Reproduced from Project Finance International Yearbook 2017 © Thomson Reuters

FERMACA

BRINGING PERMIANGAS TO MEXICOMEXICAN PIPELINE OPERATOR FERMACA RECENTLY CLOSED TWO DEALS TO FINANCE THE CONSTRUCTION OF AN 830KM PIPELINE CORRIDOR FROM CHIHUAHUA TO GUADALAJARA, IN SOUTHERN MEXICO. THE US$1.1BN COMBINED TRANSACTIONS FOR THE TWO PIPELINE SEGMENTS REPRESENT ONE OF THE LARGEST ENERGY INFRASTRUCTURE DEALS TO CLOSE IN THE REGION THIS YEAR. BY TONY RIVERA, DIRECTOR, NATURAL RESOURCES LATAM GROUP, AND RICHARD ENNIS, MANAGING DIRECTOR, ING CAPITAL.

Mexican pipeline and energy infrastructure company Fermaca is currently developing a 2,100km network of natural gas pipelines connecting the Permian Basin in south-west Texas to the energy markets across Mexico.

In October, the company closed two innovative financings to back construction of a pair of pipeline segments – the 451km La Laguna–Aguascalientes pipeline and the 379km Villa de Reyes–Aguascalientes–Guadalajara pipeline.

Valued at US$1.1bn combined, these are some of the biggest energy infrastructure deals to come to market in the region so far in 2016. At 48 inches in diameter, the La Laguna–Aguascalientes pipeline will be the largest natural gas pipeline in Mexico.

Deal structureThe US$622m financing for the La Laguna–Aguascalientes pipeline closed in early October and the US$435m financing for the Villa de Reyes–Aguascalientes–Guadalajara pipeline closed in mid-November. The deals are almost identical in structure and terms; they are both priced at a notch below Libor plus 200bp, and with step-ups come in at just under Libor plus 300bp. Both deals have a tenor of construction plus seven years and a construction period of up to two years.

Leverage sits at around 75% for both transactions, equity at 25% – although the Villa de Reyes–Aguascalientes–Guadalajara deal is slightly less leveraged. ING served as coordinating lead arranger, documentation agent and swap coordinator for the two deals.

ING has been active in pipeline financing for a number of years and active in Mexico

since 1975. Fermaca first engaged the bank to help on bidding into various tenders before continuing that relationship and mandating the bank as co-lead arranger on the financing for both its Tarahumara and El Encino pipeline projects, which closed in 2012 and 2015, respectively.

On the La Laguna–Aguascalientes pipeline financing, ING, BNP Paribas, Banco Santander, Natixis, KfW, Sabadell, Mizuho, NordLB and Intesa Sanpaolo were joint lead arrangers.

On the Villa de Reyes–Aguascalientes–Guadalajara pipeline financing Korea Development Bank joined the lending club. For both deals, Mizuho was administrative agent, BNP Paribas and NordLB acted as syndication banks, and Mexican development bank Banobras provided a VAT facility. Legal counsel on both transactions was provided by Latham & Watkins, borrower’s counsel, Galicia, borrower’s local counsel, Milbank, lenders’ counsel and Ritch Mueller, lenders’ local counsel.

The company is confident that within approximately five to seven years it will be able to refinance in the bond market at a rate that works for the tariff

Fermaca chairman Fernando Calvillo

FERMACA

One key challenge with the deals is the refinancing risk. However, the lenders were able to get comfortable given Fermaca’s track record and proven access to the bond market. Fermaca successfully refinanced its Tarahumara transaction via the bond market.

The company is confident that within approximately five to seven years it will be able to refinance in the bond market at a rate that works for the tariff structure and return on equity. This market traction helped broaden the liquidity Fermaca could attract vis-à-vis the bank markets.

ING structured swaps with multiple tranches that were designed to cover the full length of the underlying, 25-year offtake contract with the Comision Federal de Electricidad (CFE), Mexico’s Federal Electricity Commission, and cover the bond refinancing period.

Connecting Mexico with the Permian BasinThe two new pipelines, which are slated to begin operation in early 2018, will build on the network created by Fermaca’s existing pipelines – Roadrunner, Tarahumara and El Encino. The Roadrunner line, a joint venture between Fermaca and Oklahoma’s ONEOK Partners, runs from El Paso, Texas to the heart of the Permian shale fields.

