Jim McBride, managing director for Royal Bank of Scotland in Houston.

While most chatter has been about equity funding of upstream MLPs, the debt market is continuing to show up with a wide variety of capital offerings. MLPs pay cash distributions to unit-holders, and debt capital can be less expensive.

“Financing MLPs is attractive to banks due to the cash-flow-generating nature of their assets,” says Jim McBride, managing director and co-head of structured oil and gas finance in Royal Bank of Scotland’s Houston energy office.

The challenge is that most of the cash flow goes out to the investors in the form of distributions. “Successful MLPs require good management teams to put the right level of debt on the asset without overleveraging them. They must always maintain, and more importantly, grow their distributions. We typically finance MLP transactions with senior debt,” he says.

RBS has provided and arranged debt for upstream MLPs Abraxas Energy Partners LP, Linn Energy LLC, Atlas Energy Resources LLC and BreitBurn Energy Partners LP. Its midstream MLP clients include Enterprise Products Partners LP, Kinder Morgan Energy Partners and Quicksilver Resources Partners LP. It has also arranged debt capital for midstream/upstream MLP Eagle Rock Energy Partners.

Quicksilver Gas Resources owns and operates Cowtown Pipeline, which gathers and delivers natural gas in the prolific Barnett Shale play. RBS was a co-agent of the credit facility.

“Generally speaking, if an MLP is investment grade, we lend to it on an unsecured basis. If it is not investment grade, we lend to it on a secured basis, using the properties as security.”

Long-term debt can also be an appropriate financing structure for an MLP. In June, RBS was joint book-runner on Kinder Morgan Energy Partners’ $550-million, 30-year note issuance. In August, it was a book-runner on Enterprise Products’ $800-million, 10-year notes. In September, it went back to the market with a $600-million, 30-year note issuance for Oneok Partners.

Funding via PIPE (private investment in public equity) offerings has been a popular source of capital to MLPs, says Chris Miller, managing director and co-head of Citibank Corp.’s global energy group.

Citibank worked with Constellation Energy Partners LLC, BreitBurn and Vanguard Natural Resources LLC during their 2007 IPOs. The bank also underwrote three PIPE issuances for Linn Energy LLC and one each for BreitBurn and Constellation.

“In 2006 and 2007, we saw a lot of PIPE issuance,” says Miller. “There is a large amount of PIPE equity coming into the market, relative to the size of the public float, meaning those securities that are already registered and are trading. The combination of a small public float, and a small trading volume, combined with more equity coming to the market, has somewhat depressed the unit prices of some MLPs.”

Investors are concerned about the overhang of units and when that PIPE equity will be sold into the market. “My view is that this is a temporary phenomenon. Yes, there is a significant amount of equity that is working its way into the market and will become freely tradable within a six- to nine-month period, but the model is still intact. It’s a technical issue,” Miller says.

Investors in this type of unit are usually long-term holders who understand the overhang and appreciate that there is going to be some temporary volatility. “There is nothing wrong with the model, and obviously commodity prices are still extremely strong. Most of the investors holding illiquid PIPEs are not really in the mood to buy more of that paper at the moment. However, they may be in the market for more freely tradable registered units,” he says.

Many MLPS have filed shelf registrations now to make public unit offerings. “I think we are going to see that, while the PIPE phenomenon was really strong in 2007, most of these companies will now go back to traditional markets and raise capital via a public offering of registered shelf units in 2008 and later.

“We are getting back to normal issuance methods. After the market digests this round of equity coming into registration and into public markets, there should be room for new MLPS to make a market for PIPE issuance again, perhaps at the end of 2008,” says Miller.

Other deals

Most MLP debt has been provided by institutions and private capital. Miller expects some high-yield public debt to enter the market in the near future.

Accessing debt capital is helped when the lender already has an understanding of the valuation and assets of the MLP’s parent or general partner.

Such a relationship is exemplified by the Citibank-Williams Partners LP deal, says Catherine Ozdogan, a partner in Houston-based law firm Bracewell & Giuliani LP, which has represented both MLP borrowers and lead arrangers.

Bracewell & Giuliani represented Citibank in the $450-million senior investment-grade unsecured revolving and term-loan credit facility for Tulsa-based Williams Partners that closed in December 2007. Williams Partners was formed in 2005 by The Williams Cos., had closed a senior note issuance earlier in 2007, and held some operating assets.

“The MLP entered the credit facility to finance the acquisition of some additional assets from its parent company. The credit facility consists of a revolving credit and term-loan facility. That facility did not take long at all to put in place, in part because Williams had such a strong working relationship with Citibank and by the fact that the MLP had already been formed. That deal probably took only a couple of months, start to finish,” says Ozdogan.

If an outside bank has extensive experience in understanding and funding MLPs, this can override an existing lender relationship. It can also accelerate deal timing.

The firm represented Targa Resources Partners LP in its $750-million senior revolving credit facility, a non-investment-grade secured financing that was closed in February 2007. The Targa MLP was formed by Targa Resources Inc., a Warburg Pincus-sponsored entity based in Houston.

Ozdogan worked with Targa during its initial bid process in mid-November 2006 and represented the company in meetings with several banks in early December 2006.

“I’ve seen instances in which an MLP’s parent company uses the same bank with which it has a prior relationship, but that is not always the case,” she says. “In the Targa transaction, Targa ultimately chose Bank of America, partly because it has a proven track record with MLP financing.”

Targa filed its S-1 in mid-December 2006 and was able to get the company formed, do the initial public offering and close the financing in mid-February 2007. “That deal was worked within a very tight deadline,” she says.

Bracewell & Giuliani is currently representing Citibank in connection with a $2.2-billion debt financing for Anadarko Petroleum Corp.’s newly formed midstream MLP, Western Gas Partners LP. The financing was expected to close at year-end 2007.

The firm also represented El Paso Corp. during its recent drop-down of assets into an MLP, El Paso Pipeline Partners LP, and its related $1-billion senior unsecured revolving credit facility.

Ozdogan says the recent credit crunch caused by the subprime mortgage crisis doesn’t seem to be a problem for MLP financing. “During the past year I didn’t see any problems with lending syndications or dramatic changes in interest rates.”

Are more MLP formations to come? “I have noticed that some of my E&P clients are definitely contemplating forming an MLP in the future. When they are doing acquisitions, they are structuring them in such a way that, if they did form an MLP later, the acquired assets are already in a structure that is ready to be dropped down.” M