The drive to do Russian deals is stronger than western qualms about the state muscling back into the hydrocarbons sector, and that's being proved – again – at the Sakhalin II natural gas project. The second-stage financing package, now worth $6.7 billion, is set for completion in the first quarter of 2008 ... despite misgivings about the way Gazprom took a majority share.

Commercial banks will stump up most of the funding originally pencilled in from the EBRD, which had considered contributing up to $600 million but withdrew from the deal in April this year.

The commercial portion of about $2 billion will be syndicated by seven mandated lead arrangers: ABN Amro, BNP Paribas, the Royal Bank of Scotland, ING, Bank of Tokyo Mitsubishi UFJ, Mizuho and Sumitomo Mitsui Banking Corporation Europe.

The Japanese Bank for International Cooperation (JBIC) will provide $3.7 billion, and export credit agencies including US Eximbank and the ECGD of the UK about $1 billion. Full repayment is scheduled for December 2020.
Gazprom's purchase in December 2006 of 50% plus one share of Sakhalin Energy, the project company, left Shell with 27.5%, Mitsui with 12.5% and Mitsubishi with 10%. It followed pressure on Shell, the operator, over rising costs and environmental issues, perceived by many western observers saw as unfair government pressure.

Disenchantment in the increasingly assertive Kremlin with the terms of the production sharing agreement (PSA) signed in 1993 was also a factor.

The EBRD was reticent about the reasons for its withdrawal, but it appeared to reflect European political disapproval with the Russian authorities' actions.

The project financing, which has been underway since 2003, was reviewed by the new majority owners along with the project's strategy. And in spite of poor external conditions created by the liquidity squeeze, bank consensus is that the deal is now "ready to go" in Q1 2008.

After the early stages, during which the sponsors will provide completion support with political-risk carve outs, the facility will become a pure non-recourse deal. The only major issue to be resolved is pricing given the US-spawned liquidity crunch – although lending risk will be offset by liquefied natural gas (LNG) sales contracts with offtakers, mostly in Japan and the west coast of the US.

Russian majors

Over the long term, the biggest lending prizes are expected from Russia's twin colossi, Gazprom and Rosneft. Other companies controlled by the state (such as Transneft, the pipeline monopoly, and Tatneft) or coveted by it (TNK BP) are promising too.

The Gazprom-controlled North Stream pipeline, which will bring Russian gas to northern Europe, is already the subject of discussion with a group of European banks headed by ABN Amro.

Nord Stream, the project company owned 51% by Gazprom and 24.5% each by BASF and E.ON, last month [November] made its first substantial spending decision, signing a Eu1 billion contract with Europipe to supply 75% of the steel pipe needed for the pipeline. The remainder of pipes for the project will come from the Russian pipe producer TMK.

Over the longer term, Gazprom may also opt for off-balance-sheet finance for the Shtokman project in the Barents Sea, for which it has now selected Total and StatoilHydro as partners, and the South Stream pipeline project on which Gazprom is working with Eni of Italy.

There are also suggestions that foreign partners may also be brought into the Yamal peninsula development, the only gas field big enough to replace the now declining fields in Gazprom's west Siberian heartland.

Previously, Gazprom had planned to develop Yamal on its own. But last month industry minister Viktor Khristenko came out of a high-level meeting with Dutch businessmen, including representatives of Shell, and said that a Russian-Dutch working group would be set up to discuss the development of Yamal.

Gazprom's model for upstream cooperation with foreign companies is the Achimgaz joint venture with Wintershall, a BASF subsidiary, which is developing deep horizons in the Urengoi field in western Siberia. Production wells drilled last year are now being tested. Another western Siberian field, Yuzhno Russkoe, is operated by a joint venture company of which BASF acquired 25% minus one share in October. Gazprom continues to haggle with E.ON on the terms of an asset swap agreement by which it will join in.

Rosneft in East Asia

Rosneft's joint ventures are focused on the East Asian market. As well as participating in the Sakhalin III, Sakhalin IV and Sakhalin V projects, all at early stages of development, Rosneft has signed a joint financing agreement with the Korean National Oil Company to explore the West Kamchatka shelf.

In east Siberia, Rosneft won at auction in July licences for the Zapadno-Chonsky and Verkhneichersky fields via Vostok Energy (Rosneft 51%, CNPC of China 49%). Nearby, Rosneft is developing the Verkhnechonsk field under a cooperation agreement with TNK-BP. That project (where there are reserves of 200 million tonnes of oil and up to 100 bcm of gas), and TNK-BP's own development of the smaller Uvat field (rseerves of 60 million tonnes), will account for many of the $2 billion worth of steel pipes that TNK-BP ordered from TMK this month [December].

