indian Basin gas plant in New Mexico. The new owner is El Paso Energy Partners (EPN), a separate entity in which El Paso owns a general partnership. EPN is now working on putting together a permanent financing plan, which could include non-recourse debt.

EPN is a master limited partnership, the nearest entity available in the US energy arena to the Real Estate Investment Trust (REIT). Much like a REIT, the master limited partnership (MLP) dilutes a former owner's degree of operational control in exchange for the increased tax benefits that accrue to the owner of a partnership interest. They are best suited to assets with long lives and slow depreciation schedules, and partnership interest noted tend to draw yield investors rather than the growth-obsessed stock investor.

For the former owners the benefits are equally clear. As Greg Moroney, managing director at Deutsche Bank in New York puts it, ?these assets when kept on the books typically have a 12% cost of capital. By shifting them to an MLP you can get a 100% off balance sheet.? MLPs, whose ownership interests are publicly issued and traded, usually get a solid welcome from investors. Moroney says ?on an MLP you get a preferred secured position. These are not share trusts camouflaged as non-recourse vehicles, not questionable and well understood.?

Nevertheless El Paso and its peers have moved fast to explain that the vehicles do not contain any nasty surprises. Accounts are published and the partnerships are registered with the Securities and Exchange Commission (SEC). Moreover, the MLPs are truly non-recourse to the parent, with few, if any, contingent liabilities. The degree of control, and therefore the limits of consolidation, varies from partnership to partnership.

Moody's Investors Service, for instance, has the vehicles off credit, despite the strategic nature of many of the assets in the MLPs. The accountants take a similar view, since the general partnership, by which corporates exert control over their ventures, is almost always a minority interest. Williams Companies hold a 58% limited interest, as well as the 2% general partner interest, in their MLP. But Williams is very much in the minority, since its peers prefer to keep their contributions in the forms of management fees, which can account for a large proportion of income from an MLP.

The most important aspect of the MLP, as far as an investor is concerned, is its tax profile. Since partnership interest holders are viewed as the owners of the asset, the depreciation benefits are passed on directly to investors, and distributions are viewed as capital gains rather than income. MLPs ? much like Real Estate Investment Trusts ? are highly restricted in terms of the assets that they can hold, and tend to be the preserve of energy, timber and mining concerns.

The emergence of the MLP in the energy industry was down to the 1986 restrictions on the use of the structure, which was held to herald the ?decorporatisation? of America. Thanks to vigorous lobbying (and a good proportion of Louisiana and Texas senators on the Senate Banking and Finance Committee) the three now hold a monopoly on the use of the structure.

Perhaps the largest MLP is that operated by Kinder Morgan. Kinder Morgan Energy Partners (KMP) has seen its assets grow from around $325 million in size ? mostly natural gas and coal transport businesses ? to over $9 billion. Kinder Morgan's strategy has always been to build a sizeable midstream business, concentrating on stable operational assets. In March 2001 it completed the $1.1 billion purchase of GATX' pipeline business, a deal funded by a revolver of the same size arranged by JP Morgan, Merrill Lynch and First Union.

Kinder Morgan Energy Partners' latest big-ticket acquisition is the Tejas Gas system. Tejas consists of a a 3,400-mile natural gas pipeline with a transportation capacity of 3.5 billion cubic feet (Bcf) per day. It extends from south Texas along the Mexico border and the Texas Gulf Coast to near the Louisiana border and north from near Houston to east Texas. InterGen North America, presently in the throes of a reorganisation, announced the sale of the assets to KMP in December 2001 for $750 million.

Since then, KMP has put in place a five-year contract for 200 Bcf per year of capacity with Reliant Energy Entex. It has also extended contracts for natural gas transport, sales and storage with Entex' parent for roughly 84 Bcf per year for 15 years. According to KMP, much of this gas will be used to power eight power plants in the Houston area, close to the KMP and Tejas pipelines. It has signed other contracts with Southern Union Gas Company and Entergy Gulf States, Inc.

