Russian companies are starting to turn to project financing as a way to develop attractive assets, but the high cost, long lead times, complexity of the deals, and a growing lake of petrodollars in the economy mean that the number of deals can still be counted on one hand.
Last year saw Russia’s first successful project financing deal. The project company SeverTEK was set up as a joint venture between Russian oil major LUKoil and Finnish oil and gas company Fortum to develop the south Shapkino oil field in the Nenets region of Komi Republic and part of the oil rich Timon Pechora deposits. Several hundreds of millions of dollars were raised to pay for the construction of the mine and put the project into production. The European Bank for Reconstruction and Development (EBRD) played a key role in arranging the deal, which has gone very smoothly.
All Russia’s project financing deals so far have been in the natural resources sector and, this year, at least three more deals are in the process of being organised. Bankers were hoping that SeverTEK’s success would open the floodgates to a string of projects.
“Project financing is made hard by the lack of experience in the Russian market, but SeverTEK showed that it can be done,” says Marc Polonsky, a lawyer with White & Case in Moscow. “Despite the fact that the logistics of the project were not in place [at the time of signing], it went smoothly. Everyone expected there would be a flood of project financing deals to follow, but it has not happened.”
Mr Polonsky says that part of the reason is that record high commodity prices means Russia’s natural resource producers are wallowing in cash and can pay for most investments out of their pocket.
“The high oil prices mean that the oil majors are very cash-rich, so they don’t need to borrow as they don’t need to improve their cash situation by going through a complex and expensive project financing,” says Mr Polonsky.
With low demand for these kinds of deals, the EBRD has been left carrying the project-financing baton, as much for its development value as for commercial reasons, and commercial banks are leaving the running to the international financial institutions such as the EBRD and the International Finance Corporation (IFC), the commercial arm of the World Bank.
“None of the big international commercial banks have bothered to build up project finance teams in Russia. They have the experience but they don’t have people on the ground and it takes time to get to know your borrowers,” says Mr Polonsky. “On the other hand, the EBRD and IFC have been very active and they have the resources to do it.”
Metal project financing
But a few more project financing deals are in the pipeline. Furthest advanced is a plan by Russia’s second largest aluminium producer, SUAL, to develop bauxite deposits in the Komi Republic.
At the start of August, SUAL signed an agreement with the EBRD and IFC, which will provide a nine-year $150m loan – the longest ever credit to a metallurgical company – to build the bauxite mine and start the preparatory work for a refinery to produce alumna (an intermediary product) and an aluminium smelter.
“EBRD and IFC have split the loan 50-50 for the bauxite mine, as neither side wanted to finance the other. The loan was then syndicated to five commercial banks for $12m each,” says Andrey Ryjenko, a senior banker at the EBRD, who worked on the deal.
The syndicated portion of the loans mature after a shorter seven years with a margin of 3.25% over LIBOR.
The Komi project has been relatively simple to organise as the mining licences were owned by the Timan bauxite mine, in effect, a ready-made project finance company, or special purpose vehicle (SPV), which is the foundation of any project financing deal.
And the creditors can be more than confident that the project will produce a cashflow from which the debt can be repaid, as the mine is already producing roughly 600,000 tonnes of bauxite a year. The plan is to increase this to 1m tonnes a year. Even so, the EBRD and IFC has insisted that SUAL provides extensive construction completion guarantees for the mine’s expansion.
“We started work about three years ago and it was very clear that the company was at an early state in organising itself and deciding what it wanted to do. The plans are still not complete as the feasibility study for the refinery and smelter are expected next year,” says Mr Ryjenko.
Two-thirds of the loan will go on expanding the bauxite mine while another $50m is earmarked for clearing the site and doing the feasibility studies for the refinery and the smelter. The financing for these two plants will be organised once this work is finished.
The Asacha gold mine project is following closely on the heels of the SUAL deal. Also, in August, the London subsidiary of Standard Bank and the EBRD announced they had been mandated by Trans-Siberian Gold (TSG) to raise $30m to develop the Asacha in the Kamchatka Region in Russia’s Far East.
TSG was established in 2000 and already holds licences to develop the Rodnikova gold deposits in Kamchatka as well as the Veduga gold deposits in the Krasnoyarsk Region. The two banks are currently conducting their due diligence for the Asacha mine, which is supposed to be finished by the start of September.
