In March 2002, the Duke Energy Australia Pipeline project reached financial close. completed the with a US$610 million multi-currency syndicated facility.

The financing contained a number of tranches, mainly a guaranteed and non-recourse tranche. One tranche would be secured on a non-resource basis limited to some of Duke Energy’s Australian gas pipeline assets in Victoria, New South Wales and Queensland, while the second tranche (DCC) would be supported by a guarantee provided by Duke Energy’s US parent, Duke Capital Corporation.

The financing is unique in a number of respects. It allows for the debt to be recharacterised or “switched” between the DCC tranche and the project tranche. The facility allows Duke to add additional pipelines acquired or constructed, which, depending on the model, can increase the size of the project tranche.  It also allows for new projects to be funded quickly and easily using a ‘previously identified risk’ concept, under which the banks agree to accept a risk which has previously been accepted by them on a different project. The Duke project reached financial close in March 2002 and marks the first PPP in New South Wales.

Location

Initially two pipeline projects on the eastern coast of Australia.

Investment climate

Investments of this nature and magnitude in Australia’s wholesale and retail gas sector are quite common. Since the supply of gas services has been highly deregulated over the previous 20 years, both debt and equity investors have been able to achieve reasonably secure returns, banking principally on the revenue contracts of gas wholesalers.

Background and rationale

The purpose of the financing was to allow Duke to obtain funding and flexibility to continue to operate and expand its Australian gas projects in a manner which achieves a balance between corporate and project risk.  Duke needed to ensure that it could restructure its operations as cost-effectively as possible and, if desired, add and remove projects which formed the basis of the lenders’ security package.

The project originated from extensive preliminary discussions between Duke and the three joint lead arrangers, National Australia Bank Limited, Citibank, NA and the Toronto Dominion Bank (this latter bank in particular devising the essence of the initial structure).  Mallesons Stephen Jaques acted for the joint lead arrangers in structuring, negotiating, and completing the facility, and Minter Ellison acted for Duke.  For the lenders, the project was attractive as it provided an opportunity to have exposure to solid revenue-producing assets, with clearly identified environmental, commercial, structural and legislative risks. 

The Project

The financing involved a US$610 million facility.  The facility was made available by  (in the case of Australian and US dollar drawings) the issue of transferable loan certificates by Duke’s Australian borrower to a syndicate of banks and, in the case of New Zealand dollar drawings, through the making of cash advances by participating banks.  Not all members of the syndicate participated in the New Zealand cash advance facility.

The US$610 million facility consisted of several tranches. It comprised a project tranche and a DCC tranche, the latter itself being comprised of a standby tranche (to support Duke’s Australian commercial paper programme), a cash advance tranche and a New Zealand dollar cash advance tranche.  In respect of the project tranche, the borrower’s obligations were guaranteed by the pipeline owners.  In addition, charges were taken over the gas pipelines and share mortgages over the shares in the pipeline owners.  In respect of the DCC tranche, the borrower’s obligations were guaranteed by Duke Capital Corporation.

The project is unique due to its multi-option characteristics, its ability to “switch” the nature of the lenders’ recourse and the manner in which new projects could be introduced and removed from the financing.  As a multi-borrower, multi-project, multi-jurisdictional and multi-currency facility, it was somewhat more flexible than many in the Australian market.  By allowing drawings to be “switched” from being on-balance sheet to off-balance sheet, the facility provided an incentive for Duke to operate the assets the subject of the lenders’ recourse as profitably and efficiently as possible to increase the non-recourse tranche.  And by agreeing to an identified set of risks, Duke has the comfort in knowing whether a potential acquisition could be the subject of the present facility.

The project revenues are derived principally from a number of gas transportation agreements entered into by the pipeline owners. These were the subject of extensive due diligence by the legal advisers involved. Duke also had the benefit of the financial ratios being measured on the basis of the aggregate of the projects, rather than on an individual project basis.

Legal framework and risks

In addition to that set out above, the guarantors DCC provided extensive undertakings in respect of their gas projects and various ancillary matters. Subordination documentation was also put in place to subordinate inter-company debt provided by related Duke entities. The lenders also hedged any interest rate exposure through the use of interest rate swaps.

Aside from the common risks associated with a project finance of this nature, such as environmental, legislative and marketplace, other risks could be identified in establishing such a unique structure. For instance, there exists the perennial risk of counter-party solvency. The projects are funded by revenue contracts under which a range of third parties pay for gas transportation and supply. The market for these services is obviously quite low, so much depends on the continued financial stability of these counter-parties.

Conclusion

The project represents a divergence from typical notions of project financing and allows a significant, but regulated, degree of flexibility for the sponsor to develop and expand its activities, relying on the aggregated strength of the existing projects.  For the lenders, it provides exposure to an array of solid revenue-producing assets. IJ

Tony Holland is a partner of law firm Mallesons Stephen Jaques. He practises primarily in project and infrastructure finance, energy, resources and infrastructure projects, acquisition finance and domestic and international finance. Robert Valentine, who assisted with this article, is a solicitor with Mallesons Stephen Jaques.