Tejas was the subject of an unusual structured financing, led by WestLB, when it was transferred to InterGen from its (now 68%) owner Shell. Shell monetised its investment (it had purchased the assets for $1 billion) through a 50% leveraged, $300 million loan. The belief amongst syndicate banks was that the strength of Shell as a sponsor would mitigate the high level of market risk on the deal.

However, the deal did not perform as strongly as was expected, since transportation contracts alone were not enough to cover debt service, and the storage market proved to be much softer than lenders' estimates. In the event, as one lender put it, ?we went from close to workout in about four months?. A change in heart for InterGen, or, as some in the market have suggested, a retreat from full-service energy provision, combined with this poor performance to lead to the sale.

KMP has paid slightly more than the value fixed upon them by InterGen's financing. And it is happy paying for the assets in cash, since a leveraged financing poses a number of problems for an MLP. Any debt that subordinates partner distributions is likely to find disfavour both with ratings agencies and partners. The current limit of indebtedness is the use of revolving credit facilities, which are used so that an MLP can pounce upon an asset without waiting for the drawn-out process of another note issue.

The one exception to this is El Paso, whose MLP has been known to use leveraged structures to finance offshore production and exploration assets. It is unique in this regard, and ratings agencies have tended to keep a close eye on EPN's leverage. A recent report from Moody's Investors Service noted that EPN's recent asset purchase, financed using a $560 million, JP Morgan-led, bridge loan, would double its debt burden. It noted that the MLP may also use permanent, or semi-permanent, non-recourse debt to finance the deal.

External financing in general creates little enthusiasm on the part of El Paso's peers. Despite, or perhaps because of the tax-efficient structure of the partnerships, there is little use for overlaying other tax and accounting friendly structures, since most of the available tax benefits have already been passed on. Nevertheless, if shaky investor sentiment spreads to the market for limited partnership notes then a rise, in the short-term, at least, in the use of external debt is likely.

Perhaps more interesting is whether underwriters will be able to create a market in publicly traded master limited partnerships for higher-risk assets ? and whether the tax authorities will be pliable. If midstream gas assets, as appears increasingly possible, start to operate without the benefit of capacity contracts, sponsors will look again at the potential of MLPs to hold assets where conventional off balance sheet debt would not be economic.

The tax code has a little room for interpretation here, especially with regard to gas storage facilities, which are not strictly for the transportation of gas, but may be eligible for inclusion in an MLP. 90% of an MLP's income must be from eligible income, as laid down in regulation 7704. There is no requirement that the assets be contracted.

For this reason it may be possible to create a high-yielding MLP whose volatile cashflows would appeal to the more risk hungry investor. One solution would be to bring in an intermediate operating limited partner to take on the risks, as Ronald Gross, partner at Jones, Day, Reavis & Pogue suggests. He also believes that ?it may be possible to use derivatives on deals to smooth out cashflows on commodity risk, provided the assets qualify?.

Which brings the issue of transparent vehicles full circle. At the heart of several controversial recent accounting-efficient transactions has been the issue of how to account for financings as commodities deals. Enron's Mahonia deal and Dynegy's Project Alpha have received critical coverage for their less than transparent nature. Overlaying an MLP structure with such contracts would probably bring unwelcome attention to structures that have survived the current crisis intact.

But the temptation to keep sapping up assets and provide the stellar returns expected from investors remains, and the current environment provides a rich source of attractively-priced assets. The first test of how investor appetite will stand for further issuance will come when Dynegy launches its transaction for Dynegy Energy Partners. The sale was announced at the end of February, and Lehman Brothers appointed as bookrunner, but the sale of 8.75 million units has not yet been completed.

The natural gas liquids-focussed MLP will, according to Dynegy's prospectus, enter into long-term contracts with the general partner for supply, and also with Dynegy's part owner ChevronTexaco. Indications are that ChevronTexaco may have more midstream assets of interest to the nascent MLP. Dynegy's continuing legal entanglement with the rump Enron, and a slump in Dynegy's share price, which worsened as Project Finance went to press, may make close more difficult.