Russia’s only true project finance deal to date, Severtek – a joint venture between Lukoil and Finland’s Fortum – stands as a barometer for future deals of this nature.

Severtek is Russia’s first and only project financed deal in the strict sense of the term. Breaking new ground and working with nervous bankers, it should have been a difficult deal to cut, yet it sailed over all the hurdles and only took a year to go from an in-principle agreement to cash arriving in the bank.

The two joint venture partners, Russian oil major Lukoil and Finnish oil and gas company Fortum, own half each of Severtek, a separate legal entity that holds the licence to develop the south Shapkino field in Nenets region of Komi Republic and part of the oil-rich Timon Pechora deposits just inside the Arctic Circle. It is a text book candidate for project financing.

The idea to raise money on the basis of project financing was first brought to the European Bank for Reconstruction and Development (EBRD) in 1997 by Elf Aquitain, which was then the foreign partner. However, following the 1998 financial crisis, Elf withdrew and Fortum bought its stake in 1999. Lukoil bought Komitek, Elf’s local partner, at about the same time. Led by Fortum, the new team went back to the EBRD in May 2001 to revive the idea of securing project financing to develop the deposit.


The two sponsors estimated they would need to invest a total of $355m and contributed $155m between them in equity, turning to the EBRD for help in arranging the rest. The EBRD gave the go ahead to start its due diligence in June and all the documentation, including an environment audit, was completed by October 2001. By the end of the year, the EBRD had agreed to grant two loans of $100m each, at which point the commercial banks were approached.

HypoVereinsbank (HVB) agreed to underwrite one of the $100m loans early in 2002 and supplementary due diligence for the banks to which this loan was syndicated began. When HVB put one of the two EBRD-backed $100m credits up for syndication in June 2002, the offer was oversubscribed.

“On the face of it, this deal should have been difficult but there were a lot of mitigating circumstances,” says Paul Shapiro, a senior banker at the EBRD who worked on the deal. “Fortum has a strategic interest in getting out of the North Sea and expanding in Russia while Lukoil has a long list of projects in Russia that it wants to finance and so will be careful to make sure this one works. Take all the factors together and it starts to look like a good story.”

Favourable factors

The set of circumstance that contributed to the success of the deal are unlikely to occur together again. The biggest problem that Russian oil and gas projects face is how to get the product to market and generate the cashflows that are supposed to pay everyone back.

“Project finance is always difficult because you have to rely on the cashflow of something that has not been built yet,” says Mr Shapiro. “It means you are offering an unsecured credit to your sponsors. There are no Russian companies that have unsecured credits so just accepting a Russian company’s guarantee is already a difficult step.”

Severtek went into the fundraising process without arranging off-take contracts for the eventual production. However, the project is almost unique in Russia because the oil and gas deposit sits a few hundred miles from the border. Most oil fields are located in the remote interior and rely on allocations of limited pipeline capacity from the state-owned pipeline monopoly Transneft – typically 30%-35% of production – but as there are no export quotas on rail, Severtek can easily export all of its production.

Commercial sponsor

The second factor in Severtek’s favour is the involvement of Lukoil, at the time the biggest oil company in the country (it has since been overshadowed by the creation of YukosSibneft in April).

“The bigger the company, the more room for commercial involvement there is in a deal,” says Martin Wuerth, head of oil and gas and global project finance at HVB, who represented the bank in thrashing out the details. “The market still believes that the smaller sponsors don’t have enough political clout for them to carry a project financing deal on their own.”

By itself Lukoil’s participation would not have been enough to assuage creditors’ fears. However, the sponsors’ agreement to guarantee the completion of construction until the project is producing oil removes one of the biggest risks to creditors, so the latter only shoulder the risks once the project is making money.

“With Lukoil’s involvement, you have a good name that already goes a long way. But is it still hard for a Western bank to offer an unsecured loan on this basis,” says Mr Shapiro. “What are uncompleted assets in Russia worth? And this is assuming that you are confident that the courts will hand the assets over in the first place. However, with a completion guarantee, most of these worries fall away.”

Making history

Severtek also made history by being the first joint venture with foreign participation formed on the basis of just the production licence. All the other large oil joint ventures were set up on the basis of production sharing agreements (PSAs) that set the terms and taxes in stone.

Although the project is exposed to changes in the tax code, Mr Wuerth argues that the lack of a PSA made it easier to cut the deal. PSAs may increase the stability and predictability of a project but they come at a price: a sea of red tape. Mr Wuerth says the lack of a PSA sets the regulatory hurdles lower.

The EBRD’s involvement was crucial. Mr Shapiro says that creditors are mainly concerned with currency convertibility and transfer risks, in addition to the risk of confiscation or punitive taxes. However, the Russian government is one of the EBRD’s shareholders and signed its charter, promising to respect the bank’s operations in Russia and not to interfere in projects. In itself, the EBRD’s involvement cannot prevent problems developing with the local administrations but, without more judicial reform, the participation of an agency with real political clout is still considered an essential part of project financing.

“The legal system is what it is and there are still political risks in doing business in Russia,” says Mr Wuerth. “All these kinds of deals need multilateral support at this point.”


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