The Tarahumara line connects with the Roadrunner line at a US/Mexico border crossing near San Elizario, Texas, and runs to Chihuahua in north central Mexico. The new pipelines will extend that network from Chihuahua to Guadalajara, just outside Mexico

City. Once completed, the Fermaca network of pipelines will be capable of importing 1.2bn cubic feet per day – which is equivalent to 20% of Mexico’s projected gas imports.

The 25-year concession to build, operate and maintain the newest gas pipelines was awarded to Fermaca by the CFE in March 2016. Fermaca beat larger competitors to win the mandates for the pipeline corridor. The CFE offtake contracts are structured as capacity tolling arrangements. As such, neither the lenders nor sponsor assume gas volume or gas price risk.

Market dynamicsWhen structuring the deals, Fermaca faced a different market than it had on the El Encino–La Laguna financing in 2015. In 2016, the market was being challenged by low commodity prices putting pressure on many lenders’ oil and gas portfolios, and the cost of funds was going up.

As a result, ING recommended that the pipeline operator cast a wider net this time around for its lending group, rather than stick to a five-to-six-bank lending club. Ultimately,

Another challenging market factor involved deal tenor. In 2013 and 2014, a number of long-tenor transactions had come to market

The pipe

Reproduced from Project Finance International Yearbook 2017 © Thomson Reuters

FERMACA

nine banks joined the lending group for the October financing, and 10 lenders participated in the November deal.

Another challenging market factor involved deal tenor. In 2013 and 2014, a number of long-tenor transactions had come to market –some as long as 18 to 20 years. But tenors also started to come under pressure late in 2015, and that continued into this year, when these deals were being put together.

The goal was to build in some flexibility to ensure that Fermaca could time the bond market appropriately for refinancing. The tenor of construction-plus-seven provides Fermaca with a sufficient runway to find a good exit point.

Right of wayOne of the key challenges was managing right of way. As is clear with some of the debates going on in the US right now, right of way is always a critical issue with any pipeline project. For the La Laguna–Aguascalientes and the Villa de Reyes–Aguascalientes–Guadalajara lines, there were more than 1,000 landowners to work with on each of the projects, compared with roughly 300 landowners on the El Encino–La Laguna deal.

The much-heavier concentration of landowners is in part why the deals needed to incorporate some flexibility. Consequently, the threshold of negotiated rights of way was lower than in the previous transactions. With the greater number of lenders involved in the financings – a number of the banks in the lending clubs were doing their first transaction with Fermaca in Mexico – it also meant getting them comfortable with the company’s ability to successfully manage that process.

Fermaca has done a very good job working with landowners and negotiating rights of way. Having worked with the pipeline operator on previous projects, and as coordinating lead arranger, ING was able to reassure other lenders that although there would be a lower threshold of rights of ways at closing, Fermaca had the experience and track record to be able to execute on the scheduled acquisition plan.

Fermaca and the Mexican marketFermaca is one of the largest pipeline owners in Mexico. Along with other energy and engineering projects, the company also owns and operates a pipeline in the Palmillas-Toluca

region, in central Mexico. Founded by Fernando and Manuel Calvillo, Fermaca is now majority owned by Swiss private equity firm Partners Group, which acquired a majority stake in February 2014. Abu Dhabi’s sovereign wealth fund, Mubadala Development Company, and Fermaca’s management team also own stakes in the pipeline operator.

Changes in Mexico’s energy sector have progressed rapidly since the country’s Congress approved constitutional amendments opening the hydrocarbon sector to private participation in 2013. A number of laws and legislative revisions (Leyes Secundarias) were enacted the following year, but it was after governmental agencies began implementing underlying regulation in 2015 that Mexican, and global, firms were able analyse the market, market risk and opportunities.

When the CRE launched its Midstream Regulations for storage and transportation facility operators last year, it levelled the playing field between state-owned and private companies – both international and Mexican.

In the gas pipeline space, Fermaca has been a key beneficiary of these market changes. The energy infrastructure company, which has rapidly evolved into one of the largest in Mexico, now owns and operates a key transmission system connecting the Mexican and US energy markets.

With the large pipeline infrastructure in place, secondary network and gas storage may be the next big area of development in the midstream sector, while the power sector is also expected to see a surge in project development. Mexico is keen to ensure its growing energy needs are secure in the decades to come. Watch this space. n

Fermaca CEO and executive vice president Manuel Calvillo

The goal was to build in some flexibility to ensure that Fermaca could time the bond market appropriately for refinancing

Reproduced from Project Finance International Yearbook 2017 © Thomson Reuters