Developers of grassroots and expansion oil and gas projects have not been immune to the turmoil in world capital markets.
For instance, the credit crunch has driven India's Oil and Natural Gas Corp. to delay issuing tenders for a $2.7 billion petrochemical complex. Thousands of miles away, Portland Gas plc has suspended the joint venture funding process for what would be the largest onshore gas storage project in the U.K. In the Western Hemisphere, Swiss-based Glencore International AG has decided to pull out of the Colombian refinery business altogether because it could not secure financing for a refinery expansion in the South American country. These business decisions on three different continents provide a snapshot of how the woes of lending institutions around the globe have had a chilling effect on projects that less than a year ago likely would have obtained bank financing with relative ease.
Banks are no longer sources of cheap and plentiful cash for pipelines, refineries, petrochemical plants, gas storage facilities, and other projects, and the banks that are lending have become much more selective in approving financing. However, companies looking to build or expand facilities do have other options for obtaining the funding they need to see these projects to fruition. These alternative sources include conventional private equity funds, infrastructure funds, hedge funds, and mezzanine funds (see the sidebar for descriptions of each).
According to Larry Clinton, Senior Partner with Olney, Md.-based Q&E Capital Group, project developers can tap into joint-venture financing through these alternative funding sources. According to Q&E, the investors that it represents are actively seeking to finance energy projects that have a minimum loan amount of $10 million. They will lend 90 to 100% of the project cost and typically require a 20 to 51% ownership stake in the venture, depending on the merits of the project.Parked Money
Clinton said that project developers can also obtain funding through sources of "parked money" such as private equity funds, pension funds, and hedge funds. In this case, a project developer obtains a direct-pay letter of credit (DPLC) from one or more banks. Banks issue the DPLC based on the borrower's financial merit and ability to deliver the desired project outcomes. After receiving the DPLC a consulting firm such as Q&E Capital refers the developer to the parked money group, which makes the actual loan for the project.
In a parked money arrangement, the parked money group accepts the DPLC as collateral from the developer. The project is the collateral for the DPLC. Should the developer default on its loan with the parked money group, the parked money group will present the developer's bank with the DPLC and collect the money it is owed. The bank would take possession of the project.
Clinton pointed out that a key benefit of obtaining funding through an alternative source instead of through a bank is that it can dramatically shorten the amount of time needed to get the cash for a project. Once the developer garners the DPLC, funds may be issued in two to three weeks' time. In contrast, securing cash from conventional lenders may take from three months to one year.
Due diligence requirements differ in these two arrangements and thus affect how long it takes to get funded, said Clinton. In a traditional lending situation, the onus is on the developer to provide and pay for evidence of due diligence such as feasibility and environmental studies. The conclusions of these studies influence the bank's decision whether to approve or reject a loan request. Under an alternative arrangement, the bank is responsible for due diligence. Moreover, it decides whether to grant a DPLC based on the developer's financial condition and track record with previous projects -- not on the merits of the proposed project. Investors represented by a consulting firm such as Q&E, in turn, make a financing decision based primarily on the existence of a DPLC and whether the project would likely be profitable. The likelihood of realizing attractive yields from refinery, pipeline, and other energy projects is promising and makes them desirable to investors, Clinton asserted.
'Very Bullish on Energy'
John Shepherd, Houston-based Managing Director with the mezzanine funding source GE Energy Financial Services (EFS), echoes Clinton's contention that fundamentally sound energy projects are still worthy of financing despite today's economic conditions. "When we see something we like, we're fairly malleable in terms of how we participate, whether equity or and debt," Shepherd said, adding that GE EFS does not focus on the short term.
GE's longer-range outlook reflects the current drive toward achieving energy independence. Pointing out that the company has been involved in both conventional and alternative energy projects, Shepherd said that GE EFS looks for projects that will satisfy market demand for 20 to 40 years. "These are very long-lived, critical assets," he pointed out.
One such project in which GE is involved is the Haynesville Expansion Project, which calls for expanding Regency Energy Partners' pipeline system in North Louisiana to transport gas produced from the massive Haynesville Shale play. Underscoring the long-term viability of Haynesville Expansion, Regency has already secured shipper commitments for 84% of the pipeline's capacity.
GE also sees natural gas storage as an attractive long-term investment opportunity. In fact, GE EFS and project co-owner Haddington Energy Partners recently initiated service at one of the newest natural gas storage facilities in the U.S. The Bobcat Gas Storage venture in south-central Louisiana, which will boast 15.6 billion cubic feet of working gas capacity in two salt caverns when fully built out in late 2009, is 45 miles from Henry Hub and interconnects with five major interstate pipelines.
Shepherd noted that GE pursues a very rigorous due diligence process before agreeing to join any project. "We are very thorough and don't try to cut corners on due diligence," he said. This thoroughness and long-term focus has paid off, he added. "We have very, very low losses for our investments," he said. In addition, he believes that his company stands to benefit from the current dislocation of capital and project developers' eagerness to take on partners."It's a great time to be at GE," he concluded. "We're very bullish on energy, but highly selective."
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A conventional private equity fund is owned by a group of individuals or is supported by a larger organization, which raises third-party capital from institutional investors to invest in the common equity of the target investment or company. The private equity fund hence provides the company with an infusion of cash that could be used for capital projects. The level of risk associated with this type of investment may be fairly high, but it is tantamount to the risk common shareholders (such as corporate managers) are exposed to. Under this approach, capital is raised through a fund approach with a target return; the target return includes outlined investment parameters that feature target sectors for investment.
Investors in an infrastructure fund include, but are not limited to, insurance and pension funds. They gravitate toward more secure, less risky investments in critical infrastructure such as strategic pipeline projects. The return on investment in these projects may be lower, but the assets in question are typically contracted or are regulated; therefore, the likelihood of realizing consistent long-term income is strong.
The definition of a hedge fund has been somewhat fleeting in recent years. The term "hedge fund" traditionally has referred to an unregulated investment fund for wealthy, sophisticated investors. The investment fund would trade in equity as well as debt markets. It would profit from a margin between offsetting positions in more than one security interest or across a portfolio of offsetting investments. Typically, hedge funds have not invested in industrial projects. However, in recent years, they have begun to target a broader range of investments. As a result, they may offer developers a pool of capital for projects.
A mezzanine fund is a type of private equity fund that combines debt and equity. Usually, the debt and equity components are embedded in the same security interest (for instance, debt with warrants for equity). The fund lends money to the project developer and buys a stake in the project. In exchange for taking on this relatively risky investment, the mezzanine fund can earn income both near-term and long-term: regular interest payments from the developer provide income on an ongoing basis and the eventual sale of the investment may yield a significant return on investment.
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