Central to the east Siberian development is the East Siberia-Pacific Ocean (ESPO) pipeline, being built by the state oil pipeline monopoly Transneft, which is scheduled to take 1.8 million tonnes of oil to China in 2008, rising to 9.8 million tonnes in 2009.

To finance the pipeline, Transneft has issued more than $2.5 billion worth of eurobonds this year: a $1.3 billion seven-year tranche with a coupon of 5.67% in March, followed by $500 million and Eu700 million tranches, paying 6.103% and 5.381% respectively, in June.

Those amounts are in addition to bank debt from Sberbank, Russia's largest, under a framework agreement for up to 65 billion rubles of debt between 2006 and 2012. In November 2006 the company drew down a 15 billion ruble, seven-year loan under this deal, and in June 2007 took a further 6.2 billion ruble, one-year loan.

Russia's first greenfield oil refinery construction project since 1983 – a 7 million tpa refinery, plus conversion complex and petrochemical plant at Nizhnekamsk, Tatarstan, where work began in 2005 and is scheduled for completion in 2011 – is also poised for a big project finance deal.

BNP Paribas, financial adviser and mandated lead arranger, is expected to sew up the $2 billion financing in the next month. The sponsors are Tatneft, Sviazinvestneftekhim and the International Petrochemical Growth Fund. External infrastructure costs of about 16 billion rubles will be met from the Russian state investment fund.

Russian minors

As Russia's giant vertically-integrated companies struggle to keep up with the possibilities for production growth brought by historically high oil prices, independent producers have found opportunities on the industry's margins.
London stock exchange issues and loans from Russian banks may be followed by a revival of reserves-based financing, following the pattern set in other emerging markets over the last 18 months.

Urals Energy, a London-listed producer with mainly Russian owners, has in this quarter [4th quarter of 2007] received more than a billion dollars' worth of finance from state-controlled Sberbank, Russia's largest bank, which thanks to its overwhelming dominance in domestic savings has plenty of roubles to lend.

Urals Energy last month acquired 35.3% of Taas-Yuriakh Neftegazdobycha, a production company with licences in east Siberia, and took a $500 million acquisition loan, together with a $600 million development loan for Taas, from Sberbank. This was on top of a $270 million, six year loan from Sberbank earlier in the month, part of which repaid an earlier financing from Goldman Sachs.

The Taas fields will feed the ESPO pipeline and contribute to the government's strategic drive to develop eastern Siberia's hydrocarbons resources.

Imperial Energy, a 0.3 million tonnes per year producer with assets in Tomsk (Siberia) and Kazakhstan, has in contrast turned to the western markets. In March Imperial took a $200 million loan from ABN Amro priced at Libor + 3.25%, with provisions for higher interest rates if certain production targets were not met.

This month [December] the company issued a $191.3 million convertible bond, with a 5.95% coupon and a 45% conversion premium – typical of the instruments being used generally to weather the liquidity squeeze.

Reserves-based lending

The next step is a reserves-based transaction, John Hamilton, Imperial's chief financial officer, said. "The reserves-based structure will work well for us, as it enables us to bring both our production and our reserves into play as collateral." The company is understood to be seeking a deal with a tenor upwards of four years.

Stephen Enderle, senior manager at Standard Bank, who works with Russian oil independents, says that during the liquidity squeeze, club-based transactions have been easier to do than syndicated loans with light covenants.
Enderle sees 2007 as "a year of two halves". In the first, "oil companies large and small sought, and obtained, financing with finer and finer margins and lighter and lighter covenants. In the second, the credit squeeze 'tightened' markets, even in countries with limited sub-prime exposure, such as Russia and Kazakhstan; borrowing from banks on the domestic market rapidly became more difficult."

Imperial Energy and Urals Energy are "notable exceptions" in being able to conclude deals, Enderle says. "Despite the gloomy backdrop of the second half of 2007, reserves-based deals remain financeable going forward – this is due to their structured nature and fundamental exposure to the underlying commodity."

The small upstream companies are destined to grow, industry observers believe, as a result of both the vertically-integrated oil giants' tendency to divest small or difficult-to-develop fields in order to cut costs, and the state's anxiety to keep increasing production.

"Once the sector's principal assets are concentrated in state hands, a large number of less profitable assets will be released", Vladimir Matias of Asset Capital Partners, an investment advisory firm specialising in Russian oil and gas, says. "The vertically integrated companies will simply not be able to invest in and manage all the assets that come to the market. Although it may sound paradoxical, consolidation will lead to better opportunities for independent players."

He points to Urals Energy's purchase of Arktikneft's assets from the giant Lukoil in 2006 as an example. A survey of recent licence auctions shows that small independents are picking up assets that the large state companies simply don't want, Mathias adds.

"In these circumstances, we can expect to see reserves-based financing with limited recourse used as 'project finance lite' for smaller upstream players." This market for smaller borrowers should be every bit as busy in 2008 as the one for mega project deals.