“If everything goes well with the due diligence, then it will move to the document phase in September. It is hard to say how long this will take. SeverTEK took a year to organise but this could take less,” says Mr Polonsky, who is working on the deal.
Oil/gas project financing
Mines are relatively cheap to build, but Russia’s oil and gas companies are also looking to tap project finance as a source of funding and hope to raise billions instead of millions.
The Sakhalin Energy project is the closest to signing off on a deal, which promises to be the single biggest investment ever into Russia. A consortium of international companies – Japanese trading houses Mitsui and Co Ltd has a 25% stake, Mitsubishi Corporation another 20% and operator Royal Dutch/Shell holds the rest – has already started developing natural gas resources off the island of Sakhalin in Russia’s Far East.
The first drilling platform went into operation in July 1999, and another two are planned for this year. In addition, the holding company Sakhalin Energy plans to build Russia’s first ever liquid natural gas (LNG) plant, which will allow gas to be shipped by tanker and reach markets in Japan, south-east Asia and on the west coast of America.
The sums involved are huge but lawyers are optimistic a deal can be struck by next year. Lawyers say the basic terms have already been drawn up and negotiations are ongoing with half a dozen banks that will provide the lead financing – the last round of talks before the project financing documents are drawn up that set the form of the project company and its obligations in stone. “We are looking to raise in the order of $5bn and we are negotiating with a group of possible lenders,” says Michael Clark, Sakhalin Energy’s spokesman. “We hope to close the deal by next year.”
The consortium has already committed about $1.5bn of its own money to get things going and is now trying to raise more to start phase two, which includes the construction of the LNG plant. In all, the project will cost “in the order of $10bn,” says Mr Clark.
The gas and oil fields under licence contain an estimated 1.2bn barrels of crude oil and 500bn cubic metres of natural gas. When the LNG plant goes online in 2007, it will produce 9.6m tonnes of liquid gas a year and both Japan and the US have already started work on terminals to receive deliveries.
Sakhalin Energy has managed to avoid many of the pitfalls hindering project financing in Russia. The company is actually registered in Bermuda so creditors are not subject to the vagaries of Russian courts or the unpredictable interpretations of law, should something go wrong (see pages 78-79). And the project is being developed under one of the few remaining production sharing agreements, which lock in the government’s tax and royalty obligations, removing another area of uncertainty.
Hopes to project finance Sakhalin V, another project on the oil and gas-rich island, are going more slowly. BP signed an agreement with state-owned Russian oil major Rosneft in the summer to develop the bloc that is thought to contain 800m tonnes of oil and 600bn cubic metres of natural gas. Currently, Rosneft’s wholly owned subsidiary Elvarineftegaz is licensed to develop the field and has already invested roughly $3bn. This deal is still at a preliminary stage, but both companies have said they want to develop it using project financing and would contribute about one-third of the needed financing apiece.
More deals could be in the works for next year, particularly if international commodities come off their record highs. In July, Gazprom’s board of directors met and announced that the company planned to make more use of project financing as a way of increasing the number of developments, improving the supervision of quality of investments and raising fresh investment capital.
Already labouring under about $13bn of debt, Gazprom is one of the few Russian companies in the natural resource sector that is not flush with cash especially as the government has been holding down tariff increases in an effort to keep inflation in check. The company is, if not short of money, at least thinking hard about the most effective way to finance its slate of huge and expensive investment projects.
The biggest of Gazprom’s projects is a plan to build the north European gas pipeline between Vyborg in north-west Russia to the coast of Germany via the Baltic Sea with extension to the UK, at an estimated cost of between $5bn and $15bn.
Dresdner Bank was engaged in February to be one of the financial consultants on setting up project financing for the pipeline and while law firms have been approached to do some preparatory work, they say that no progress has been made, partly as the result of political wrangling over the need for the pipe. Also the route has not been settled.
“The attraction of project financing to Russian companies is the long-term financing as well as reducing the liabilities at a corporate level,” says the EBRD’s Mr Ryjenko. “We won’t see an explosion of project financing but it is playing an increasingly important role in a number of cases.”
